What Western supply and Asian demand mean for gold: Brien Lundin

Brien Lundin: You’re absolutely right, and it’s all based on the metals markets. In a typical year, the precious metals markets bottom out at the end of July to early August, when physical demand from Asia abates, before kicking back up in late August and September.

This year, gold bottomed out in a final downward thrust at the end of June and then started building back up. At the same time, a lot of anecdotal evidence began to reveal an extremely tight supply situation in the global gold market. Taking all of that together, I was fairly confident in calling a bottom for gold.

Then, the equities started to respond. However, the situation in Syria prompted some safe-haven demand in the last few days and the mining equities stepped back; with safe-haven demand, investors want the metal, not the paper. But that was just a brief blip. I see an open road ahead for gold metal and gold equities.

TGR: Gold is moving higher, but without much of an explanation. What is your take on the situation?

BL: The market has had some strong performance, jumping $15, $25, even $35 in a day. I think those spikes are a result of the extremely tight demand situation in the gold market. In the spring, Western speculators and some of the big holders of SPDR Gold Trust (GLD), the gold exchange-traded fund (ETF), abandoned the market in anticipation of the imminent end of quantitative easing (QE). We also had some manipulation, notably on April 12 and April 15, in a blatant attempt to force the market through sell stops, thus benefiting from short positions. As a result of these speculative selloffs, the market was dramatically oversold.

But this rapid price decline sparked tremendous bargain hunting in Asia. Asian demand more than overcame the selling by Western speculators. The supplies of gold in the Comex warehouses dropped to record low levels. We saw gold being transferred from vaults in the West to the East, causing the rare occurrence of a negative Gold Forward Offered (GOFO) rate—the interest rate difference between gold holdings and LIBOR. That has happened only twice in this bull market, at the beginning of the major bull trend around 2000, and in 2008. Both times it marked a major turnaround in the metal.

There is a lot of evidence that this unprecedented supply situation was behind the sharp, brief upward spikes in the gold price. As you add up these sharp spikes, gold was gradually and then more rapidly coming off that bottom in late June.

There are number of players in the East who want gold and are willing to pay higher prices. There also is a shortage of gold in the West. From a fundamental supply-demand standpoint, we still have some room to go in this oversold rebound.

TGR: Could you expand on why you believe China will soon be “driving the bus” for the global gold market?

BL: The Shanghai Gold Exchange (SGE), putatively a futures exchange, is actually a physical delivery mechanism for the Chinese market. Most of the gold traded on the SGE is actually delivered to end-users. As of the end of June, SGE reported nearly 1,100 tons of gold have been traded so far this year. That equates to all of the metal that had been traded on the SGE in 2012, which itself was a record year.

Put another way, at this rate of consumption, demand on the SGE this year will equal the entire newly mined global output projected for 2013. In effect, all of the new gold supply in the world is being consumed by a single exchange in a single nation.

China will soon exceed India as the largest source of gold demand in the world. There are demographic factors behind this: a deep cultural affinity for gold, a growing population and a rapidly growing middle class. The per-capita use for gold in China is still relatively low but has a lot of upside. As incomes grow in China, gold demand will grow on a per-capita basis even as the population grows. The potential for growth in the demand for gold is almost exponential.

TGR: Who in China is buying gold?

BL: The assumption is that the People’s Bank of China is buying gold to build up the nation’s gold reserves. China also has become the world’s largest gold producer, yet none of the gold it produces ever gets exported.

There is tremendous upside potential in central bank buying of gold in China, in that China holds a huge amount of U.S. dollars in its foreign currency reserves. If it were to increase its gold reserves to the average level of most developed nations, it would quickly absorb all of the available metal in the global gold market.

TGR: Would the gold price be on an even stronger upward trajectory if India hadn’t taken measures to curb gold buying?

BL: Yes, Indian demand would have been much stronger if its central bank hadn’t increased the tariff in phases to 10%. Just as importantly, it imposed an 80/20 rule, which requires that 20% of all of the gold imported into India must be subsequently exported as finished goods. Those rules, imposed without explanation of how to follow them, effectively shut down Indian gold imports from the end of July through the end of August.

TGR: You recently wrote “Gold has bottomed. The market is set up for a large sharp rally when and if a short covering stampede is sparked.” What could those sparks be?

BL: One appears to be the situation in Syria, although we don’t know how that will develop.

“I see an open road ahead for gold metal and gold equities.”

A more important and fundamental driver for a short-covering rally would be the flow of economic data in the U.S., where economic growth had been showing signs recently of slowing. That slowdown, if it were confirmed, would eliminate any justification for tapering off the Federal Reserve’s QE program. A growing consensus that QE will be here for a while will be the driver that gets the shorts to abandon their bearish gold positions.

TGR: How does all this translate to gold equities?

BL: The majors had a fairly good rebound and were outperforming gold until the Syria situation erupted. That touched off broader equity market selloffs, and the gold stocks were victimized.

Interest is just starting to filter down to the junior resource stocks. I’m not as negative on that subsector as some of my compatriots. Greed is the most powerful motivator in the investment markets, and greed will draw investors to the juniors like iron filings to a magnet if we see a sustained upward trend in gold and silver.

TGR: What do patterns in the market trends tell you?

BL: This year the gold market has experienced a number of head fakes, where we thought we had a bottom, then it dropped to a lower plateau, then dropped again. I think the June 28 bottom will hold. The fundamental evidence argues for an extremely tight situation in the gold market, which will keep the prices from dropping to an even lower plateau.

A lot of evidence, from stochastics to moving averages, is delivering very strong buy signals. There is anecdotal technical evidence like the negative GOFO rate and backwardation in the near-term futures. All this added together points to higher gold prices and a more sustained rally.

Yet, in the broader market, sentiment is still not very positive for gold. We’re still climbing a wall of worry in regard to sentiment, yet, for those willing to look, an increasing amount of evidence is pointing toward higher prices. This is really the perfect situation.

TGR: Your newsletter reports on a host of companies. Can you tell us about some junior plays with leverage to the gold price, starting with those that have assets in safer jurisdictions like Canada and the U.S.?

BL: Safer jurisdiction is an important point. In this market, there are so many undervalued companies out there that there is no reason to take on sovereign risk if you don’t have to. As we start this rebound, it’s important to look for undervalued juniors that have proven resources or are in production. You can get them at bargain level prices, and they will be the first to respond.

I expect Brigus Gold Corp. (BRD:NYSE.MKT; BRD:TSX) to surprise a lot of people. The company spent a lot of money to upgrade its facilities and prepare for a higher production rate. Its capital expenses will therefore drop considerably going forward, while it benefits from the higher production rate.

TGR: Brigus just recently increased its guidance by 5,000 ounces (5 Koz) through the end of 2013.

BL: And the exploration potential in the Grey Fox deposit gives it a good growth profile.

TGR: Brigus’ new estimate for Grey Fox, issued in July, is up to 736 Koz. How big could Grey Fox get?

BL: It’s hard to tell, but grade is just as important as size. Its grades are so exceptional that, if Brigus were a junior, it would be the exploration story of the year. The widths are good, too. Grey Fox should generate fairly high-margin production given the richness of the mineralization. It will be significant to the company’s growth profile because of its size, and significant to its earnings profile because of the high grades.

TGR: How about some other names?

BL: A number of exploration stories in the U.S. and Canada are undervalued. Gold Standard Ventures Corp. (GSV:TSX.V; GSV:NYSE) had great exploration success in 2011 and 2012 in Nevada, then was forgotten by the market in the downturn. It has a great geological staff. I think it has narrowed down on the trend and the mineralization. The company is selling at prediscovery price levels, which I find very attractive.

TGR: Gold Standard Ventures recently raised $5 million ($5M) to continue exploring the Railroad project in Nevada. How important was that?

BL: Its ability to raise money validated its project and its upside. Any experienced, knowledgeable hand in Nevada exploration will tell you that Gold Standard Ventures is as close to a sure thing as you can find in Nevada. It’s the wise guys’ play in Nevada exploration.

Comstock Metals Ltd. (CSL:TSX.V) has a project in the Yukon that could be an analogue to the Underworld Resources Inc. discovery at Golden Saddle—the discovery that sparked the new Yukon gold rush. Recent results were mixed, but did nothing to extinguish the upside potential because it has a number of targets on the project. The question is whether the grades will be high enough over the current widths to justify development in the Yukon. I think it has a really good shot at it.

TGR: Comstock had some good results in the VG zone of the QV project. Is that the tip of the iceberg?

BL: It’s the tip of the exploration potential. It will take a bit of drilling to see if there’s an iceberg underneath. Comstock has good showings from the Shadow and Stewart zones. By no means is the potential for VG cut off at this point. The company knows where the mineralization is trending. There is plenty of potential there.

“As incomes grow in China, gold demand will grow on a per-capita basis even as the population grows. The potential for growth in the demand for gold is almost exponential.”

At this point, the company needs another phase of drilling before the season shuts down to see if it can expand the known gold zones. In my view, there is a joint venture ahead for Comstock. That would advance the project without further financial drain.

TGR: Do you have another name?

BL: Another overlooked company working in Nevada isRye Patch Gold Corp. (RPM:TSX.V; RPMGF:OTCQX). It had a great plan to develop a number of larger-scale, lower-grade satellite deposits in Nevada where, due to the infrastructure, resources can be produced in a hub-and-spoke type of an operation with a central mill.

The key with Rye Patch is its legal dispute with Coeur Mining Inc. (CDM:TSX; CDE:NYSE), in which Rye Patch restaked some claims that Coeur had let lapse. The two companies recently came to an agreement, but the agreement didn’t meet the market’s hopes of a buyout for Rye Patch. However, the agreement did give Rye Patch significant cash flow in the form of a $32M royalty on the disputed claims. This will limit dilution or will allow the company to explore with no drain on its capital resources for years to come.

The next step for Rye Patch is to prove the viability of its resources and exploration targets. It has some walking-around money and a great management team. For a junior, $32M is extraordinary. Today, the company isn’t being valued on the basis of that cash flow. Based on cash flow alone, it is a great speculative investment.

TGR: How does silver fit into what’s happening with gold?

BL: Silver is leveraged to gold. It follows the moves of gold, but it exaggerates those moves both upward and downward.

With gold rising, silver is outperforming gold—a sign of a healthy bull market. In turn, silver equities are a way for investors to leverage the moves in silver. Investors get a double-play action by investing in silver equities.

TGR: Which silver plays are you following?

BL: I like Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE) and Great Panther Silver Ltd. (GPR:TSX; GPL:NYSE.MKT). Santacruz Silver Mining Ltd. (SCZ:TSX.V; 1SZ:FSE) is a new recommendation of ours. SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) has been a very profitable recommendation for Gold Newsletter readers.

We also like Silver Standard Resources Inc. (SSO:TSX; SSRI:NASDAQ) and Silvercorp Metals Inc. (SVM:TSX; SVM:NYSE).

TGR: Do you want to expand on any of those?

BL: Santacruz made it into production at an incredibly low cost. It has laid out production plans for its three projects over the next few years. It’s a great growth story.

SilverCrest has two projects in line, is growing production and has a great management team. It offers leverage to the rising silver price and to the company’s growth.

Endeavour Silver has become much more aggressive in its acquisitions over the last year, taking over and turning around mines that other companies had trouble with. That aggressive growth strategy will pay dividends going forward.

Great Panther is a well-managed company with a number of projects under development. It is cutting costs and optimizing operations.

TGR: All of those projects are in Mexico. Are you following any Mexican gold plays?

BL: Mexico is a great mining region. I really like Cayden Resources Inc. (CYD:TSX.V; CDKNF:NASDAQ). The company has two primary projects, one in the Guerrero Gold Belt. It sold off a portion of that project—Morelos Sur—to Goldcorp Inc. (G:TSX; GG:NYSE)—and raised $15.7M in cash to fund another couple of years of exploration without any dilution.

“All the evidence is pointing toward a new rally in the metals. It’s time finally for investors to get back into the market.”

Cayden’s primary exploration project now is El Barqueňo, where it has gotten tremendous trench results over a wide-scale area. It recently received its drilling permits and will start drilling soon. That project’s potential, combined with the company’s cash position, its great management team and its relatively tight share structure, offers a lot of upside.

TGR: The Guerrero Gold Belt is one of the prime areas for gold exploration in Mexico.

BL: It is. Geophysical anomalies mark every big discovery along that belt. A number of multimillion-ounce discoveries line up along that belt like pearls on a string.

Cayden adjoins Goldcorp’s Los Filos project, one of the top two gold-producing mines in Mexico. That’s why Cayden was able to sell some of Morelos Sur and can still sell the Las Calles portion of its property, where it has already demonstrated that the mineralization extends onto its ground from Goldcorp’s operations.

Cayden also has a large geophysical target called La Magnetita, where it has only scratched the surface, so far without very positive results. Given that La Magnetita is the largest geophysical anomaly in the trend, there is still tremendous blue-sky potential there.

TGR: When will it get to drill that?

BL: It has already completed a first-pass drill program. The results indicated the right kind of mineralization, but the grades were low. La Magnetita is such a large target that it will take time and more drilling to find the deposit or kill off the potential. Right now, Cayden is focusing on El Barqueňo, which offers the near-term potential to move the company with some good drill results.

TGR: Gold Newsletter is good at getting out in front of certain companies. What are some new names that have had early success?

BL: Columbus Gold Corp. (CGT:TSX.V) is one. The company has a resource of more than 4 million ounces. People don’t seem to realize that it has upside potential and appears to be an economic project. It’s still selling for a pittance, a fraction of where it should be compared to its peer group.

You also don’t read much about Lara Exploration Ltd. (LRA:TSX.V). The company’s focus is on South America, primarily in Brazil and a bit in Peru. It is a pure prospect generator, with a superb management team that sticks to the business model. It also has a number of strong, smart shareholders, so there has not been a lot of volatility in the stock. Nonetheless, it took a downturn recently when it reported that several of its projects had been dropped by its joint venture partners. But that really is just part of the business plan; it’s a numbers game, rolling through a long list of projects in its pipeline. This is a bargain right now.

TGR: Tell us what people can expect at the New Orleans Investment Conference this November.

BL: We have a tremendous lineup, highlighted by Dr. Ron Paul, the iconic leader of the libertarian movement in the U.S. Dr. Charles Krauthammer, one of the smartest guys in geopolitical analysis out there today, and Peter Schiff, one of the smartest guys in the investment business, will be there. Other big names include Dr. Marc Faber and Dr. Benjamin Carson.

Dennis Gartman, who has made some very accurate calls on the commodities markets, and Dr. Martin Weiss, a leading authority on the bond market and rating financial institutions, are scheduled. And, of course, we have dozens of today’s top experts in every investment area.

TGR: Do you have any parting thoughts on the gold and equities space?

BL: Over the past 12 or 13 years we’ve seen a shift to a secular megatrend in the metals and commodities markets. There have been some tremendous profit opportunities along the way, including periods when junior resource stocks multiplied in value very rapidly. We’ve also seen some severe setbacks.

Right now, we’re seeing an analogue to previous periods where, with courage and cash, investors could reap tremendous gains as the metals rebound. All the evidence is pointing toward a new rally in the metals. It’s time finally for investors to get back into the market.

TGR: Brien, it’s always a pleasure to talk with you.

With a career spanning three decades in the investment markets, Brien Lundin serves as president and CEO of Jefferson Financial, a highly regarded publisher of market analyses and producer of investment-oriented events. Under the Jefferson Financial umbrella, Lundin publishes and edits Gold Newsletter, a cornerstone of precious metals advisories since 1971. He also hosts the New Orleans Investment Conference, the oldest and most respected investment event of its kind.

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DISCLOSURE: 
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Reportas an independent contractor. He 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: Brigus Gold Corp., Gold Standard Ventures Corp., Comstock Metals Ltd., Rye Patch Gold Corp., Great Panther Silver Ltd., Santacruz Silver Mining Ltd., SilverCrest Mines Inc., Silver Standard Resources Inc., Cayden Resources Inc. and Goldcorp Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Brien Lundin: I or my family own shares of the following companies mentioned in this interview: Comstock Metals Ltd., Rye Patch Gold Corp., Cayden Resources Inc. and Lara Exploration Ltd. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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