Are Gold Equities on the Cusp of an Upswing?

The Gold Report: Ron, the Federal Reserve has decided to continue quantitative easing (QE) for the foreseeable future. Gold has risen steadily since that news. Is that what you predicted the Fed would do?

Ron Struthers: It is not that hard to predict the Fed's behavior when you understand what it's trying to do and how it's trying to do it. I do not take what they say literally, except within the context of its goals. The Fed is trying to instill confidence in the economy because of massive U.S. debt and its future debt appetite. The economy needs to improve for there to be higher tax receipts. We need foreign investment to finance the debt. If the Fed can convince Americans and those abroad that its bonds are the safest/most attractive, its stock market will have the best returns and that debt machine keeps running.

But the truth is that the economy is very weak. Employment is weak. Foreign investment has been fleeing. The Fed has to purchase $85 billion of debt a month because nobody else will. The Fed can't do this forever, and it knows it. It has to talk as if the economy is improving so the Fed debt purchases can end in the near future.

If you dig into what's really going on in the economy and markets, you'll find the underlying weakness that guarantees that QE will be here for a long time, as least as long as the markets themselves will allow it or are tricked into allowing it.

TGR: Why are Americans so complicit in this?

RS: Too many take for gospel what they read and see in the mainstream media. There's a pretty good media propaganda machine out there for the government.

TGR: Do you think the Fed should exist?

RS: I've never gotten into whether it should exist or not. Let's just deal with what we have. I do think that its hand has gotten way too heavy in the markets.

TGR: Now that QE is going to continue for a while, what is the trade in gold and where are the catalysts for an even higher gold price?

RS: We've been waiting for a bottom. We've seen that now, and it's time to buy. There are still a lot of the same catalysts, such as many central banks are switching out of the dollar, yen, euros and diversifying to gold. Continued QE just means a continuation of that diversification.

Asia still has record demand for physical gold. Since the Bank of Japan announced the most aggressive QE program thus far, Japanese funds and the pension funds have started to buy gold-related investments; this is a first and has only just begun.

Since the price drop, we've seen a lot of mine closures and curtailment, which will only result in less supply in an already tight physical market.

However, the main catalyst is the reason gold was driven down in the first place. It has run its course and that was fulfilling the goal of the bullion banks.

TGR: Which is?

RS: The bullion banks run a fractional reserve gold system just like the bank system, meaning they only have one ounce of gold for every 50, maybe even 100 or more, sold. We don't know the exact numbers, but it's something along that line. That system came under stress with the lack of confidence and was driven, in part, by major countries like Germany repatriating gold. The fact that it is going to take seven years for Germany to get its gold tells you something about this fractional reserve system.

The bullion banks were, and are still, seeing a run on their physical reserves as inventories are falling, and so are the COMEX inventories. But at the same time, the bullion banks had this huge short position in gold and silver. We've seen a behind-the-scenes rescue of these bullion banks, at least for now.

TGR: In a recent edition of Struthers' Resource Stock Report, you said that many of these bullion banks are actually long gold now.

RS: We don't know exactly what any one bullion bank does, but we get some very good clues from the weekly COMEX Position of Traders report. The section of the report called "The Commercial," which includes the bullion banks, shows the reported short and long positions. We have seen a large net short position there for many years. But with this big drop in gold prices, that short position has been taken down to near nothing. At the same time, we've seen the category where we find the speculators and hedge funds at record net short levels. The short position has been moved from the strong hands to weaker ones. I see this as another bullish signal.

TGR: You also see some weakness in the recent jobs data. Tell us more about that.

RS: We hear the U.S. headline job number, talk about all these jobs we're creating and how good it is. The devil is in the details, they say. The last report actually saw 220,000 full-time jobs disappear. All the gains were part-time jobs. Right now, the second largest employer in the U.S. is a temp agency, and some 10% of the workforce is temporary because companies can't afford full-time workers or have little confidence for that commitment. That's a big sign we never have seen a real recovery.

Only 47% of Americans have full-time jobs. Some people have two part-time jobs now. The same person working in two places counts as two jobs, but it's just one person. The previous month's report sounded good, too. It reported more new jobs, but the hours of work dropped. I just see these employment numbers as part of the virtual economy, not the real one.

TGR: Do you believe that gold has already bounced off of its 2013 bottom?

RS: I think so. The $1,1001,200/ounce ($1,1001,200/oz) barrier was a good support level for gold, and we bounced out of that. I think we've seen the bottom. I thought we could possibly see a retest of that support, but because gold has done so strongly already, I think a retest of that becomes less likely now.

TGR: A group of Canadian financial companies led by the Royal Bank are attempting to launch a stock exchange to rival the Toronto Stock Exchange (TSX). The carrot at the end of the stick seems to be the elimination of predatory trading by computer-based programs. Does this idea have any traction?

RS: It has traction given that a large bank is behind it. I talk to investors and traders almost daily, and they've been fed up with computer trading for quite a while. Very simply, it's just totally unfair. Orders are not real and come and go quicker than humans can act.

"If you dig into what's really going on in the economy and markets, you'll find the underlying weakness that guarantees QE will be here for a long time."

Maybe you see a bid for 1,000 shares on some stock. You try to sell, but the computer sees your order coming, maybe fills 200 and then reduces the bid and you remain unfilled. You can take lower and lower prices if you want.

The same with buying. More shares can show up less than a second after you buy, so you don't know how many shares there are on offer, who is selling, how much or whether something is wrong because there's so much selling. Sometimes you don't even see your trades. You'll see, say, a bid at $0.35 and an offer at $0.40 on some particular stock. Maybe you put an order in to buy at $0.40, and you see no trade go through, but your brokerage account shows filled. The next day you find it settled at $0.38 because there was an offer there from a different trading platform.

For the most part, these different platforms are computer-driven participants. It has induced a huge lack of confidence and unfairness in the markets. It created two playing fields: the rich, big players and the small investor on the bad end of the stick.

What is also unfair is that these computer trades are given a rebate or less fees on their commission, so they're even given an advantage on commissions over regular investors. They say it's in the name of supply and liquidity, but it's just another unfair practice.

TGR: Wouldn't the Toronto Exchange argue that it's not a profitable enterprise without computer trading?

RS: I'm sure it is going to put up any kind of blocks that it can.

TGR: This sounds like an almost ideal bourse for junior mining stocks. What incentive would the new exchange offer for companies to come over?

RS: I don't think they will have to actually come over; TSX-listed companies could trade there. It would operate like another trading platform. The TSX has already lost about 40% of the volume to other trading platforms out there now like Alpha. This bourse is still in a discovery period right now. It's still exploring all the options for how to work this. It has an outline, but the goal is to go with a formal application around year-end. If it makes an official application by year-end, we could see this in 2014.

One thing I found quite interesting is it would take private company shares. A brokerage could take in the shares and create a market, creating some liquidity for private companies.

TGR: Why would private companies list? They have no desire to make their financials public.

RS: They actually don't list but it creates some liquidity for their current shareholders. At the same time, they don't have the regulatory burden as a public startup company. They can put more money into their companies and bring them to a stronger level before going public.

TGR: Without the transparency, investors could lose a lot of money.

RS: On the private sector side, it would only be qualified/accredited investors under the current TSX guidelines that could own and trade in these shares.

TGR: Is there any word from the federal government on whether it would back a new exchange such as this?

RS: I haven't heard much yet. This just came out at the end of June. We're going to hear lots about it between now and year-end, but it's just in its infancy now.

TGR: You follow a number of small-cap, mid-cap and large-cap gold and silver equities. Please outline your thesis for the small-cap silver and gold equities.

"I keep a long-term outlook. We have these ups and downs. This has been the worst, but this could be the fourth good correction."

RS: We use stop losses, and we got stopped out of almost all of our gold stock positions quite a while ago. I've never seen anything like it, but the market is what it is. Seeing a bottom, we first started going in and buying back the larger and midtier producers and some of the junior producers. Then later on, we'll start adding more of the exploration plays as long as the market keeps advancing.

TGR: What are some junior companies you're writing about in Resource Stock Report?

RS: Claude Resources Inc. (CRJ:TSX; CGR:NYSE.MKT) is one I recently bought back. I couldn't believe how far that got beat downto about $0.20/share. The main reason was that its costs are high at around $1,245/oz. However, it just completed a shaft extension at its Seabee mine that will reduce costs. It already has higher costs at the first of year because it has to restock its mine utilizing winter ice roads. The restocking program went well this year, with lower costs than last year and lower costs in many consumables. Given that and the recovery in the gold price, we could see quite a turnaround in that stock.

TGR: Claude posted a loss of $0.01/share in Q1/13. Is it on track to turn that around?

RS: The extra leverage you get is another advantage when you buy companies with costs very close to the current price. A $100/oz increase in gold would turn it from losses to profits. Just that $100/oz can make quite a difference, and you can see that leverage reflected in the improvement in the stock price.

TGR: Where is the growth going to come from, Ron?

RS: It is going to get some growth from the Seabee mine, but the big growth is going to come from its Madsen project in Red Lake, Ontario. It actually has more gold resources there than its mine. It has been advancing that project. Bringing that into production down the road is going to provide quite substantial growth.

TGR: What is another junior story?

RS: Richmont Mines Inc. (RIC:TSX; RIC:NYSE.MKT) has 2 million ounces (2 Moz) in reserves and resources and is producing about 65,000 ounces (65 Koz) a year. Its cash cost was high last quarter, at $1,300/oz, but that should improve. It had lower grades mined the previous quarter, which is going to improve in H2/13. It is also putting a new W Zone at the mine into production. It did a successful bulk sample test, at grades of 5.3 grams per tonne with 97.4% recovery.

The company has always been managed very prudently. It only has 40 million (40M) shares out, a strong cash position of $43M and less than $1M in debt. It has a $50M loan facility available as well, so it is in a strong position. The market is valuing its mines and ounces at just $20M right now. If you look at 2 Moz reserves and resources, they're valued at $10/ozand that's at a producing mine. I just find that ridiculously cheap, but the market is ridiculous now.

TGR: Do you think Richmont would use its cash position to take advantage of some other players that are not as cash rich?

RS: I don't think so. The management's track record is to more or less invest internally. It is more apt to improve the current mines and to acquire and advance some other properties. It could take advantage of acquiring properties off some of these other companies instead of taking out a whole company.

TGR: You mentioned its cost of production was a touch high. What is it doing to remedy that?

RS: The high costs are a short-term issue. It will get by this as the year progresses and fall more in line with normal grades that are a bit higher. This additional zone is a higher grade zone that will help with that. It's also paring costs wherever it can, cutting corners here and there like all the gold miners now.

TGR: What other stories are you following?

RS: On the senior side, I added Newmont Mining Corp. (NEM:NYSE) recently.

TGR: Because of the yield?

RS: Newmont gives good leverage as a dividend play because its dividend is based on the gold price. The dividend was $1.40/year, which is yielding about 5%, but that's probably going to drop to about $0.80/year because of the current gold price.

The dividend goes by the average of the previous quarter. The dividend increase is for every $100/oz increase in gold, $0.20/year. Once gold hits $1,700/oz, then it increases $0.30/year for every $100/oz increase. At $2,000/oz gold, it jumps $0.40/year for every $100/oz increase. That's some pretty good leverage there. If we get to $2,000/oz gold, the dividend would be $2.70 each year per share.

For now, I'm just betting gold recovers and Newmont is at least paying $1.40/share. That would give us a 5% yield at the current stock price.

TGR: Is yield the only reason why Newmont hasn't been beaten up like Barrick Gold Corp. (ABX:TSX; ABX:NYSE)?

RS: They've all been beaten up pretty good. Maybe Newmont was spared a little because of the yield. Most of the majors are paying some kind of dividend now, but Newmont is among the highest.

TGR: Are there some distressed names that offer compelling value in this market?

RS: They're all distressed at this point!

I've been looking at another good company that is quite interesting in South Africa. I haven't picked much up there for a long time. Gold Fields Ltd. (GFI:NYSE) spun a company out of its holdings this year to create Sibanye Gold Ltd. (SBGL:NYSE). It came out trading around $7/share in February, just in time for the market to get hammered, and it dropped all the way down to a few bucks.

It is actually going to be the third largest producer in Africa behind Gold Fields and AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE). The trailing price-earnings ratio is just 2x earnings. It had a very positive Q1/13 with $170M profit and $66M free cash flow. Falling gold prices would naturally have an effect, but its impact has been overdone on the share price. Sibanye has two producing mines and offers good value down at these prices.

TGR: Why did Gold Fields decide to spin it out?

RS: It wanted to split its mining into two types. It spun out narrow-grade, underground mining that's labor intensive. Its other projects are more open-pittable, bulk scenarios with more machinery-type mines. It felt it was trying to manage two different types of mines. Now there is better concentration with a split along synergies.

TGR: Could you give us another small-cap name?

RS: Argonaut Gold Inc. (AR:TSX) has not been beaten down nearly as much because its costs are quite low at around $600/oz. The company has two producing mines and produced 93 Koz last year. It is projected to increase to 120140 Koz this year. Argonaut has two advanced projects under economic assessment, two more mines that could come onstream down the road. It should be able to fund all this internally because it is sitting on $168M in cash and has no debt. Argonaut could be a stock that could continue to outperform in the market going ahead. It's quite a good growth story.

TGR: How are you staying positive throughout what's happening in the junior mining sector?

RS: I keep a long-term outlook. We have these ups and downs. This has been the worst, but this could be the fourth good correction. Each time, these corrections get a little bigger and a little longer, but they're from bigger and higher prices. The next move will be a bigger and longer upmove. That's the carrot for belief in what's yet to come. Being that these stocks are so depressed, it's the best buying opportunity that I've ever seen, even better than in 2000 at the bottom.

TGR: Are you buying?

RS: Yes. I like the long-term call options on some of these majors, too. Because the market is so beaten up, the call premiums have gone to nothing. You can buy these call options that are out a year-and-a-half for $1 or $2 and control a $510 stock. There's a lot of leverage there.

TGR: Thank you for your insights.

For Ron Struthers' investing ideas on graphite, click here.

Ron Struthers founded Struthers' Resource Stock Report almost 20 years ago. The report covers senior and junior companies with ample trading liquidity. Since 2000, $1,000 invested in Struthers' Model Portfolio ended 2012 at $9,251. Struthers' Newsletter Stocks went from $1,000 to $20,934. Struthers' Millennium Index, which started in 2003, began at $1,000 and was worth $4,133 at the end of 2012.

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DISCLOSURE:

1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Report as 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: Richmont Mines Inc. and Argonaut Gold Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.

3) Ron Struthers: I or my family own shares of the following companies mentioned in this interview: Claude Resources Inc. and Richmont Mines Inc. 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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