The Gold Report: You sent us a graph that charts gold's
downtrend in bear markets since 1975–1976. That chart suggests that some bear
markets end in a capitulation selloff, while others build a base for an
extended period. How is this bear market trending?
Eric Muschinski: Due to the duration of the current bear market, we
are more in a "grinding" bear market, which doesn't necessarily
mean that we're not going to have a capitulation selloff at the end. In
1975–1976, for example, there was a harsh mid-cycle flush, so it was painful
and brief. The 50% drop in the price of gold was actually more severe than
what we are seeing now. But if this is a mid-cycle correction, we could see a
similar percentage decline to what we saw in the mid-1970s. The current
grinding bear market just exceeded the 1996–1999 bear—the second-worst bear
market in both duration and severity. Only the 1988–1993 bear market, which
we've already surpassed in severity, lasted longer.
This analogue is designed to follow correlations of
different historical bear markets over the last 40 years. The analogues help
us track how the gold price might bottom into the final low. Since an asset
corrects in both price and time variance, it is important to notice that some
bear markets end in a capitulation sell off, while others build a base for a
prolonged period of time.
Source: Comex,
ShortSideofLong.com
TGR: What else should investors know about that chart?
EM: For me, it helps to look at facts and data instead of the
emotional side of investing. Anyone who has been in the precious metals
sector has been brutalized for the last four years. Our perception can be
skewed in that environment, and it can work against us in the sense that
investors become complacent or worse—they give up on these stocks or the
sector. The chart helps me remember that we've already gone through most of
the pain. Typically, 9 out of 10 bear markets in the gold sector have not
lasted this long. The end is coming. How near is it? The summer of 2015 could
potentially be the bottom but this bottom feels like a process that has
already begun.
TGR: Is comparing this market to previous bears an apples-to-apples
comparison given the relative strength of the gold price throughout this bear
market and the unprecedented level of global debt?
EM: )It's a good question. It is because we can only look at
history and we're comparing apples to apples in historical gold and silver
prices. And from a macro standpoint, with global debt and money supply levels
climbing over the last five or six years, especially in Japan and Europe, we
should see a stronger rebound in the gold price from wherever the bottom ends
up. I'd keep that in mind. We also have to keep in mind that gold trades
differently in different currencies. Against currencies not named the U.S.
dollar, gold has been incredibly strong of late. It looks as if it's already
in a bull market.
Source: Gold Investment Letter
TGR: The spot price for gold has not closed below $1,150 per ounce
($1,150/oz) since its peak in September 2011. How low do you expect it to go
before the next bull market begins?
EM: We've seen gold pull back before in the middle of a cycle, and
I believe we're still in a secular gold bull market. We could see gold shake
out below $1,000/oz, yet still be within a historical metric that is
consistent with what we've seen in the last 30 years. If we see gold break
below $1,000/oz, it would be frightening and could be that final shakeout
that's necessary for long-term gold bulls and goldbugs to throw in the towel,
which is really what we need to see. We need to see that final capitulation
process or event and extreme bearishness across the sector. We need to see
more bankruptcies, as we saw with Allied Nevada Gold Corp. (ANV:TSX;
ANV:NYSE.MKT). That would mark the low in the gold price. I'm prepared for
$950–1,050/oz as the ultimate low. But so are a lot of other professional
investors, so it may not play out that way.
TGR: Allied Nevada filed for bankruptcy and a dozen or so
Canada-listed companies have changed course to become medical marijuana
companies. Yet you see positives in those stories.
EM: It comes down to investor psychology. Everybody wants to buy
when things are rising. For example, when I was a broker in 2000 there was a
buying frenzy for Internet stocks. A client in construction sent his great
aunt to me to open her first brokerage account because she wanted to buy
Internet stocks. That's the type of mentality we see at market tops. We tend
to see the opposite at market bottoms—disgust, fear, indifference and negativity.
We want to hear about more bankruptcies because bull markets are birthed in a
negative environment, and capital then supply dry up, eventually boosting
prices via economics 101. If we see more companies turn into medical
marijuana companies and if we have more Allied Nevadas, it means that we're
getting closer to the bull being birthed.
TGR: Most of the people that I talk with for The Gold Report
seem to believe that there are 12 to 18 months to go in this bear market. How
should investors play it?
EM: Another 18 months would make this market the longest bear in
history. If we get a flush in gold—a scary flush—this summer or fall, which
is usually the worst time for gold and gold stocks, then we're going to be
aggressive buyers, so you want to have some cash to put to work. You want to
be a buyer toward the end of the bear market. You do not want to be
complacent or a seller.
My challenge is that I have subscribers and friends that bought certain
mining stocks a lot higher and it's imperative to bolster their long-term
positions versus just "hanging in there" and not selling. It's not
about picking the absolute bottom. It's about accumulating your favorite
companies on a regular basis and averaging in and buying assets at massive
discounts. There are companies out there that are trading at less than cash.
That means you can own multimillion-ounce gold deposits for free. That's not
going to last. You don't have to pick the exact bottom, and you probably
won't even if you try. Be patient. Buy and chip away. Start to get more
aggressive, especially this summer.
TGR: Is that what you're telling your subscribers?
EM: We have been aggressive at the Gold Investment Letter,
especially late last year when we were not afraid to play the downside of the
market by taking positions in the 3X ETFs like Direxion Daily Gold Miners
Bear 3X ETF (DUST) and Direxion Daily Junior Gold Miners Bull 3X ETF (JNUG).
We had a good rally in the gold shares, yet it was clear that we were not
done with the bear market, so I like to trade the downside to generate more
capital to buy cheap companies. If you're losing sleep at night, instead of
selling out of your gold stocks, buy one of the inverse exchange-traded funds
(ETFs) to mitigate the decline in your portfolio. You can do that with 10–20%
of your portfolio to help you sleep at night.
TGR: What are some specific ETFs or exchange-traded notes that you
like?
EM: The one I love the most to have exposure to physical gold and
silver is the Central
Fund of Canada Ltd. (CEF:NYSE.MKT; CEF.A:TSX), which is trading at a 7–8%
discount to net asset value (NAV). ETFs like this one tend to trade at
discount to NAV in really bad markets and at premiums to NAV in really good
markets. There are two other components that are good about the Central Fund.
One is that you actually own physical gold and silver, about a 60/40 gold to
silver split, that you know is there because of its meticulous third-party
audits. The other component is storage. You don't have to worry about buying
a monster box of silver to have a good position. You can have that exposure
to the physical metal by buying the Central Fund. I really like it.
If you want pure gold, there is the Central Gold
Trust (GTU:NYSE; GTU.UN:TSX), run by the same people who run the Central
Fund. It's liquid and trades at a discount to NAV.
TGR: What's your investment thesis for equities?
EM: The beauty of this type of a market is that we get to be very
picky. It's absolutely a buyer's market. I look to buy best-of-breed
companies with strong cash positions. There are companies out there with at
least a couple of years of operating capital. Those companies are not going to
need to raise capital at the bottom of the market and can be looking to
acquire cheap projects. If a company has to raise money in the next, say, 9
to 12 months, it goes off my list. Moreover, a company's flagship project has
to be in a potentially safe jurisdiction (with certain exceptions) and have a
proven resource, so you know you're buying gold at $5–10/oz in the ground or
less. Then these companies should have a catalyst that makes them the cream
of the crop.
TGR: What are some narratives that you're following?
EM: A quality junior is Midway Gold
Corp. (MDW:TSX.V; MDW:NYSE.MKT). This is a Nevada-focused explorer and
producer. The company poured 100 oz gold in late March at its Pan gold
project, and production is going to scale considerably from there. In
addition to Pan, Barrick Gold Corp. (ABX:TSX; ABX:NYSE) is spending about
$20 million ($20M) drilling Midway's Spring Valley project and has earned a
70% stake in the joint venture. Midway has another project in Nevada called
Gold Rock, which could be put into production in short order.
Midway is a junior that is going from explorer to producer and has raised
well over $100M in the last 18 months. Its market cap is around $72M, with
roughly $28M in bank debt. But the company needs another $5M to meet its
obligations. CEO and President Bill Zisch is a former executive with Royal
Gold Inc. (RGL:TSX; RGLD:NASDAQ), which finances companies in exchange for
production royalties. I wouldn't be surprised to see a deal with Royal Gold
to get that shortfall covered. About 50% of Midway shares are owned by
institutional investors and the stock had been trading at a market premium.
If the stock is under $0.35/share, I think it's a real bargain. We crushed it
just last week buying in the high $0.20s/low $0.30s and trading out of a
chunk at a nearly 50% profit, holding for about one week. But, I'm looking to
add some of that back and kept the shares I own now for free from the trading
profits.
TGR: Tell us about another name.
EM: One that's interesting is Patriot Gold
Corp. (PGOL:OTC.MKTS) and I should disclose that I am an advisor to the
board of directors and a fairly significant investor in the company. It's not
super liquid and trades at around $0.07/share, but it has two properties that
many investors will recognize: Bruner in Nevada, a joint venture with Canamex
Resources Corp. (CSQ:TSX.V; CNMXF:OTCQX; CX6:FSE) as operator, and Moss
in Arizona, which is run by Northern Vertex Mining Corp. (NEE:TSX.V; NHVCF:OTCQX) in
a similar structure.
Canamex has to spend $8M to earn a 70% stake and it is approaching that
amount. The potential at Bruner is fantastic. Both Gold Resource Corp. (GORO:NYSE.MKT)
and Hecla Mining Co. (HL:NYSE) have invested in Canamex directly to get
exposure to Bruner and may be candidates to buy Bruner from Patriot and
Canamex or buy one or the other.
Northern Vertex, meanwhile, has to spend $8.5M and provide a bankable
feasibility study to earn a 70% interest in Moss. However, Northern Vertex
has spent closer to $20M so far and produced about 5,000 oz (5 Koz) gold
testing a pilot plant. Patriot has received nearly $30M in development
spending on its two discoveries, one of which should produce about 40–50 Koz
per year in Arizona. Yet Patriot's market cap is only $3M.
TGR: Patriot and Canamex recently released an initial resource
estimate for Bruner. What are your thoughts on it?
EM: It's early. It was a modest maiden resource estimate that will
probably grow considerably over time. I've talked to a couple of geologists
who have brought mines into production and they feel extremely confident that
Bruner has the potential to be a mine. There's a lot more gold there to be
found.
TGR: What is the next step for Patriot Gold?
EM: Moss requires about $30M to get a mine built. Patriot has a few
different options. If it raises its share to maintain 30% ownership, $8–9M,
then it will be a partner as a producer, but its worst case is being diluted
to a net smelter royalty (NSR) of 3% on Moss, which is a healthy royalty.
We're talking about millions in cash flow from a 3% royalty on annual
production of 40–50 Koz gold. It would be easier for Northern Vertex to raise
the necessary capital as the sole owner of the project, so we could see
Patriot do a deal with Northern Vertex where Vertex takes the whole project
over in exchange for an expanded NSR, maybe some shares and cash.
TGR: What are some other companies you're following?
EM: The other one I love is Orca Gold Inc.
(ORG:TSX.V), with a market capitalization of about $37M. The company has
$35–37M in cash. The people who run Orca ran Red Back Mining, which was sold
to Kinross Gold Corp. (K:TSX; KGC:NYSE) for over $9 billion ($9B). It was a
huge success. They're all rich beyond belief, so they're not going to get
involved in anything that's going to be small or modest.
Orca is working in an area of Sudan that seems substantially safe. The
Measured and Indicated resource on its Block 14 mineral license is already
over 1.3 million ounces. There's never been any drilling done in this area.
Orca is going to move this project forward at a modest pace to conserve cash while
we're still in a bear market. Meanwhile, we are seeing more drill results.
Some of them look very compelling. This one could be a monster.
TGR: You also follow some small-cap equities that are not in the
precious metal space. Please tell us about some of those stories.
EM: One is Medallion Resources Ltd. (MDL:TSX.V; MRD:FSE; MLLOF:OTCQX),
a rare earth elements (REE) company. The rare earth sector has been
slaughtered. However, there is a need for rare earths, especially the heavier
rare earths, in the many products that we use every day like tablets, smart
phones and LED lights. The question is which company is actually going to get
into production? A lot of REE projects have huge capital expenditure numbers.
Medallion has an interesting angle on rare earth production: it's a REE
separation play. Separating REE from monazite is a known process and the
company is working with potential customers to process REE at a facility that
would cost $15–18M to build. If it can secure supply agreements with certain
firms, Medallion could generate $30–35M annually processing REE. Medallion is
a speculative play at $0.06/share. It's a good one to keep an eye on.
TGR: Any others?
EM: Jagercor Energy Corp. (JEM:CNSX; JAMTF:OTC) is an
interesting oil play in Argentina, which has been a problematic jurisdiction
for quite a while. Jagercor is producing oil and the Argentine government
pays domestic producers a set price of $77 per barrel ($77/bbl). That has
come down from $84/bbl on Jan. 1 but remains well above the price of Brent
Crude. It should remain above world market prices because the bureaucracy in
Argentina has destroyed domestic production in a country that has massive oil
and gas reserves. Last year Argentina imported $14B in oil and the country
needs to stimulate domestic production.
Jagercor has taken the risk out of being a producer and has strong
management with a CEO who has managed over 500 people and 15 active rigs for
YPF Repsol, Argentina's largest oil producer. Jagercor produces roughly 200
barrels per day at $77 each or approximately $250,000 a month, with a burn
rate of $50,000—that's $2.4M annually with only three wells. Let's call it
$2M, and with a modest multiple of 10 times earnings Jagercor is a $0.20+
stock. That should grow as Jagercor expands to eight wells this year with its
partners. The stock is trading around $0.05/share.
TGR: What is something investors should always be cognizant of in a
bear market?
EM: Be cognizant of when you want to be aggressive as a buyer. The
problem with bear markets is that they go on for so long that we fall asleep
or get pissed off and end up shunning the best buys in the market. One of the
greatest values in any asset class right now is where we are focused:
precious metal mining companies. They're trading at massive discounts to
historical norms and are flat out cheap. We understand this sector. Let's be
the ones to take advantage of it and be buyers of these cheap assets.
TGR: Thank you for talking with us today, Eric.
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