Worldwide monetary creation today
has implications for the watchful investor in gold and silver. In this
exclusive interview with The Gold Report, Leonard Melman, publisher
and editor of The Melman Report, explains
why, and shows who will be well positioned to benefit from current economic
The Gold Report: Now that the curtain has
been raised and we can see the Federal Reserve's much-anticipated program of
a third round of quantitative easing (QE3), what are your thoughts? How do
you expect QE3 to affect your portfolio?
Leonard Melman: There are two portions to the QE3 program.
First, there's the open-ended agreement to buy $40 billion (B) of mortgage
assets every month. The second is the commitment to hold and extend
short-term interest rates to near zero through mid-2015. What this tells me
is that the Fed is essentially throwing in the towel and abandoning
conservative economic policies. It is going to stimulate the economy as long
The Fed's pledge of
virtually unlimited money creation will almost certainly have a negative
impact on the U.S. dollar, which in turn should have a tremendously positive
effect on gold, silver, other precious metals and, to some extent, all other
TGR: Have the Fed's prior QE1
and QE2 programs delivered?
LM: The results have been
less then inspiring. It's worth remembering comments made when the Fed first
enacted those policies back in 2008 and 2009 and 2010. President Obama and
Ben Bernanke assured the world that this was needed to bring about a surge of
new and long-lasting prosperity. Obama promised that unemployment would fall
sharply and that it would never rise above 8%. Well, those two things haven't
The most interesting
thing to me is that the Fed has returned to its basic premise that monetary
creation leads to economic stimulation. As long as old Keynesian theories
drive thinking at the Fed, unless the economy takes off with a real bang, I
think we are going to see more problems. And, by the way, if the economy does
take off with a real bang, that should also be
positive for the metals because of enormous associated inflationary
Since the announcement
of QE3, the Treasury Yield Index (TYX), showing U.S. 30-year bond interest
rates, has shot up from 2.4% to 3.1%. At the same time, the U.S. Dollar Index
has weakened and dropped from over 84 to just under
79. In currency markets, that's one heck of a move. So, all of these things
are implicit in the U.S. government's current monetary policy.
TGR: Should junior precious
metals investors or commodities investors buy on the QE3 news?
LM: Yes, I believe they
should buy, and here is a brief explanation of why. I'm fully aware that many
junior mining companies have hit rough times over the past year and that
share prices have fallen. Because of the low share prices, it's been hard to
raise capital and equity financing is very difficult to get. But if the price
of gold continues to surge—and it's already gone up $250/ounce (oz) since the low of $1,520/oz
earlier this year—the value of the ore bodies in the ground becomes
increasingly apparent. That should bring new buyout offers. Large mines whose
resources are being depleted or end-users of the products will be looking for
smaller operations to take under their wings. Moving forward, as the
increasing value of assets in the ground becomes more and more
evident—particularly if gold exceeds $2,000/oz
before the end of the year, as I expect it will—I think an amazing
burst of activity in the junior mining shares could be triggered.
TGR: Are we back to pre-2010
levels, before junior precious metals equities as a whole went on a bull run?
LM: There are tremendous
parallels between the period from which we are just emerging and late
2008/very early 2009. As you recall, 2008 was a devastatingly bad year for
the junior mining shares. With the monetary collapse, bank loans for junior
miners dried up and shares collapsed. The price of gold dropped from well
over $1,000/oz to about $680/oz. Yet investors who
stepped forward during the end of 2008 or early 2009 would almost certainly
have reaped the rewards.
I believe there's a
great similarity between what happened in 2008 and what is happening now. I
would also add that a long-term chart of gold performance going back 25 years
would show we've been in a gradually accelerating bull market since 2000.
Corrections such as those seen in 2006, 2008 and the one we've just been
through still fit very neatly inside that long, powerful, accelerating
TGR: How much does the
looming presidential election in the U.S. have to do with QE3 right now?
LM: I think the timing is
political but that eventually we would have seen it anyway. I think Bernanke
has a sizeable ego and really wants to be remembered as the person who
finally and ultimately solved the economy problem. Mitt Romney made it very
clear that he would not renominate Bernanke to his
position as Federal Reserve chairman. If Romney wins, it's apparent that
Bernanke won't be around to be that person. So the election can't help but
influence Bernanke to move fast to improve the psychological backdrop of the
economy, and to help Obama's chances.
TGR: Compared to previous
attempts at economic stimulus, what do you think of the strategy of buying
mortgage-backed securities to the tune of $40B a month?
LM: It is a way of putting
more money into the banking community that can then be force-fed into the entire
economy in hopes of generating sufficient economic activity to finally drop
unemployment rates to 7%, 6% or maybe even 5%. In that sense, I think it
could be an effective strategy. It will also reassure mortgage lenders that
if their loan judgments are wrong, the Fed will be ready to back them up. And
that is going to help the housing market.
TGR: What do you think it
will do to mortgage rates?
LM: In the short term, the
strategy will hold mortgage rates level and maybe even drop them a little
bit. Long term, I think mortgage rates will move in tandem with interest
rates. Because these policies have implications for inflation, I think
interest rates are going to head higher. I will even be bold enough to
predict that, over the next two to three years, a rise in interest rates will
be the biggest financial news story out there by far.
TGR: Do you think that there
could be a rise in interest rates, despite the Fed's efforts to keep them at
around zero through 2015?
LM: Absolutely. I hesitate
to say this but, deep inside me, within the next three years, I believe we
could see a psychological background of interest rates comparable to what we
all saw in 1979–1981, if not in magnitude, then at least in tone.
That's when long-term interest rates reached 17–18% and short-term
rates actually hit 20%. The housing market went into chaos, as anybody who
owed money and had to refinance at those rates would well tell you. I think a
scary time of the same nature awaits.
TGR: So one place to be is in
junior resource equities?
LM: Absolutely. Right now,
there is a combination of rising inflation and rising interest rates that
have historically been positive for gold. A mistaken notion persists that
gold is hurt by high interest rates, going back to 1981 when Ronald Reagan and
Donald Regan shot interest rates higher to finally wring inflation out of the
system. Interest rates went up, but people also knew they were serious about
addressing inflation, so the price of gold collapsed. Thus, people have come
to associate high interest rates with collapsing gold prices. But,
historically, that isn't the case.
A better illustration
comes from 1976–1980, with a scenario of rising inflation, rising
interest rates and exploding gold prices. That's by far the more typical
TGR: A lot of your portfolio
exposure is silver-related. What about silver?
LM: In a bull market, silver
almost always outperforms gold, and sometimes by a very good margin. I can
illustrate using recent figures. Gold bottomed at $1,530/oz
about a month and a half ago. As of this morning, gold is $1,780/oz, a gain of $250/oz, or about
16–17%. At the same time silver has gone from $26/oz
to $35/oz, which is a gain of $9/oz and well over a 30% increase. Rising bull markets in
gold almost always correspond to faster acceleration in the price of silver.
There are two reasons
for silver increases. First, silver is not just a precious metal; it's also
an industrial metal. New uses for silver are discovered almost every week.
Dual demand works to silver's benefit. Second, silver is commonly regarded as
a storehouse of monetary value. When gold hits $1,800/oz,
people who can't afford to buy an ounce of gold can still afford 20 or 30
ounces of silver. What follows is compressed inflation, hedging and buying
into silver compared to gold. So, silver has a very powerful future and
that's one reason I like junior silver mines very much.
TGR: Did you add to your
positions over the course of this downturn, which has lasted a little more
than a year?
LM: Looking on our website,
you'll see that we've added several companies that have a specific feature
that we like. Companies that have production to finance additional
exploration can avoid share dilution or taking on too much debt. Those
companies are out there in growing numbers.
TGR: Right now it takes about
50 oz of silver to buy 1 oz
of gold. Do you expect that ratio to narrow over the next six months to a
LM: Yes, the gap between
gold and silver is starting to narrow. This morning's price of silver was
$35/oz and 50 times that would be $1,750/oz. Gold
is just under $1,800/oz. So, this is almost exactly a 50:1 ratio.
Historically, the original ratio was 16:1, but at the depths of the bear
market in 2000 or 2001, it climbed as high as 83:1. If we get a huge rally in
gold, that ratio will start to fall dramatically to 40:1, 30:1, and maybe
even into the middle-20s. The resulting leverage on the silver miners' bottom
line could be just spectacular to watch.
TGR: Explorers, let alone
producers, are reporting escalating costs. Does this concern you?
LM: Cost escalation has to
be factored into decisions about any potential investment. I am concerned
about the cost of diesel power generation; crude oil hit $100/barrel (bbl) and the gasoline contract moved back about $3/bbl.
That's a huge cost, particularly when contemplating underground mining
operations, because it takes a lot of energy to hoist material from the depth
to the surface.
I'm also concerned about
the cost of geologic talent. Many of the best geologists have been around for
35, 40, 45 years and are getting a little long in the tooth, frankly. There
was a period from the early '80s right through to about 2000 when the number
of geology students dropped off a cliff and a whole generation of geologists
wasn't created. As more and more companies explore, the demand for fewer
experienced geologists drives salaries that much higher.
Then there are
bureaucratic costs. Servicing all the government bureaucracies with endless
reports, filing exchange-mandated reports, etc. creates yet another area of
costs to factor in. But, if metal prices can continue to rise at the rate of
the last couple of months, potential revenues will still exceed potential
cost increases by a considerable margin and I remain bullish on the group.
TGR: Is there a way for
investors to limit their exposure to cost escalation?
LM: I don't think they can.
Cost escalation is not going to go away and may even become a bigger factor.
But it really becomes the responsibility of the investor to truly understand
all the factors that contribute to escalating costs, such as employment,
transportation, electricity generation, heating or air-conditioning. Of
course, companies have to accurately reflect these variables, so potential
investors have enough knowledge and awareness to make appropriate decisions.
But, with the monetary creation that is occurring in the world now, I still
think that inevitable price increases in gold and silver will more than make
up for any cost escalation.
TGR: You like to vett projects "up close and personal." What
companies have you visited recently?
LM: Two visits really stand
out in my mind. SilverCrest Mines Inc. (SVL:TSX.V;
SVLC:NYSE.MKT) has a terrific setup. SilverCrest has a producing mine in Sonora, Mexico, that
is throwing off continually growing revenues used to explore properties near
the mine. It's called the Santa Elena mine, located northeast of the city of
Hermosillo. And, while I shouldn't use terms like "wonderful," the
company has a very prospective property called La Joya
located in the famous Mexico mining state of Durango. SilverCrest
is using the revenues from Santa Elena to finance the exploration at La Joya and other places, yet SilverCrest
has not undergone the share dilution that has troubled so many other
companies. I like that.
TGR: Is Santa Elena
generating enough cash flow to fully fund exploration activities at La Joya?
LM: Yes. Not only that, SilverCrest is also continually expanding both the size
of the processing and the quantity of ore being processed at Santa Elena. So,
it looks as if the revenue stream will become even greater. As far as I know,
just a few years of ore remain in the mine. But, through nearby exploration,
it looks as if its life expectancy could be extended. In fact, SilverCrest has stated that is wants to double production
at Santa Elena.
Looking at the history
of the share price, starting at a few pennies and now approaching $3/share,
it's frankly been a bonanza for anyone who's held on for the long haul. I
happen to like SilverCrest very much down the road.
Another company I've
visited that offers excellent opportunities is El Tigre Silver Corp. (ELS:TSX.V;
EGRTF:OTCQX; 5RT:FSE), another case where production is expected
to finance continuing exploration. The El Tigre property is also located in
Sonora and is a huge project area that had operated from approximately 1908
until 1935. It produced around 75 million ounces (Moz)
silver and averaged 30–40 ounces per ton (oz/t)
for all those years. But the problem was, given the refinery techniques
available back then, very high-grade ore was needed for the mine to be
profitable. Well, they left behind tailings amounting to 750–800K tons
at least. It is ore, the rock has already been crushed, and it's just sitting
there. It turns out that recent studies show that these tailings contain 2.5–3
oz/t silver. There are also smaller tailings piles
on the project. Furthermore, mined-out areas were also backfilled with
additional material. So, there are considerable opportunities for recovery at
El Tigre and it is forecast to be in production before the end of the year.
El Tigre is very
prospective in two senses. Good gold results are appearing in one of the
project areas and silver exploration is occurring in hopes of finding more
30–40 oz/t ore near the mined-out areas.
Obviously, risk is involved, as reflected in the lower share price of $0.25.
But my opinion is that the risk-to-reward ratio is highly favorable.
TGR: In addition to the 75 Moz silver mined there historically, the property also
produced about 300 Koz gold.
It has had a number of owners, but in 1984 Anaconda Minerals walked away from
the property. Why?
LM: That's because of the
low price of silver and gold at that time and a lack of enthusiasm in the
TGR: So, it has sat dormant
LM: It's been inactive. As a
matter of fact, traveling through the project area, I was struck by the
number of ruins that are very aged and date back maybe a century or more.
Suddenly the whole thing has started to come back to life again. It's very
interesting to see.
TGR: What other Mexican silver
plays are you following or can tell us about?
LM: None that I've seen very
recently. But, one that I did visit a couple of times over the past four or
five years is Orko Silver Corp. (OK:TSX.V), also located in Durango.
Orko has gone through reorganizations, joint
ventures and so forth. But, I do remember speaking with the geologist three
or four years ago and there is huge potential for discovery. The big
questions have been about financing. Orko has done
a magnificent job of exploring and has some of the finest core displays I've
ever seen. Over the past few months the share price has suddenly ticked quite
a bit higher. So, Orko is just one to keep in mind:
A substantial ore body is there and a huge body of exploratory work has been
completed over the last 10 years or so. I think that Orko
is worthwhile to look at.
TGR: What about some primary
gold exploration plays and some small gold explorers?
LM: I just came back from a
very interesting trip to perhaps the most fascinating area of mining history,
certainly in North America, and that's in the Klondike, up in the Yukon.
There are wonderful things to see in Dawson City and in Whitehorse, and the
general mining history there is simply fascinating. One of the properties I
saw was Northern Freegold
Resources Ltd. (NFR:TSX.V; NFRGF:OTCQX), which has a substantial
area under exploration. Metallurgical work showing very positive returns has
just been completed and a press release on that very subject was made just a
couple of days ago.
The problem for Northern
Freegold has been in arranging sufficient financing
because the shares, currently selling around $0.14/share, declined
considerably during the latter part of 2011 and the first half of 2012, like
those of so many other junior miners. But, with estimated reserves of about 3
Moz, Northern Freegold is
the kind of company that should be attractive to a major. Potential financing
is there and it is a company that people might keep in mind.
TGR: Northern Freegold completed a private placement financing in
August of 10 million (M) units at $0.10 each. Does that sort of dilution
frighten you at all?
LM: About $1M was raised,
which keeps the door open and the geological staff intact. And, while I'm
always concerned about dilution, I think it is a positive development that
Northern Freegold was able to raise cash, despite
the loss in share price. Dilution is just a regrettable consequence of shares
having fallen during the previous year. Somebody out there is saying this is
a risk worth taking and they put up their cash to buy, even at those prices.
TGR: What does Northern Freegold need to move the needle here?
LM: More than anything else,
what's needed is an extremely positive background for the price of gold
itself. I think that would bring in an interested joint venture partner or
end-user of gold looking for a reliable source or, of course, a potential
buyout offer from a major who likes the size of the eventual mine that could
be created. But, I think the key for Northern Freegold
is the positive background for gold itself.
TGR: This is a large
low-grade deposit. How close is it to infrastructure?
LM: The Yukon generally has
very, very weak infrastructure. There's only one major highway through the
center of the Yukon, and that's from Whitehorse to Dawson. Then there's the
southern route of the Alaska highway, which goes from Whitehorse to the
Alaska border. But, fortunately for Northern Freegold,
a government-maintained side road takes off at Minto
and heads west, right into where the company's projects are located. John
Burges, the company president, told me that, by comparison, it would cost one
of the other mines in the area $100M just to bring in a road. It is a
tremendous advantage that NFR has an open, government-maintained road that
goes directly into its project area.
Electric power is a
little more difficult to access. Right now power has to be generated by
diesel. Compared to power grids in the other provinces and states, the Yukon
power grid is nowhere near as sophisticated or widely available. It's only a
partial grid and that part of the project's future is questionable. For some
time, Northern Freegold would probably have to
count on diesel generation.
TGR: You recently visited
sites in Alberta. What did you find?
LM: I had the pleasure of
visiting DNI Metals Inc.'s (DNI:TSX.V; DG7:FSE) mineral development
projects, located to the north of the famous Alberta tar sands projects.
DNI's SBH property covers a wide area and DNI's president and CEO, Shahe Sabag, told me that
knowledge of metals contained within the oil sands has been known for years,
but it is only through the recent discovery of a process known as
"bioleaching" that a method of recovery has become available. That
process is now being used at a project in Finland.
There are numerous
project areas at SBH, and Sabag noted one of the
most promising is the Buckton Zone, where there is
presently an drill program with the goal of
advancing Buckton South through to a preliminary
Sabag noted that the areas
under DNI's control are known to contain sizeable resources of several
metals, including 338 million pounds of molybdenum, 34 Moz
silver and just under 1 billion pounds of zinc.
TGR: What other companies
would you like to mention?
LM: Harry Barr is a mining
persona well known throughout the industry, and El Nino Ventures Inc. (ELN:TSX.V; ELNOF:OTCBB) is one of the companies
in which he has an interest. El Nino has been able to consolidate its
ownership with Votorantim Metals—the big Brazilian
company—of a portion of a promising project, Murray Brook, in New
Brunswick that has had some excellent assay results recently.
Votorantim has many projects
around the world and has sunk some good money into this one. And, with assays
now coming in, project development is moving along very quickly. It's worth
noting that the latest Fraser Institute survey has put New Brunswick right at
the very top of the list of jurisdictions that are favorable toward mining.
TGR: Murray Brook is in a
mining camp that was one of the most prolific in the history of Canada.
That's the Bathurst Camp that Falconbridge [now part of Xstrata Plc (XTA:LSE)] had mined for
LM: Exactly. Production just
ended one or two years ago. Because a great number of people trained in
mining remain there, potential labor staff doesn't have to be imported from
distant areas. Also, a huge backlog of core samples assembled and maintained
by the government of New Brunswick exists near the project area. So, very
favorable stuff: good background, good province, good regulatory area and
good assays that show there could be a real profitable mine developed there
TGR: Some of the companies you're
following have very low trading volumes and thus liquidity problems. What
advantages do those companies have that offset their lack of liquidity?
LM: I hate to say this but
low price is perhaps their best advantage. If a huge bull market seems to be in
the offing, many investors will surge up prices of junior miners that have
decent potential discovery but low prices. Heck, if you buy a share for $0.03
and you are able to sell it for $0.06, you've made 100% gain.
That's a much more likely scenario than a major like Barrick
Gold Corp. going from $40 to $80/share. A lot of people speculate on buying
things at bargain levels. It's the old Bernard Baruch saying, "Buy when
there's blood in the streets." There has been a lot of bloodshed in
mining share prices over the last year, and a body of investors is waiting to
pick up bargains.
Of course, low share
volume is a problem. If you've got to buy 25K shares of a company priced at
$0.05/share, you yourself may drive the price up to $0.065 or $0.07/share.
Then when you go to sell, you may drive the price down to $0.03 or
$0.04/share. That is a risk always inherent in low liquidity stocks.
TGR: What further advice do
you have for retail investors at this time?
LM: Keep your eye on the
entire world macroeconomic situation because I believe that will be the
greatest influence on the price of gold and silver and the base metals. As
long as tidal waves of money are created, I cannot see the world escaping
inflation and the depreciation of paper currencies. And we have every
indication of this happening at present. The Central Bank of England
announced it stands ready to hype the British economy. The European Central
Bank stands ready to hype the entire European economic structure. The Federal
Reserve Bank is advancing strongly to hype the U.S. economic structure. And,
just recently, the Bank of Japan made the same type of announcement regarding
Gold and silver and
solid commodities are antithetical to depreciation of paper currency and,
therefore, I expect them to profit enormously. So, the best investment advice
I can give is simply keep your eyes on the general macroeconomic structure
and the longer term. I think both favor the metals enormously.
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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1) Brian Sylvester of The Gold Report conducted this interview. He
personally and/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: SilverCrest Mines Inc., Northern Freegold Resources Ltd. and DNI Metals Inc. Streetwise
Reports does not accept stock in exchange for
services. Interviews are edited for clarity.
3) Leonard Melman: I personally and/or my family
own shares of the following companies mentioned in this interview: None. I
personally and/or my family have been paid by the following companies
mentioned in this interview: SilverCrest Mines
Inc., El Tigre Silver Corp., Northern Freegold
Resources Ltd., El Nino Ventures Inc. and DNI Metals Inc. I was not paid by
Streetwise Reports for participating in this interview.