These Three Triggers Will Produce a Resurgence in Natural Resources Prices: Greg Dorsey
Wed, Apr 17, 2013
The Gold Report: Greg, at the MoneyShow Las Vegas on May 16, you will present the report “Three Tipping Point Triggers to a Massive Surge in Natural Resource Stocks.” Can you give our readers a preview?
Greg Dorsey: We are in a secular bull market in commodities that started in 2001. These tend to run 15 to 20 years, so we are in an interim period now. Three factors will make the next leg of this bull market spectacular: resource shortages, resource nationalization and resource inflation.
Looking at shortages, on the demand side, emerging markets—most notably China—are creating unprecedented demand. People in these countries aspire to Western consumption standards: cars, high-rise apartments, air conditioners. This situation is similar to where Japan or Korea was back in the late 1950s and early 1960s. They still have a long way to go to catch up to the Western countries.
The supply-side picture is grim, but bullish for commodity investors. We hear a lot about peak oil, but it is resources in general, not just oil. Copper and silver ore grades have been plummeting for decades. Copper is important for wind energy and for a smart grid needed to deliver solar power from the desert and offshore where wind power is generated to the urban centers where it is consumed. Silver is important for solar power.
Resource nationalism relates to the situation that the countries that host these minerals want a bigger slice of the pie. Prices are rising and governments are taking more in the form of taxes and royalties. This is most pronounced in South America in Venezuela, Argentina and Bolivia. In Argentina, for example, we’ve seen assets expropriated, companies can’t lay off workers, and if a company wants to bring in mining equipment, it has to export an equal dollar amount of Argentinian goods.
This puts companies in a tough bind and they are more reluctant to set up operations in Latin America. This will reduce global output in the long run.
TGR: What about resource inflation?
GD: Resource inflation stems from living in an interconnected world. When the price of oil goes up, it leads to higher costs for extracting coal, which increases the cost of making steel, which leads to higher steel prices. The circle feeds on itself.
We have seen a dramatic rise in the cost of extracting resources. That will continue. The marginal cost of an ounce of gold right now is well over $1,000/ounce ($1,000/oz), probably closer to $1,100–1,200/oz. That will continue. These shortages will draw prices higher and higher.
At the same time, we are drowning in debt, and are trying to inflate our way out of it. Recently Japan announced a dramatic increase in its version of quantitative easing. The U.S. and the European Central Bank are doing it, too. If we print enough dollars, yen or euros, the hope is that will spark inflation, which will make paying down that debt so much cheaper. At the same time, it will cause inflation in resources.
TGR: In light of the dramatic declines in the last week, it would take a surge in natural resource stocks to recoup the value lost over the last two years. In percentage terms, what kinds of gains are we talking about, and in what timeframe?
GD: When it will really take off is hard to say; prices could stay flat for another year or two.
We will probably have 6 to 12 months of relatively benign inflation, seguing to double-digit inflation. Looking out over the next decade or longer, the price increases will be spectacular.
I mentioned earlier that these cycles tend to go on for extended periods. The biggest gains typically happen in the latter half of the cycle. If you think back to 1965–1980, the biggest gains in commodities happened at the tail end of that cycle.
TGR: Your thesis on gold relates to some extent on the proliferation of global debt and the efforts to drive currencies ever lower. Does your thesis extend to supply-and-demand fundamentals, too?
GD: It is both. Steve Leeb and I outlined what is going on in China in a book we wrote, “Red Alert.” China’s leadership recognizes the problems resource shortages present and is taking steps to prepare. China is the world’s largest gold producer, and it does not export a single ounce; it is a big importer as well. We think China is moving toward a currency that is at least partially backed by gold. In a world of countries printing money from here to eternity, we will need a medium exchange like gold.
TGR: You identified Venezuela and Argentina as examples of resource nationalism. But what about jurisdictions like Canada that are quietly raising taxes and royalties and reducing tax writeoffs?
GD: That will be a problem. It will cut into corporate returns, but it is inevitable. Canada is headed in the wrong direction, but the returns to be had there still make it worthwhile.
TGR: Will it happen in the U.S.?
GD: The U.S. is probably the best place to do business, and it is the third-biggest gold producer in the world right now. The cost of leases and royalties paid by companies for mining on U.S. government-owned lands is quite low. Increasing these fees would be an easy way for cash-starved Washington to raise revenue. I expect these fees to rise in the future.
TGR: What resource plays do not fit your thesis? Where should investors fear to tread?
GD: They have to tread carefully in Latin America. Chile is OK, but other countries are more dicey. Central Asia has problems. I would be careful in Africa, even in South Africa. The cost of doing business there is rising dramatically. There are problems with labor unrest and chronic power failures.
Investors still have plenty of good choices in safe jurisdictions like Canada, the U.S., Mexico and Australia.
TGR: Are there specific types of commodity plays investors should avoid?
GD: We are leery about some of the unconventional oil plays here in the U.S., like the Bakken. These companies have done a tremendous job of extracting oil, but are not earning back their cost of capital. They have to drill constantly and will soon run out of good targets.
TGR: What should investors own to protect themselves?
GD: Start with physical metals. Buy coins or bullion if you want to store your own, or use an exchange-traded fund (ETF).
While bullion and ETFs offer good downside protection, they do not offer the upside return of equities. So, physical metals should be only part of a portfolio. You will do better with the leverage that stocks offer.
TGR: What is the equity mix in your ideal portfolio?
GD: I would avoid the largest companies, such as Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Newmont Mining Corp. (NEM:NYSE). Because they are so big, they will have a difficult time increasing their reserves. They cannot do it with picks and shovels any more, they will have to do it through the boardroom.
You are better off with a smaller company where exploration can have a big impact on its reserve base: Near-term producers that are just starting up or those that are not mining yet. Their time horizon may be five to eight years before commercial production. We think you should look at these companies as a long-term option on the price of the metal.
TGR: What names do you believe offer value in a weak market?
GD: In the mid-cap gold space, Detour Gold Corp. (DGC:TSX) is a one-project company, but its Detour Lake property in Ontario is a good project. The company has Proven and Probable reserves of 15.6 million ounces (15.6 Moz). It just went into production and will probably produce 650,000 ounces (650 Koz) this year and annually. The mine will have a 20-year life span.
Because it is in production, Detour is less risky than companies that may be further away from commercial production. It has growth potential, too. Detour has outlined only a small portion of the property’s 330-odd square miles. The chances are high that it will be able to add to the reserve over time. This is an $11/share company and will earn $2–2.50/share next year.
TGR: You are a proponent of income investments. Detour will reach commercial production this year. Should it offer a dividend then?
GD: I think a dividend is a couple of years out. Right now, I would like to see Detour spend that money looking for gold to replace and increase its reserves.
TGR: Osisko Mining Corp. (OSK:TSX) leveraged its assets to buy smaller players with sizable gold assets. Do you see Detour taking that route?
GD: That is possible, but I think it has its hands full with Detour Lake.
TGR: What other equity names are you bullish on?
GD: Another producing company with good growth potential is New Gold Inc. (NGD:TSX; NGD:NYSE.MKT). The company has operating mines in Mexico, the U.S. and Australia. It will do 460–470 Koz gold this year. New Gold is cash flow positive and will probably earn $0.60/share. The company has the potential to double its production in the next five years or so at an all-in cash cost below $900/oz.
New Gold’s chief project is Blackwater in south-central British Columbia, which has more than 8 Moz Measured and Indicated. It is working on a feasibility study due out next year. Blackwater should produce about 0.5 Moz gold and a couple million ounces silver over a 15-year lifetime.
Longer term, its El Morro project in Chile is a joint venture with Goldcorp Inc. (G:TSX; GG:NYSE). New Gold has a 30% interest in the project. El Morro is on hold for environmental reasons that should be cleared up this year. Although it is several years from production, this copper-gold project is projected to average 90–100 Koz gold and 100 million pounds copper. At a byproduct cost, its costs are negative $550/oz or so; the copper will pay for the gold’s production costs.
The right people are running New Gold. Its chairman is the former president and CEO of Barrick Gold. Pierre Lassonde of Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) is on the board and is one of the largest shareholders.
New Gold is making money right now and it has an excellent balance sheet. It is running around $6.75/share now and it has $1.50/share in cash. This stock has held up much better than a lot of small- and mid-cap shares.
TGR: Are you bullish on Franco-Nevada, too?
GD: We are. If you look at it just on a price/earnings basis, you will scratch your head and wonder why you would pay up for something trading 30 times earnings. But the company has done an incredible job of sussing out good properties. It puts up money to advance mine development and it streams for the life of the project.
TGR: Franco took a different tack in 2012 when it invested in the Weyburn oil field in Saskatchewan. Is that the start of a new path?
GD: Yes. I think precious metals represents about 90% of its revenue right now, but Franco wants to move into other commodities.
As I said earlier, we are concerned with resources in general. Oil certainly plays a key role. We think prices do not accurately reflect scarcity value in resources.
TGR: What did you think of Franco’s $1 billion ($1B) investment in the Cobre Panama gold stream?
GD: It is a difficult environment to operate in, but it is a huge mine. We see copper prices heading much higher. It currently is trading in the $3.17–3.30/lb range, and we see it at $10–12/lb in just a few years. Cobre Panama could be a big winner for Franco in the next decade.
TGR: Why do you think $10/lb copper is a possibility?
GD: Ore grades are down to next to nothing, and explorers are not finding many significant deposits to replace what is being mined, despite going to extreme locations to find it. Getting back to demand, wind turbines require a lot of copper, as do the smart grids that control distribution.
TGR: Is that growing demand for green energy the twist on China in your investment thesis? We have heard the China investment thesis will go on for 10 or 12 years.
GD: Very much so. China continues to dramatically raise its targets for wind and solar installations. It plans to install many gigawatts (GW) of power in just the next few years. To give you an idea of the stunning speed with which China is moving into solar, consider that little more than 18 months ago the country targeted 5 GW of solar capacity. A few years earlier, solar was nothing more than a footnote on the Chinese energy landscape. It’s now targeting 40 megawatts by 2015—only two years from now. That means China will achieve roughly the same installed solar capacity that existed in the entire world just two years ago. It’s a similar story with wind power. China will need a lot of copper to do that and silver for photovoltaic solar. There is not enough copper or silver to meet Chinese demand without pushing prices much higher.
TGR: Silver prices have shown weakness lately. Is that a short-term issue?
GD: Yes, and it is not strictly focused on silver. You see weakness in copper, platinum and palladium, too. There are concerns about where growth is headed.
TGR: In your ideal portfolio, where do you get exposure to silver?
GD: From Tahoe Resources Inc. (THO:TSX; TAHO:NYSE) in Guatemala. It just received the final exploitation permit needed to move forward with its mine and should be in production in
This is a large project, rich in silver. It works out to 13–13.5 oz/ton ore and is one of the highest-grade deposits around. Once the mine is up to speed, it will produce 20 Moz/year, without the gold, lead and zinc in the mix. It also will be one of the lowest-cost producers around.
You have good, smart management. Kevin McArthur, a former CEO of Goldcorp and Glamis Gold Ltd., is running the show. Goldcorp still owns about 40% of Tahoe. We suspect that Goldcorp may want to get back into silver in a couple of years and will want to take this over.
TGR: I was thinking that last permit approval might clear the path for other suitors. Do you see Goldcorp as the eventual buyer?
GD: Not necessarily, but owning 40% of the shares puts it in the best position.
A lot of companies with large asset bases will be targets at some point. Recent firings in C-suites across the industry have made firms much more conservative. Given current market behavior, companies are not inclined to acquire right now. Once prices head back up, which they will, we will see more activity. Tahoe would make a good target.
TGR: You also are bullish on platinum group metals (PGMs). What is your investment case there?
GD: Palladium and platinum are primarily industrial metals, but they also act as a store of value. Scarcity value is not reflected in PGMs either. There may well be 15 times more gold in the world than there is platinum and considerably more gold than palladium. Yet palladium is selling for less than half the cost of an ounce of gold.
TGR: Leaving lots of upside.
GD: Incredible upside. Palladium is used as a catalyst, primarily in autos. While auto sales are flat in the U.S. and Europe, they will top 21 million this year in China. One out of four new vehicles is now sold in China. In just a few years, the number of light vehicles on the roads will have increased by about 25%. All of them will need catalytic converters that use palladium.
TGR: One hurdle to exposure to PGMs is that most of the miners are based in South Africa, a very risky jurisdiction. How do you get around that?
GD: You do not have to go far. Here in the U.S., you can buy an ETF’s physical palladium shares. Each share represents 1/10 oz/palladium.
If you want more leverage, buy Stillwater Mining Co. (SWC:NYSE), the only domestic, producing palladium miner in the U.S. with two mines in Montana. It is much more leveraged than the metal itself. It is pulling 0.5 Moz/year out of the ground at a cash cost around $550/oz. and has more than 15 Moz in reserves.
Stillwater also has a pretty big PGM-copper project in Canada in the permitting process that could add reserves down the road. It acquired a copper-gold-molybdenum mineralization in Argentina a couple years ago. It has no current plans there, but we see it as an option on the price of copper.
TGR: The price of copper or the price of PGMs?
GD: In Argentina, it is a copper play.
Stillwater should earn $0.40/share this year, rising to $0.75/share next year. If metals prices rebound, that figure could be much higher.
TGR: The companies you are talking about tend to be producers with very large mines or project pipelines. Is that what you look for in mining equities?
GD: Most certainly. We do have some stocks that are years away from mining. In those cases, we look at them as being an option on the price of the metal.
TGR: What exploration plays do you follow?
GD: NOVAGOLD (NG:TSX; NG:NYSE.MKT) has a $1B market cap. Its flagship project is Donlin, which it is developing with Barrick in Alaska. This high-grade deposit has close to 40 Moz gold. It is going into the permit stages and is years away from production. The stock is currently trading at the very small faction of the value of its reserves, offering tremendous leverage on the way to those reserves being extracted. A lot of smart people, including very successful hedge fund managers, like NOVAGOLD.
TGR: Paulson & Co. Inc. and Vinik Asset Management have significant positions. Does it add a measure of confidence when companies with significant amounts of capital are vested in a company like NOVAGOLD?
GD: Definitely. We think this will be a $30 or $40 stock at some point.
TGR: What about playing NovaCopper Inc. (NCQ:TSX.V; NCQ:NYSE.MKT), its spinout company that has the Ambler copper asset?
GD: NovaCopper has a large reserve base that will take years and billions to develop. Again, you should view it as a long option with no expiration. It gives you considerable leverage to the copper price.
TGR: Are you following any other exploration plays?
GD: We like Pretium Resources Inc. (PVG:TSX; PVG:NYSE), which was spun off from Silver Standard Resources Inc. (SSO:TSX; SSRI:NASDAQ) a couple of years ago. The company has a high-grade gold resource in British Columbia.
Pretium’s two projects are located side by side. Its Brucejack project has 8.5 Moz Indicated and more than 16 grams/ton. A feasibility study is due out in a couple of months. This will be a long-life mine with relatively modest capital expenditures. The property has not been fully explored and could add substantially to the reserves over time.
The Snowfield project has a low-grade deposit of copper and gold. Development there is at least a decade off, but it could add to the company considerably.
The stock is down by half in the last six months for no fundamental reason other than gold has come down and pessimism has gone up.
TGR: Its 52-week high was $16.70/share; it is now $5.79/share. The Valley of the Kings deposit has 8.5 Moz gold Indicated and 2.9 Moz Inferred. The underground feasibility study is due out in Q2/13. Should investors take a position before the study is released or does that matter?
GD: The report could disappoint, but that is unlikely. The stock has a very low market cap given its known reserves. We think investors will be well rewarded over the long haul. And the chance of an upside surprise with additional reserves remains.
TGR: Do you have any parting thoughts for us?
GD: We are in an interim period in a secular bull market, unlike any bull market we have seen in the past. If you look at the last great bull market in gold stocks, from 1976–1979, gold increased 100%. At the tail end, it took off and rose 400% in 13 months. The gold shares, including the smaller ones, did considerably better. Many of them rose 20- or 30-fold. Looking out 10 years, we see that same potential, if not greater. There may be more pain first. Gold could trade lower, but any decline will be temporary and patience will be rewarded.
TGR: Would you be willing to ballpark where gold could be headed?
GD: Certainly to $5,000/oz, possibly closer to $10,000/oz over the next decade.
TGR: What about silver?
GD: We see silver trading above $100/oz before this decade is out.
TGR: If gold hits $10,000/oz, is the world still stable?
GD: We are in an unstable world that is likely to be more unstable. In an era of resource scarcity, nations will be more aggressive. We see that between China and Japan over those little islands in the middle of the East China Sea where there is oil underneath the waters.
Given that countries are printing money as rapidly as they can, we will need a trusted medium of exchange. Precious metals are the logical way to go. We see incredible upside for the metals themselves.
TGR: Greg, thank you for your time and your insights.
Greg Dorsey will be speaking at The MoneyShow Las Vegas May 16.
Greg Dorsey is editor of Leeb’s Real World Investing and a contributor to several other Leeb Group publications, including The Complete Investor. Dorsey has spent more than 25 years analyzing stocks and writing on an array of investment topics. He specializes in providing readers with in-depth analysis of undervalued resource stocks and small cap shares. Dorsey also serves as a portfolio manager for a New York-based investment firm. Before joining the Leeb Group team, Dorsey ran an investment management firm that he founded. Prior to that, he worked for more than a decade at a leading investment newsletter publisher, researching stocks and providing clients with expert investment advice. With Stephen Leeb he co-authored “Red Alert: How China’s Growing Prosperity Threatens the American Way of Life,” which was honored with a prestigious Axiom Business Book Award for 2012, recognizing it as one of the world’s best business titles published during the year.
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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: Detour Gold Corp., Goldcorp Inc., Franco-Nevada Corp., Tahoe Resources Inc., NOVAGOLD, Pretium Resources Inc. and Silver Standard Resources Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Greg Dorsey: I or my family own shares of the following companies mentioned in this interview: None. I personally or my family am 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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