The world’s economic woes may be far from over, but deflation or inflation, gold is as good as it gets, according to Jay Taylor. Jay, whose passion for the king of metals prompted him to pursue geological studies after earning his MBA in finance and investments, has established an enviable track record in the markets. According to webeatthestreet.com, “J. Taylor’s Gold & Technology Stocks Model Portfolio has more than tripled its value since January 2000 while the S&P 500 has barely moved.”
After a career in commercial and investment banking, Jay now devotes himself full time to researching stocks and producing widely acclaimed publications that have evolved into his weekly Gold, Energy & Technology Stocks newsletter. In this exclusive chat with The Gold Report, he talks about how gold has not only sustained but strengthened its purchasing power vis-à-vis other metals and commodities, tells readers what he watches for when he evaluating companies and explains why the time may be ripe for picking up gold stocks while they remain at bargain-basement low prices.
The Gold Report: It seems we are moving into a deflationary environment. What's your take on what's going on, and what it means for gold?
Jay Taylor: My view of the markets in general changed very dramatically with the Lehman failure in mid-September. That’s when we had a real sea change, a real tipping point, if you will, from an inflationary environment to a deflationary environment. This deflationary environment is really changing things dramatically. We’re being much more selective with base metal projects and gold projects, as well as uranium. Since the decline started in the financial markets and in the commodity markets, I’ve shifted my major focus to gold mining. I think that’s where the most money is going to be made. The economics for gold mining look outstanding at this point.
TGR: You mentioned the deflationary environment. But doesn’t gold normally perform best in an inflationary environment?
JT: That’s what people think. Frankly, gold mining does absolutely the best during a deflationary environment. Let me give you some examples as to why that’s true. Since the Lehman collapse, an ounce of gold buys 125% more oil than before the Lehman collapse and that was only the middle of September. Since then, an ounce of gold buys 128% more copper than it would have bought on September 12, and 90% more of the Rogers Raw Materials (Rogers International Commodity Index). The real price of gold has risen dramatically and does tend to rise dramatically in a deflationary environment. That was true in the 1930s and especially since the Lehman collapse it looks to me that it’s true now.
There’s a pretty good reason for that. People buy gold because it is natural money. They would always use gold—and silver to a lesser extent—if they were allowed to choose the money they use as the medium exchange. We’re not allowed to. Government tells us we have to use paper money. That’s why it’s called fiat; it’s the money by law, not by market. But when people lose confidence in the fiat currency system, they go to gold. In nominal terms, it’s true that gold is down from its highs. But, as I said, in real terms, in terms of what an ounce of gold will buy, it will buy a lot more than it would have a little while ago.
We’re also seeing, in the gold mining sector, lower labor costs. Part of the reason is that with copper collapsing in price, with zinc and lead and all the base metals coming down so much, a lot of the base metal mines are closing down and laying people off. That makes lots of labor available now for gold mining and any kind of mining—but gold mining is the one that’s thriving and doing better. I expect to see some very much better earnings reports coming out from the major mining companies starting the fourth quarter of 2008.
TGR: As you pointed out, in nominal terms, gold is holding its own and it does appear that we’re in a deflationary environment. But is this environment likely to be a short-term blip? Won’t the current printing of dramatic amounts of U.S. dollars push us into an inflationary environment? So are we looking at an investment strategy now that’s really only going to be a couple of months in duration?
JT: That remains to be seen. I’m not convinced, as many of my gold bug friends are, that printing money has to necessarily result in an inflationary environment. If you go back and look at the 1930s, and if you’ve read Murray Rothbard’s book (America's Great Depression, first published in 1963, fourth edition published in 1983) and various accounts of the 1930s, it seems to me the policies that we’re pursuing now are not exactly the same, but basically the same and to a much greater extent now than in the ’30s.
It comes down to the question of whether you believe Milton Friedman and Ben Bernanke that they just didn’t do enough fast enough in the ’30s. They did everything they could in the ’30s to avoid the deflation. They were not successful. In fact, Roosevelt’s New Deal was a major flop, propaganda and contrary opinion notwithstanding. It wasn’t until the U.S. involvement in WWII that the economy came out of the Great Depression. By that time excessive debt had been repudiated, setting the stage for a recovery in any event. But the intervention of Roosevelt prolonged the Depression.
We have a debt situation now that is far greater—far, far greater than it was in the 1930s. We have something like 350% of GDP now in total U.S. debt, where it was like 270% at the peak in 1932. And, by the way, that peak of debt to GDP resulted primarily from a collapse in GDP. So far, we haven’t seen a collapse in GDP this time, although it’s starting to look like we may be facing that now, and we have this enormous indebtedness. What people have to realize is that debt is deflationary by its nature.
So in a way, the policies that are being put into effect increase that debt, which is the root cause of our problem because fiat money is debt money. Unlike gold-backed money, unlike silver-backed money, it’s not asset money. It’s money that’s created out of thin air through the creation of debt and debt is growing exponentially. If you look at the growth of debt relative to GDP—and this is a slide I show frequently in my talks—debt is growing exponentially and GDP is growing in a linear fashion. Actually, of course it’s not growing at all now; we’re in a recession so we’re having negative GDP growth. Sooner or later, we will not have the ability to meet those debts. So the argument is, do we inflate, can we print so much money that we just overcome the debt by debasing the currency, by making the units of currency worthless that we pay the debt back in.
I’m not convinced that they’re going to be able to do that and we’re seeing now the enormous amounts of money being put into the banks, but the banks aren’t lending. This is exactly what happened in the 1930s; the banks would not lend. Why are they not lending? Well, they’re looking around for credit-worthy borrowers and they can’t find many because the easy credit conditions, especially during the Greenspan years, resulted in a virtual default of a very large percentage of American consumers. The corporations aren’t in as bad a shape, at least not yet, as we are now just entering a recession. But because individuals borrowed beyond their ability to pay we now have a U.S. landscape littered with insolvent consumers.
The mining industry is having quite a time raising capital. I think that’s going to change with the gold mining industry. I’m seeing evidence just within the past couple of weeks that some very worthwhile gold projects are going to get funded. I think where the return on investment is outstanding, where the risks are low, we’re going to start seeing some life breathed back into the economy. But, quite frankly, in the mining sector, the only place I’m seeing any real ray of hope there so far is in the gold. Again, this is for the reasons I mentioned a moment ago; the economics are improving with the cost of production going down very dramatically relative to the price of gold.
TGR: You say the economics of mining are working well because other base metal miners are stopping projects so more workers are available. Is that true worldwide or is that a U.S. phenomenon?
JT: I don’t know to what extent that’s happening but I know it’s happening in North America. There certainly is anecdotal evidence. For example, Sangold Corporation has a very exciting gold mining project in Manitoba. A few weeks ago, when I was talking to Dale Ginn, the CEO, he said that the economics are improving drastically because to a great extent, energy costs have come down, but even more significantly because he now has an abundance of labor. When I went to visit that project a year and a half ago, one of the major problems they had in Manitoba then was a shortage of labor. Well, Dale said that he just hired two geologists, two mining engineers, and 12 underground miners who were begging for work because they were laid off from their base mining operations.
You see, copper prices collapsed and a collapsing copper price suggests that global economic growth is slowing down and doesn’t look very bright. Copper is sometimes referred to as “Dr. Copper” because its price foretells global economic activity. We’re looking at a copper price of about $1.40 now, when it was up close to $4 not that long ago. So with the prices falling that drastically, the base metal mines are shutting down.
But again, gold will buy more than twice as much copper as it did two or three months ago, twice as much oil as it did two or three months ago. Gold has come down in nominal terms from its all-time high of slightly over $1,000; it’s around $800 or so now. But in percentage terms, its value has risen, and the margins are improving because the cost of production hasn’t come down nearly as much as the price of the metal itself.
TGR: So we can assume that you’re more bullish on gold than you were six months ago.
JT: Yes, I’m more bullish on gold. I’m much more bullish on gold than uranium too. When you have a boom period, people don’t want gold too much. Everybody’s happy because everybody’s making money and there’s no worry about credit and all of that. But when you start to have a problem and the credit markets seize up as they have now, then people go to the ultimate money—gold—but not until they completely give up on paper.
Now, for goodness sakes, people are buying Treasuries and actually getting negative yields or zero yields because they have no confidence in the highly leveraged monetary system. People are lending their money to the government and saying, “We don’t want anything; we just want our capital returned.” Ultimately they go to gold because its value is intrinsic—unlike paper money, its value is not dependent on the ability of people to pay their debts. And by the way, low to negative yields are extremely bullish for gold. An excuse for not buying gold has been that it provides no yield. Well, now U.S. Treasuries provide no advantage over gold even in that respect.
If we start to inflate, as you were suggesting, it could be a concern and I don’t disagree with that. If we start to inflate, the dollar loses its value and then I think you see people fleeing from Treasuries and going into tangibles of one kind or another, including gold. But that doesn’t mean the economics of gold mining will improve with inflation because the cost of producing gold, unlike now, might rise faster than the price of gold. The nominal price of gold would likely rise; but profit margins may or may not rise along with a higher price of gold.
For example, in March of 2008, when gold was briefly over $1,000, mining company shares were not performing very well and I believe the main reason was that their profits were being squeezed. They were reporting disappointing earnings because the cost of energy, the cost of labor, the cost of steel, capital costs in building projects were going up very much more rapidly than the price of gold was going up. Now the opposite is happening.
The system becomes very illiquid at that point when the debts can no longer be repaid. That’s clearly where we are now. Debts cannot be repaid; there’s an implosion of the credit system, forcing people to sell everything they can get their hands on. But gold is under the least amount of pressure because as that happens, the price of gold gains versus everything else.
We need to liquefy the system. When we bottom out, when we get all of this debt behind us and it’s repudiated and wiped out of the system to the point where we can start to grow again in a healthy way, then I would expect to see some of the other things—the base metals and all those other items—coming back.
TGR: Can you give us some examples of projects you're looking at these days?
JT: We’re really looking at gold mining projects and companies that have the best potential. First of all, that would be the majors that are producing cash flows and earnings, such as Agnico-Eagle Mines, Newmont Mining Corp., Goldcorp and Yamana Gold Inc.—those major producing companies that are doing well.
And then from those down to the juniors that are evolving into production—Sangold, New Guinea Gold Corp. Some of these are really off the radar screens of most serious investors, but they’re really starting to produce and perform well. And if they can generate their own capital from cash flow, then they don’t need to worry about financing in a world that is very, very difficult from which to gain financing.
TGR: Your discussion about the cost of mining coming down dramatically implies that they’re already producing.
JT: Yes, it does. Take an example such as New Guinea Gold, which is a favorite of mine that is producing from its first mine now, Sinivit, in New Guinea. It’s had some startup problems, but it looks like things are starting to pick up. The first mine is a small one. It will produce 36,000 ounces a year, but at a cost of under $200 an ounce. They have a second project that is really a major deposit, high-grade, open-pit, low-cost target that should be very profitable.
They’ll take the cash flow from the Sinivit mine and use that to build and develop this world-class deposit that could host between 3 to 5 million low-cost ounces. Because New Guinea is off the radar screen and because of the credit implosion, this company is selling at a mere 15 or 16 cents and a market cap of under $30 million. We see a possible $3 or $4 number in that stock primarily on the basis of the high-grade gold they have on the second project.
TGR: Can you share some more of these advanced stage gold juniors?
JT: Let me say a little more about Sangold. Its mine in Manitoba is now producing, and should be producing cash flow positive results by the end of this year and growing its production very substantially over the next two or three years. In addition, it has recently discovered a very high-grade deposit there that actually could rival the Red Lake deposit that was Goldcorp’s company maker. So Sangold is another company with cash flow now that it can use to fund its growth now when equity is so expensive or even impossible to obtain. It can now grow its business from internally generated cash. That's the ideal given current market conditions.
TGR: How about those that are promising but not yet producing?
JT: As for projects going forward, when they start doing the feasibility studies, they will be looking at energy costs, the cost of labor, the cost of all the inputs. Because it is such a difficult market now, share prices have been obliterated. I’m looking at Luna Gold Corp. as a company on my list, for example. The company’s market cap is only $7 million now. It’s got a bankable feasibility study to produce about 60,000 ounces at $422 in Brazil. When you’re looking at prices, if you figure $800 gold, it would throw off an annual $28 million in operating cash flow over a minimum of eight years. So its current market cap is a mere 25% of a single year’s cash flow. That’s what I call ridiculously undervalued!
I think Luna and a lot of others are going to be targets for takeovers. Especially bigger companies, bigger projects will be attractive to majors unless we see a revival of the share prices of these junior and they can then start to raise their own capital, to put their projects into production. Luna is selling at 10 cents a share. To raise $47 million, which is what it needs to raise to build its mine? At 10 cents a share, it’s just not going to happen.
I think a lot of these juniors that have advanced stage gold projects look like they’ll be very profitable on the basis of bankable feasibility studies. Again, though, if they can’t raise their own capital, I think they’re going to be takeover targets of some of the cash-rich gold mining producers.
TGR: Where do you stand on AuEx Ventures ?
JT: AuEx is a very interesting company. They are earlier stage company, but I believe that AuEx is on to a major discovery, at least one and possibly two. They don’t necessarily expect to be a producer. They are mine finders. They have a very good business model, a very conservative business model that has other people spending money to earn in to very good projects. AuEx is headed by Ron Parratt (as CEO) and some other very strong operators who picked up some very good exploration prospects and they’re developing those properties.
At least one of them looks like it will be a world-class project. Another one is joint-ventured with Agnico-Eagle and that one is also starting to look very exciting. My sense of AuEx is that they’re on to at least one and possible two major deposits. Then I would expect that they’ll get carried into production or work an arrangement, a joint venture or a share deal or something down the road. AuEx has a very low market cap. It's under $30 million so I think its share price potential is huge in percentage terms from here.
TGR: Any others?
JT: In terms of companies that can soon go into production, I love Romarco Minerals. Like so many others, it’s selling for peanuts at this point, but Romarco has 1.5 million ounces at the Haile mine in South Carolina, of all places. This mine was actually in production in the 1980s by Piedmont Mining. And Robert Friedland headed a company nearby that was a larger scale producer. The region is economically depressed and from what I understand, the permitting process is going along even better and with more speed than in mining-friendly Nevada. . .looks like it could produce gold at $350. Capital costs should be relatively modest. $800 gold, costing $350 to produce 100,000 ounces per year should result in a very robust gold mining operation. Romarco’s market cap is something like $28 million.
TGR: Anyone else?
JT: ATW Gold Corp.is one that’s in Australia that looks really good. ATW Gold is expecting to be a producer in Australia next year. Interestingly enough, they raised some capital, I think, in U.S. dollars and kept it in U.S. dollars. With the surge in the U.S. dollar compared to the Australian currency, they were able to convert those U.S. dollars into Australian dollars without having to raise more capital to build their mine.
TGR: That’s great.
