Using Gold and Silver Stocks to Survive Debt Deleveraging Deflation
Commodities / Deflation Jul 15, 2010 - 01:43 AM GMTBy: The_Gold_Report
Newsletter Writer Michael Berry, PhD, is one of the most respected economic strategists in America and a frequent to contributor to The Gold Report. On this occasion, Michael's son, Chris, joins the discussion and shows he's clearly a chip off the Berry block. Among other things, the Berrys discuss the growing fears of deflation as well as several promising junior gold plays in Colombia and the Yukon. It's all part of their "three legs of the survival stool" approach to investing that you will learn about in this exclusive interview with The Gold Report.
The Gold Report: People are hearing and reading about the potential for deflation. On its surface, paying less for everyday items seems like a good thing, but please paint us a picture illustrating why we should all fear deflation.Michael Berry: I want to point out that deflation isn't foreordained; it just looks likely. Given the history over the last two or three years, where there's been a lot of money printed, some people have assumed that we would hyperinflate. But when you look at the macroeconomics in the U.S., you see almost 10% unemployment and in various groups it's much higher. It really looks like we're not going to pull out of this, and then you have the overhang with respect to debt. There's a lot of potential for deleveraging, for a higher dollar, as dollars are sought to deleverage.
People fear deflation because basically, nobody's really experienced it since the Great Depression. Central bankers think they can do something about inflation; Paul Volcker did in the early 1980s, but central bankers don't really have tools to deal with deflation. Deflation occurs when the money supply shrinks; prices tend to fall in a deflationary environment, and there's not very much you can do except let it run its course. This is very painful.
The other aspect of a deflationary environment is that if you have a lot of debt, either public debt or corporate debt, deflation works against you. On the other hand, inflation works for the debtor; deflation works against him. In that kind of environment the system wants to deleverage, and consequently asset values fall, demand for dollars rises as the system deleverages. The value of the dollar increases; interest rates tend to fall. Basically, the bond market strengthens but not the stock market. It also introduces a completely different investment scenario for individual and for institutional investors.
TGR: If such a scenario did occur, how long would it last?
MB: That's really a tough question, but a very important one. If you talk to some of the top economists, such as Professor Krugman, who believe that we're going to head into a deflationary spiral, the consensus is two to five years. We're probably a year into that now. When you look around and you see what's happening with Greece and the European banking system, the overhang on growth is significant. You're going to witness significant austerity programs in Europe; growth is going to be restrained. And perhaps the only place on earth right now that wants to continue fiscal spending is Washington. Of course, if you look at the Japanese situation, starting in about 1990, they've never really been able to inflate out of their problem. Deflation can last for a very long time if bankers don't get hold of it.
You remember back in 2002 then Fed Governor Ben Bernanke said we could cure deflation because we have a printing press, meaning that we can print dollars. They've tried to do that and it's failed. The fiscal programs they've put in place really have not worked to restore growth, and it does not look as if they're going to.
TGR: Given what you said about deflation being a problem for those carrying debt, it seems deflation would be have a larger impact on the U.S. than other nations.
MB: That's an interesting thought; actually, because we have the world's reserve currency, we can continue to borrow for a while. But at what point does the rest of the world say, "No, we're not going to bank the dollar anymore?" Then, the level of deficit and the debt to GDP ratios become very, very large and serious. No one knows when that tipping point in the U.S. is; that's the problem.
TGR: What would happen to gold in a deflationary environment?
MB: I am not sure. Most people would say that gold works well in an inflationary environment, and it appears to, because it holds its value well; at least some gold stocks did well in the Great Depression. I think there's another rationale in this particular environment we're in now; gold isn't necessarily being viewed as either a deflation hedge or an inflation hedge, but more likely a flight to safe currency or real money. In other words, gold is becoming money because of what people are finally beginning to understand. People distrust the euro. They really don't trust the yen. They don't trust the Chinese yuan; and people are slowly but surely losing trust in the U.S. dollar. I think under a nascent deflationary environment that we have now, where gold is around $1,200, it's more a flight to safety than a hedge against deflation.
TGR: In July's Morning Notes, you refer to having precious metals exposure in an ever-weakening economy as another leg of the survivor stool. In your view what's the best way for investors to gain precious metals exposure?
MB: I think it's pretty critical that you look at what's happening with fiat money. We've only been on fiat money since 1971, thanks to President Nixon. That's 39 years now, and you know fiat money is going the way of the wind. I think you've got to have precious metals, either silver or gold, preferably gold, and you need to have some in-kind. I think you need to own coins or, if you can afford it, some bars and also some exposure to some top-quality stocks. For instance, Goldcorp Inc. (NYSE:GG; TSX:G), or Kinross Gold Corporation (TSX:K; NYSE:KGC) or some precious metal stocks like that. Silver stocks as well, such as Silver Wheaton Corp. (NYSE:SLW;TSX:SLW), Endeavour Silver Corp. (NYSE:EXK; DBF:EJD; TSX:EDR) or Coeur d'Alene Mines Corporation (NYSE:CDE; TSX: CDM).
TGR: Yes, you're big believer in silver.
MB: We've spent a lot of time analyzing silver. I was involved in a big gold-silver find a few years ago, which was Penasquito, and that is now over a billion ounces of silver. I think silver is undervalued. Silver was the original money, if you will, that was used in the ancient days. The Greeks used silver from Laurion to defeat the Persians and restore democracy in Athens in the fourth century BC. When FDR sponsored the special silver purchase in 1934 some academics believe he broke the back of deflation. I think silver is very much undervalued, and it will be pulled along with gold. It's very wise to have silver exposure, and with silver you can actually afford to own it in-kind. You can own silver coins. We've seen silver go from $4 maybe eight or nine years ago to about $18 today. Silver hasn't performed quite as well as gold, but it's moved up well.
Chris Berry: Silver's one main difference from gold is that silver is an industrial metal as well as an investment metal. It sort of depends on your view of where you think the markets are going, but the "poor man's gold" is certainly one way to accumulate hard assets and protect against some of these geopolitical hiccups.
TGR: Going back to Michael for a second, what are the other legs on that stool?
MB: After I came out of academia and spent some time on Wall Street, I began to realize that despite the fact that some of these markets were moving up significantly, we still had the potential for a deflationary depression. I don't think we're going to have a depression, but certainly we could have a double dip here, so we developed what I believed would be an investment approach for all seasons. We called it a barbell. At one end of the barbell you want to own precious metals, primarily gold and silver, in the forms that we talked about. At the other end you want to be in cash. Deflation is much more likely today than it was a year ago. Following a two-to five-year hiatus of deflation, I think we could inflate out of this and have very high rates of inflation. The barbell portfolio could conceivably work in all economic "seasons."
Essentially, precious metals and cash were what I call two legs of the survival stool at this point.
And then, of course, the third leg. Discovery is going to go on because we have to continue to make discoveries in high tech, resources and biotech. I think you need to own a discovery portfolio that's suitable for your risk preferences, and that's the third leg of the stool.
TGR: You're slated to talk to the Fed about emerging economies, which provide the high percentage economic growth that investors want. Can you tell us a little bit about the importance of emerging economies and some highlights from your presentation?
MB: You're beginning to see the impact of debt, the overhang of debt, spread to the rest of the world, particularly in Europe. Some of the dangers are coming from countries such as Greece, Spain, Italy and Ireland, and perhaps Austria and France as well. The banking systems are being stress tested, but no one believes the test will be strong enough. Other than Canada—which I think is probably held in the highest regard for not having allowed its banking system to go into freefall—the countries that appear to have weathered the storm are the emerging markets. Colombia, Chile, China, India, Brazil and probably Russia all obviously have a lot of natural resources and growing populations.
At this stage of the game, it seems that the engine of growth will come from the emerging world because the emerging world must provide its citizens, who have been denied a better quality of life, new opportunities. That is where the infrastructure build will be; demand for energy will come from this. I think the emerging markets are going to be very important to global economic growth in the next five to 10 years.
Chris, you're involved in that area.
CB: I would really echo what you said and add that emerging markets will be important engines of growth for arguably longer than the next five to 10 years. It may be perhaps 20 to 30 years, as the debt burden in the West—we are hopeful—slowly unwinds. Everybody talks about the BRICs (Brazil, Russia, India and China). A huge amount of growth has been, and still is, coming from those four countries in particular, but I see a number of other interesting plays out there as well, Colombia being one of them. Mexico has a lot of problems, but still some substantial economic growth potential from the mining industry there.
Going back to what we were talking about beforehand with deflation, every dollar of debt you issue is going to have to be paid back, and it ultimately can't be paid back with additional debt. It's going to have to be paid back with organic growth, and when you see China growing at 10% and India growing at 8% and Colombia growing at 4.5%, that's the type of growth an economy needs to sustain to ultimately maintain a healthy fiscal balance. The growth in emerging markets isn't debt-fueled growth the way it has been in the U.S. and in Europe. When you look at it from a standpoint of fiscal balances, it's definitely going to be the emerging markets that lead us out of this over the long run.
TGR: You mentioned Colombia running at 4.5% growth. Michael, you were born in Colombia. Tell us about what's changed in that country.
MB: I think what's changed is the leadership, and leadership is everything. There's been a freely run election; democracy is now in place. The drug problems are under control. I'm delighted; I've chaired a couple of Latin American mining congresses, and they care about capital coming into the country; they care about safety, about laws, about the environment. Colombia is rich in gold, uranium, emeralds and oil. Oil is another big area in Colombia now, which is where my father was working when he was there in the 1930s and 1940s. In fact, there's a really big stampede into the country to explore for oil. There's plenty of it there.
TGR: Perhaps we could have you back to talk about that black gold, too, for The Energy Report. Going back to the yellow metal for now, you mentioned a Colombian gold play the last time you talked with The Gold Report. Could you give us an update?
CB: Antioquia Gold Inc. (TSX.V:AGD) has a market cap of about $14 million today, and about 5,600 hectares in the Antioquia Department, which is near Medellin, Colombia. The centerpiece property is known as Cisneros. In 2009, they went through a fundraising and did about 4,000 meters of drilling. They're going to ramp that up in 2010 to 10,000 meters. They're about halfway through the year, and they're about halfway done drilling. They've got results on about 7,000 meters and are working to compile the data so they can issue a National Instrument 43-101 resource. As I understand it, the plan is to try to get this completed before year-end.
Antioquia likes to say that they really have their ear to the ground in Colombia. They're based in Calgary, but the overwhelming majority of the employees—I think 56 of the 60—are based in Colombia. When you have a company making a solid commitment to a region, creating jobs and giving back to the community, I think it's a plus to factor in when you evaluate investment prospects. If they can continue drilling and compiling data at this pace, I think in a year we're going to see some really interesting numbers.
TGR: They've hit some high-grade veins and this type of mineralized system tends to become higher grade as you go deeper, doesn't it?
CB: Yes, that is my understanding as well. I'm hoping the drilling they're continuing with for the remainder of this year will prove out your statement.
MB: When I was there in October, they were really probing these veins. I think the discovery process is all about staying on something long enough until you begin to understand it. My sense is they're now getting enough holes into the system in Antioquia Province that they're beginning to understand what it is. Antioquia really does have some nice assays coming back. The Golden Rule in mining is that once it starts to get better, it usually gets much better. It's a very cheap stock, just like most of these juniors being offered by the marketplace. It's a good opportunity.
CB: One of the other exciting things about Antioquia is that the majority of the drilling has taken place at Cisneros, but they have another 30,000 hectares sitting in the pipeline. Once they get their head around what they have in their current drilling program and come out with some positive results, they can move to this other 30,000 hectares. A land package like this, just a shade over five times larger than the area they're currently drilling, is a big competitive advantage, in my opinion. As we said before, good results tend to beget good results and so the company has itself in a good position going forward.
TGR: What are some other companies you like in Colombia?
CB: One in particular is Ventana Gold Corp. (TSX:VEN). We've been studying Colombia for a little while, and as a result, we came across these guys. They've been active there since 2006, and have mineral rights to about 4,500 hectares. They're located not terribly far from Antioquia, in the northeastern portion of the country.
MB: I think Ventana Gold has had some tremendous success with drilling. It's only a matter of time until they prove up a decent size ore body, and I think they will. I'm partial to them. The shares have been punished and it is a very good mature discovery stock selling very cheaply.
Another one I like is Galway Resources Ltd. (TSX:GWY). I did some work with them a few years ago. Rob Hinchcliffe, formerly an analyst for a large investment bank in the U.S., runs the company. Originally, the company started out with two or three properties that were molybdenum and tungsten, and I think Rob, quite rightly, caught the Colombiano bug. He speaks Spanish; he'd been in Latin America a lot in his previous profession and tied up some really interesting land. In fact, Galway has property that I think Ventana will want to have, and already is starting to get some great drill results there. Again, the stock is a little less than a dollar now. I think it's positioned to go higher. I very much like what they're doing.
TGR: How long would you hold these companies?
MB: That's a good question. In the discovery world, if you own a stock at $0.50 and it goes to $1.20, I think you have to take some profits, but you don't have to sell it all. My view is to take the money off the table, particularly in this environment, because this environment isn't really friendly. Ventana, Antioquia, Galway and probably another half dozen in Colombia are great to have in a portfolio, great for longer-term wealth creation simply because you know they'll drill more holes and get high-grade results because that's what Colombia is all about when it comes to gold. But the Golden Rule today especially is to take some profits.
TGR: Moving north, one of your Morning Notes had a little bit about the Yukon and how it's a hot play. You talked about three categories of discovery companies: incubator, mature and legacy. What are some Yukon plays in each of those categories?
MB: The Yukon is hot indeed. A huge gold belt goes through it called the Tintina Gold Province, where pretty high-grade gold is near the surface. And of course, it's in Canada. The stars are almost aligning. People want to go to Canada for a good reason; it's a stable country with great resources, and the Yukon is underexplored. I think in a few years this Tintina Gold Province will look like Nevada's Carlin Trend looked in the early days.
In terms of companies, Underworld Resources Ltd. (TSX.V:UW)—I talked to them in January when they had just had tremendously good results. Of course, they were taken out with about a 35%–40% premium shortly thereafter by Kinross.
Another one that's interesting now is Kaminak Gold Corporation (TSX.V:KAM); they're going to have a mine. They're getting great results. They're in the Tintina's White Gold belt not far from where Underworld was. This area was mined for placer gold, but it's never really been mined for lode gold. Now with all of the new discovery techniques that miners have, they're heading up there looking for the hard rock deposits—and finding them.
And then the final one, perhaps the best of the bunch, is an incubator that will move very quickly into mature discovery, and that is Bill Sheriff's Golden Predator Corp. (TSX:GPD).
TGR: Chris wrote a report on that one.
CB: I have followed these guys since the beginning of the year when I first got turned on to prospects in the Yukon. They have a really interesting business model; they aim to become self-funded through some cash flow generators—a royalty business in Nevada, a non-core asset disposition business, and producing gold from some properties in the Western U.S. The company has said that these cash flow generators exist to fund exploration in the Yukon, where they have nine projects totaling more than 700 square kilometers.
Another reason why I like Golden Predator is that company management has a track record of success. Bill Sheriff was able to take Energy Metals Corp. from the TSX to the NYSE in 30 months and ultimately sell the company to Uranium One Inc. (TSX:UUU) for $1.8 billion. I'm not saying the same thing will happen with Golden Predator, but it's a huge plus knowing Golden Predator has people at the helm who have grown companies successfully in the past.
Incidentally, Bill Sheriff basically echoes what my father just said about the Tintina White Gold belt being the new Carlin Trend. They're really expecting the types and frequency of discoveries in the Yukon that we all saw in Nevada, say, over the last 20 to 30 years. The Yukon is interesting because you have the political will and you have the resources.
TGR: How do you define political will?
CB: The Yukon has a single window regulatory process so that there's no going back and forth to Ottawa to try to get mining permits; everything happens through Whitehorse (Yukon's capital). This process is known as "devolution" and has made the permitting process much more efficient. That's why the Kaminaks, the Kinrosses, the Golden Predators of the world like being there. Another reason is you've got this huge expanse of territory with only 4%–5% under mineral claims.
TGR: Is the Quaterra Resources, Inc. (TSX.V:QTA, NYSE.A:QMM) Herbert Glacier project sitting on an extension of the Tintina Gold Belt?
MB: No, it is not actually, but that's a really interesting one. It's not in the Tintina; it's in northern Alaska, and it will be drilled out by Grande Portage Resources, Ltd. (TSX.V:GPG) this year; so Grande Portage is going to earn a piece of that. I am glad you brought up Quaterra, though, because that's a stock I've followed a lot, and own a lot of. I think they could have a low-cost open-pit mine in their Nieves Silver Project in Mexico. There are no open pit silver mines. My guess is that they're onto one with this property. I think we will see something there that could be very, very interesting. Within the next 90 days.
The other great silver play in Mexico is Endeavour Silver, which Chris has written on as well.
CB: Endeavour is an interesting story. Their goal is to become a mid-tier silver producer, and when I say mid-tier, I mean 5 million to 10 million ounces per year. They have two main areas in Mexico where they mine and produce silver. One is Guanajuato and the other is Guanacevi. In May, I visited Guanajuato, and between the two areas, they have about 56 million ounces of silver between the proven and probable and inferred categories, 85% of which is mineable. The name of the game for them is to continue to make discoveries on their current high-grade properties, and basically, just acquiring more land to justify a higher valuation. I think they're going to continue to do that, which is one of the reasons I like them.
Michael Berry was born in Colombia and raised in Canada but has lived in the U.S. for 36 years. A math major at the University of Waterloo in Ontario, he earned an MBA at the University of Connecticut and obtained a PhD specializing in quantitative analysis and investment finance from Arizona State University. While a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia (1982-1990), Michael spent considerable time with some world-renowned geologists on the Carlin Trend, and he also published a case book, Managing Investments: A Case Approach during that stage in his career. Michael also held the Wheat First Endowed Chair at James Madison University in Virginia, and managed small-and mid-cap value portfolios for Milwaukee-based Heartland Advisors and Chicago-based Kemper Scudder. His Morning Notes (www.discoveryinvesting.com) publication, distributed worldwide, provides analyses of emerging geopolitical, technological and economic trends, as well as identifying opportunities for the Discovery Investing strategy he developed.
Chris Berry, with a lifelong interest in geopolitics and the financial issues that emerge from these relationships, founded House Mountain Partners in 2010. House Mountain firmly believes that the emerging Quality of Life Cycle emanating from Emerging Markets is a "game changer" that will affect every one of us throughout the world for decades. With that in mind, the firm focuses on the intersection of three topics: the evolving geopolitical relationship between emerging and developed economies, the commodity space, and junior mining and resource stocks positioned to benefit from this phenomenon. Chris spent 13 years working across various roles in sales and brokerage on Wall Street before founding House Mountain Partners. He holds an MBA in Finance with an international focus from Fordham University, and a BA in International Studies from The Virginia Military Institute.
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