Finding Safety in the Precious Metals
Traditionally, the bond market is where investors have gone for safety in their portfolios. Discovery Investing pioneer Dr. Michael Berry says that investors may need to look elsewhere. In this exclusive interview with The Gold Report, Michael says the bill for deficits and debt in the U.S. will be coming due soon and that bond investors may be in for a rough ride. Michael says precious metals could be part of the safety portion of investment portfolios.
The Gold Report: In one of your recent Morning Notes you said you were worried about the state of the U.S. economy because the bill for government spending and debt creation is coming due. Can you give us the highlights on your concerns on that?
Michael Berry: The issues here that have been getting increasingly more difficult to handle are the deficits and the amount of debt that we have issued and continue to issue. To be able to push forward on what we’re doing in this country, like saving the housing industry and the new healthcare bill will be difficult. They’re going to cost a lot of money. They’re not going to save us money. They’re not going to reduce our deficits. They’re going to increase them and they’re going to have to be financed.
My concerns are that sooner or later, the debt that we’re using is going to be a bill that will come due. By that I mean that we will need to roll the debt forward—just like Greece must now do. We’re very likely to have a bond refinancing situation that fails or partially fails. When that happens, interest rates are going up.
You have debt, you have the dollar and you have interest rates. We’re already seeing some pressure on the long end of the yield curve. It’s going to cost more for the federal government to sell its debt to foreigners. If indeed they can do it. Now couple this with the issue of what’s happening in Greece, and what will likely happen in Spain and Italy with respect to sovereign debt. You’re going to have a similar occurrence in the U.S. in terms of how much debt has to be issued. We’re actually seeing signs of that happening now.
TGR: Where do you think the solution lies in correcting this problem?
MB: You can’t keep printing money. For 60 years, because we’ve had the world’s reserve currency—the dollar—it’s allowed us to run staggering deficits and to be able to fund our deficits by issuing debt. That’s coming to an end. It will mean that we’ll have to pull in. We’ll be forced to slow the economy, to de-lever the economy and those are going to be painful. There’s no easy way to go about doing that, but it has to happen.
TGR: Now for those people who are in the bond market, is this a time they should be looking to get out?
MB: That’s a really interesting question. I mean what do you do? I do discovery investing. The optimal portfolio is 10% in discovery and a 90% in safety. The 10% in discovery is easy. The 90% in safety is no longer easy. It used to be. You could go to the long end of the yield curve, go to a 30-year Treasury or you could go to the short end. Now, you have to find another area of safety and that could be partly in cash and partly in precious metals. Not necessarily in discovery for the “safe” portfolio allocation.
TGR: Last December, you thought inflation was still 18 to 24 months in the future. Is that still your thinking?
MB: It depends whom you talk to. We don’t have any inflation in this economy right now. If anything, there’s still de-leveraging. There’s excess capacity out there. We’re not moving down the unemployment scale very much. We still have 9.7% unemployment, even after a lot of government intervention in the labor markets and hiring for the census. Right now inflation is hard for me to see. In my view, we’re still that magical 18 to 24 months away from inflation, or maybe even more.
Certainly, if interest rates move up, we could have inflation, but there’s still a lot of excess capacity. There’s a lot of debt. The Obama administration and the Bush administration really didn’t deal very well with the excess debt. They just kind of rolled it over and pushed it out.
I’m an optimist. If you’re an optimist in this market, you believe inflation is coming. If you’re a pessimist in this market, you believe that we’re going to be in deflation for some time to come. I’m an optimist, so I think within the next couple of years we’ll be able to inflate out— at a cost, of course.
TGR: Would inflation be good for the market?
MB: No. I don’t think anything is going to be good for this equity market.
TGR: Do you anticipate continued recession?
MB: We could have another downturn. The growth that we’ve had isn’t extraordinary. It’s been pinned up by the federal spending programs that we have to pull back on pretty soon. You’re going to have to be very careful how you are positioned in this market. You’re going to have to be extremely defensive. I think being in the precious metals, and from my perspective, being in the discovery arena, are good places to be.
TGR: So is the opportunity for investors in all of this to be in the precious metals, especially in discovery?
MB: Certainly. I think I’d get a lot of agreement. Gold really doesn’t want to go below US$1,100. If you look at gold in any currencies other than the dollar it’s been a tremendous bull market. It looks like it’s going to go higher. Gold in U.S. dollars has been a poorer performer relative to gold in euros, for example. Gold performance in other currencies has been outstanding.
I think silver is going to go much higher. Silver is very strong. So are platinum and palladium. You’re seeing tremendous upside pressure in precious metals. We did have a pullback last year, and I think it was healthy, but I don’t think we’re going to have another big pullback in precious metals.
TGR: So you don’t see another correction on the horizon when it comes to gold at this point?
MB: I really don’t see a big correction. I don’t think we’re going to see under $1,000 again. There are so many issues that are positive for gold right now. We’ve already talked about some of them. I think gold could reach $1,500 to $1,600 over the next year to two years. It’s going to be a place investors want to be. What’s also interesting, and we talked about this in our last interview, is that the Chinese government not only is buying gold, but they’re encouraging their citizens personally to buy gold and silver. That speaks volumes.
TGR: That’s certainly a big change for China.
MB: Absolutely. They’re being very vituperative and very stubborn, perhaps rightly so. They are not going to float their currency until they decide it is in their best interest. They are going to continue for as long as need be, because they have a trillion dollars or more worth of U.S. assets in their foreign exchange kitty. Because of that, they want their citizens to have some protection, and that’s why they’ve allowed ordinary Chinese citizens to purchase gold and silver. And Chinese citizens love silver.
TGR: Other countries are buying up gold as well.
MB: It’s not just gold. To build out an infrastructure in China, India and Brazil, you’re going to have to have a secular and strong commodity cycle. It’ll probably vary in the short run, but it’s going to go on. We’ve got copper at $3.50 now. Nobody would have expected that in September of 2008, that’s for sure. It’s a good place to be. The mining industry generally is a good place to be, and the commodities sector in general.
TGR: Where do you see gold, let’s say by the end of 2010?
MB: Higher. It might be a couple of years before we really see gold in the $1,600 to $2,000 range. It could definitely go there.
I’m probably going to be branded for saying this, but I’m convinced from my work over the last 15 years that the futures markets have been somewhat of an impediment to the spot markets in both gold and silver. Silver’s a very small market. If the Commodity Futures Trading Commission (CFTC) were to modify position limits and margin requirements on the futures contracts, I think that you’d see these commodities go to their true values, particularly silver. You could have much higher levels of silver, which interests me because I deal with a lot of companies that mine silver.
TGR: Do you think that gold could approach $1,400 by the end of this year?
MB: It could. Resolution of the Greek debt refunding situation in Europe will be important. It’s also important where interest rates go in our country, and how much more the dollar has to fall. I think it has further decline potential. Once gold breaks over $1,250, all bets are off. It’s been trading in a range. I’m really not a trader. I’m a real long-term investor. Frankly, I really don’t care about short-term volatility, but I know it’s going higher, and I want to have a position in it.
When gold comes off, I buy it in preparation for something higher. Gold hasn’t really fallen much below $1,100. Once gold goes over $1,250, I think we’re away to the races. Once silver appreciate to the $18.00 to $19.00 range, we’re away to the races there as well.
TGR: What are some of the companies that you’re watching as far as silver goes?
MB: Well, one of the companies I like very much is called Endeavour Silver Corp. (NYSE.A:EXK;DBF:EJD;TSX:EDR). They’re a junior. Juniors are pretty tough to deal with, but they’ve got two mines, Guanacevi and Guanajuato in Mexico. They are increasing production. They’re looking to acquire more silver assets. I’m very fond of them. They’re cheap, I think, in terms of their production. They have a good management team.
Recently, Quaterra Resources Inc. (NYSE:QMM;TSX:QTA.V) had a great announcement of drill results on its Nieves silver property. I’ve always owned a lot of this one. Quaterra’s management, Dr. Tom Patton and Tom Turner ,discovered Peñasquito, which Goldcorp (NYSE:GG;TSX:G) now owns. That’s a billion-ounce silver resource company at Penasquito alone.
TGR: When you’re looking at silver companies, are you looking primarily at explorers or producers?
MB: In discovery investing, we have three classifications, based mostly on risk-to-reward classification. I happen to like to invest mostly in the first one, which is primarily early explorers. I like to find the best geologist and go in drill and find that first discovery hole and then expand it and eventually get a NI 43-101 resource on it. We call these Incubator companies. I call them Incubator because they incubate their resources. Then with more drilling and discovery, and lower risk profiles, they move into a classification as Mature Discovery companies. I would say Endeavour is a Mature Discovery company. Quaterra is probably an Incubator company moving rapidly into the Mature status. There are different risks-to-reward ratios as you go forward.
Then, of course, you get to the Goldcorp’s and the companies like NovaGold (NYSE.A:NG;TSX.V:NG) and so on. They’re Legacy companies. They’ve got a lot of resources and reserves. In any of those three areas, you have a different risk/reward ratio. Different analysis when you go through them. I tend to like to start at the beginning and follow a company. Of course, a lot of Incubator companies don’t work out because there’s a lot of risk.
TGR: I think in one of your other interviews you likened it to a baseball, saying a good hitter is only going to hit 300, so 7 out of 10 times they’re not going to make it. That seems to be your attitude when it comes to discovery investing, right?
MB: It is. I used to manage money, so as a money manager, I wanted all my stocks to be winners. I didn’t want to lose on any of them. It’s not that I want to lose on them, but I think when you play in this micro-cap mining game, you are in an area where there are many unknowns. They offer a great upside potential because you’re looking for world-class discoveries. But sometimes they just don’t work out. If you find a Peñasquito, a Nieves or a Guanacevi, you’re going to do very, very well. You’re buying stocks at $.05, $.30 and $1 and they are going to end up being $5, $10 and $20 stocks.
TGR: When it comes to the gold companies, I’m assuming that you manage things the same way?
MB: Absolutely. I have a factor model which I developed when I was a fund manager at Heartland Advisors. The 10 factors allow me to rank companies in any of the three categories that we discussed. You’re dealing with young companies in the early stage of development of their mines. I use exactly the same model for any of these companies. Is this a world-class asset? Has the management team got a great track record? Is it capable?
TGR: What gold companies are you watching these days?
MB: Well, I own and am fond of Goldcorp. Goldcorp is my number-one pick and it’s way undervalued. It does puzzle me, but I’ve learned that the markets have a way of evening things up. At $38, it’s way too cheap. They produced 90,000 ounces of gold in 2009 and a million ounces of silver. They dedicated their mine in Peñasquito on March 23rd. This is going to be one of the biggest open-pit mines in the Americas.
I like NovaGold at this time. I think they’re doing the right things and they’ve got the right investors. There are a number of other companies that have real potential. At the exploration level, you look at companies like Quaterra. Quaterra is being backed by Goldcorp in Mexico. In other words, Goldcorp did a private placement into Quaterra. Quaterra has got a number of gold targets in the Mesa Central and Goldcorp’s going to fund exploration and development of them. Anytime I can find a company that’s being funded by a major I like that, because it reduces dilution and risk.
TGR: A lot of the people we’re chatting with are talking about Colombia as being sort of the new find. Are you following anything in Colombia?
MB: I was born there and just went back recently. I went back to see Antioquia Gold Inc. (TSX-V: AGD), which is really interesting. Here you have a $.30 stock and they’ve got some great holes, some great discoveries. It’s about 70 kilometers northeast of Medellín. It’s going to take a significant amount of money to find the source, but these are very high-grade veins.
I’m going to be chairing the Latin America Mining Congress on April 28th. We’re going to have the Mining Minister from Colombia. It’s equally important to know that Colombia is a good place to be. Not just because there might be a good deposit, but because the Colombians want Canadian and American capital and companies to come in.
Galway Resources Ltd. (TSX.V:GWY) is a company that I’ve known for a long time. They’re making some darn good discoveries down there in Colombia. Another little one that is not on anybody’s radar screen yet is Horseshoe Gold Mining Inc. (TSX.V:HSX) . They’ve just lined up a gold deposit down there, but it’s pretty speculative right now.
There’s a company in Guyana called Sandspring Resources Ltd. (TSX.V:SSP) that I really like. I went out to visit them in the jungle. They are actually mining alluvial gold and drilling on the hard rock portion of the deposit. I think they’ve got a good chance. This stock has gone from $.35 to $1.50. They just raised around $14 million. So this is a good one. This one has a chance.
TGR: Now do you see their price going higher?
MB: Oh yes. The great thing about Sandspring, Galway and Antioquia is their drilling. When you’re drilling and you’ve made a discovery, things usually get better. In other words, once you’ve made that first good discovery hole, things tend to get better. When you drill, often good things happen and that’s when the price goes up. That’s the catalyst.
Right now, this market isn’t rewarding anybody for anything, though. This stock market is idling, at least on the juniors. That’s true with Goldcorp. Goldcorp is a cheap stock at $38 a share, considering its production potential.
TGR: If it’s idling at this point, what’s it going to take to kick things into gear?
MB: $1,600 gold would certainly do it. $50 silver would do it. Both of those things are definitely possible in the next couple of years for a number of reasons that we’ve discussed.
TGR: Are you sitting on the sidelines at this point?
MB: No. I’m invested 100% in discovery companies and in gold bullion and in mature companies. I’m in the discovery market. That’s what I do. I don’t own Apple (NASDAQ: AAPL). I don’t own Microsoft (NASDAQ: MSFT). But I’m in biotech discovery and 70% in mining discovery stocks.
TGR: The last time that we talked, you mentioned Revett Minerals Inc. (TSX:RVM; OTCBB:RVMIF) as a company that you liked. A federal judge has put their Rock Creek mine on hold. Do you still see the company as a buying opportunity?
MB: I do. I’m glad you picked up on that because I think it’s an important point. It brings us back to the discussion of whether benefits to the economy trump environmentalism. I think somewhere both of these things have to come together. Jobs and the environment have to come together.
Rock Creek is fully drilled out and fully permitted by the U.S. Fish & Wildlife Service. It is 230 million ounces of silver and 2 billion pounds of copper. The Troy Mine, which is a few kilometers down the road, is in production. It’s exactly the same geology as at Rock Creek. They’re making a million a month or more on their mining at that place. Here you have a stock that, when the judge made this decision, opened down $.15. It’s since come back and I think it’s down $.03 or something like that. So here you have an extraordinarily inexpensive mining company making a million dollars a month on its silver and copper.
Ultimately, what the judge did was throw out the environmental challenge on water and on species like grizzly bears and trout. So, he threw those out and vacated the Fish & Wildlife permit until certain things are done. We don’t know what those certain things are because he hasn’t issued the written details yet.
This will be developed because it needs to be. In any event, you have a company that’s in production. I think Rock Creek will be developed. However, if for any reason it is not developed, I think that they will go ahead and bring other properties into their portfolio that are easier to permit.
TGR: What is their appeal process at this point?
MB: This is not about them. The U.S. Fish & Wildlife Service has to do the appeal. It’s the government that has been vacated, not the company. The government will now receive written complaints from the judge. We know they won’t be about fish. We know they won’t be about grizzly bears and we know they won’t be about water. So we’re waiting to see.
Then the U.S. government, on behalf of the company, will answer the federal judge. I’ve spoken with the governor of Montana and the governor’s staff. They’re in favor of the mine. If you talk to people in northwestern Montana, they’re in favor of the mine because of the jobs. So there are two sides to this story. I guess I’d have to say that I think that, ultimately, it will be permitted, but we’ll have to wait and see on that. One more point. Tim Lindsey is the new chairman of the company—a native Montanan—and John Shanahan is the CEO. They have done a great job with a company that was once struggling to stay alive. Keep your eye on Revett.
TGR: Thank you for your time.
Dr. Michael Berry has lived in the U.S. for 36 years but raised in Canada. 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. He has specialized in the study of behavioral strategies for investing and has been published in a number of academic and practitioner journals. His definitive work on earnings surprise, with David Dreman, was published in the Financial Analysts Journal. While he was 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. While a professor, he published a case book, Managing Investments: A Case Approach.
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 publication, distributed worldwide, provides analyses of emerging geopolitical, technological and economic trends, as well as identifying opportunities for the Discovery Investing strategy he developed.
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