The Gold Report: Craig, in June you wrote that real interest rates are the primary factor driving the rise in gold prices. Can you elaborate?
Craig Stanley: It's important to know the fundamental drivers of the price of any financial asset or commodity in order to determine the long-term trend. For commodities like copper, you have to focus on factors such as mine supply and scrap on the supply side, and GDP forecasts, restocking and index demand on the demand side. But gold is different. It's stored, not consumed in the traditional sense. Hence, basically all the gold ever mined can come back to the market
Real interest rates are the only metric that is correlated with the gold price. If you can hold U.S. dollars via Treasury bills, notes or bonds and they are paying a positive real interest rate that is not being inflated away, then why hold gold that doesn't pay anything?
However, it is not a linear relationship. Instead, gold prices tend to significantly increase only if real rates become negative. The current bull market in gold that started in 2001 corresponds to U.S. three-month Treasury bill real rates falling below 0%.
That's why I like to state that gold is money—money that offers no yield (a negative yield after taking into account storage and insurance) and which is continually valued against fiat currencies that offer a yield.
During times of low to negative real interest rates, gold reclaims its traditional role as money, with investment demand the prime driver of the gold price.
During the summer, the gold price in U.S. dollars stagnated as the three-month nominal rate was flat. Then starting in September, the three-month yield started to fall as inflation expectations (as measured by The University of Michigan one-year inflation expectations) rose, meaning real rates went negative and gold price went higher.
TGR: Using the real interest rates measurement, is that a price where gold overcompensates for negative real interest rates? What is that price?
CS: Real rates are a measure to identify the long-term trend of the gold price, not a short-term trading tool. And there is not a specific gold price that compensates for a specific real rate. Look at the trend and focus on when real rates go negative.
Given the U.S. dollar's role as the world's reserve currency, I look at U.S. interest rates. The gold price starts to rise when three-month real rates go negative (when rates are positive, you're getting paid to hold dollars whereas gold doesn't pay anything). However the gold price really takes off when 10-year real rates go negative. That's what happened in 1979 and very briefly at the end of 2007. The 10-year real rate is positive right now, around 1.6%. As the three-month rate is negative, it's positive for the gold price but if the 10-year real rate goes negative and stays in negative territory, look out. The gold price could really spike.
TGR: Given the tremendous increase in metals prices, why can't most mining companies greatly increase profits?
CS: Some producers have been able to increase free cash flow. But in general, for the gold miners, up until the past year, prices for the inputs used in building and maintaining mines rose faster than the gold price. On average, these inputs, such as labor, steel, diesel and increased over 15% annually. However since peaking in 2008 these costs have come down and should flow through to the bottom line once higher cost inventories are worked through.
In addition, foreign exchange has had a big impact. In general, cash costs have increased for mines operating outside the U.S. as the greenback has declined.
Another factor that is rarely discussed is decrease in average grade—in order to produce the same amount of ounces each year, companies have been moving an ever-increasing amount of rock.
Of course, even if earnings and cash flow increase, they won't necessarily on a per-share basis given the large amount of share issuance, for example in early 2009.
TGR: Pinetree invests in junior exploration and development companies because they represent superior returns, but with that comes higher risks. How does Pinetree minimize these risks?
CS: Our portfolio consists of a large number of holdings diversified among stage of exploration and/or development, commodity focus and geography.
TGR: Can you comment on some of the holdings in Pinetree's precious metals portfolio?
CS: The three largest positions as of September 30, 2009 were Queenston Mining Inc. (TSX:QMI), Colossus Minerals Inc. (TSX:CSI) and Evolving Gold (TSX.V:EVG).
Queenston Mining is a gold explorer focused on the Kirkland Lake camp in northern Ontario. On the west end of the camp it has a joint venture with Kirkland Lake Gold Inc. (TSX:KGI) as well as 100%-owned ground. KGI is in production and has had great exploration success with the discovery of the high-grade South Mine Complex, which trends onto QMI's ground. On the eastern side of the camp, QMI is advancing four gold deposits towards production: Upper Beaver, McBean, Upper Canada and Anoki.
Colossus Minerals has a 75% interest in the high-grade gold-platinum-palladium Serra Pelada project in Brazil. It's a very unique project that was mined in the 1980s by garimpeiros. Colossus has reported phenomenal grades and widths, such as 70.7 metres of 53.59 g/t gold, 20.77 g/t platinum and 31.30 g/t palladium.
Evolving Gold is a gold explorer focused on the Rattlesnake Hills project in Wyoming. It's still relatively early but they've produced intercepts that indicate the rocks were subjected to a large gold mineralizing event similar to the Cripple Creek mine in Colorado. Quinton Hennigh, EVG's president and chief geologist, previously worked at Newmont and is a great geologist.
All three companies have healthy cash positions and provide great gold price and exploration leverage.
TGR: Pinetree is bullish on base metals (copper, nickel and zinc) because of the growth in China and India. On your website you comment on copper's supply issues related to outages and strikes spiking the price of copper. If the supply issues are choppy, doesn't it make investing in this sector choppy as well and if so, are you trading in and out of this sector to maximize the spikes in copper prices? Any base metal company in your portfolio you care to comment on?
CS: Pinetree's mission is to identify long-term trends then invest in small-cap companies that can benefit from such trends. We're a long-term buy and hold investor.
In regards to copper, we're focused more on companies exploring for copper, not producing it. The biggest factor driving the share price of a copper explorer is exploration results. Short-term fluctuations in the copper price don't generally have a correlation to the share price of an exploration company.
Also, you can miss out on the potential gains from investing in the long-term trend by getting cute and trying to time short-term reversals. That's not our objective.
Pinetree has been involved in Noront (NOT-TSXV) for a while. The company is advancing its Eagle Nest nickel, copper, and platinum group metals (PGE) and Blackbird chromite projects in northern Ontario. A big challenge to mining these deposits is infrastructure as they are located in a very remote region. Noront recently failed in its hostile takeover of Freewest Resources and its nearby Black Thor chromite project to Cliffs Natural Resources. However, we think it's positive for Noront and all the other companies active in the McFaulds Lake region that a large company like Cliffs, with its deep pockets, is moving into the camp as it could help address the infrastructure challenges. However Noront's Eagle Nest project is the lynchpin in developing the camp as it will likely be the first deposit to be mined, due to its higher rock value than the chromite deposits, and hence will drive and fund the camp's initial infrastructure. Also, Noront is much farther along in working and consulting with the First Nations communities in the region, who will be very important in getting these deposits developed.
TGR: In your view, where are we in the base metals cycle? Does your answer depend on the particular base metal?
CS: We're in a very long-term cycle whereby metal prices are supported by factors that have become well known over past few years: demand from emerging markets, especially China; limited exploration and resulting discoveries of large deposits over the past few decades; and the secular downtrend of the U.S. dollar.
We focus more on a company's management and its projects, only taking the outlook for the commodity into consideration after this.
TGR: Craig, thanks for your time. Much appreciated.
Other holdings in Pinetree's Precious Metals portfolio, as of Sept. 30, 2009:
African Gold Group (AGG:TSXV), Bear Lake Gold Ltd. (BLG: TSXV), Caledonia Mining Corp. (CAL:TSX), Canaco Resources Inc. (TSX-V: CAN), Commander Resources Ltd. (CMD:TSXV), Gold Canyon Resources Inc. (GCU:TSXV), Latin American Minerals Inc. (LAT:TSXV), Mega Precious Metals (MGP-TSXV) , Merrex Gold Inc. (MXI:TSXV) , Metallic Ventures Gold Inc. (MVG:TSX) , NioGold Mining Corporation (TSX-V: NOX) (otc: NOXGF.pk), Nortec Minerals Corp. (NVT:TSXV), Ontex Resources Limited (ONT:TSX), Redstar Gold Corp. (RGC:TSXV), Rye Patch Gold Corp. (RPM:TSXV), Silver Quest Resources Ltd. (TSX-V:SQI), Solitario Exploration & Royalty Corp. (SLR:TSX), Temex Resources Corp. (TSX.V:TME) (FSE:TQ1), TNR Gold Corp. (TNR: TSXV) and Unigold Inc. (UGD:TSXV).
Craig Stanley, Vice President, Research joined Pinetree Capital (PNP:TSX) in January 2009 as Resources Analyst. Pinetree is a diversified investment, financial advisory and merchant banking firm focused on the small cap market. Pinetree's investments are primarily in the resources sector: Uranium, Oil and Gas, Precious Metals, Base Metals, Potash, Lithium and Rare Earths. Stanley is responsible for aiding the management of Pinetree's existing portfolio as well as researching and analyzing new investment opportunities. Prior to joining Pinetree, Craig worked both as a buy-side and sell-side analyst, the former at a firm with over $1 billion in mining investments in actively managed mutual funds, exchange-traded closed-end funds and flow-through limited partnerships. Craig holds a Master of Science in Geology from The University of Western Ontario and is a member of the Society of Economic Geologists, the Society for Geology Applied to Mineral Deposits and the Prospectors and Developers Association of Canada.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.
DISCLOSURE:
1) Karen Roche, of The Gold Report, conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Queenston Mining, Colossus Minerals and Evolving Gold, NioGold Mining Corp. and Noront.
3) Craig Stanley—See Pinetree Capital's disclosure policy http://www.pinetreecapital.com/investments/disclosure_criteria
Craig Stanley: It's important to know the fundamental drivers of the price of any financial asset or commodity in order to determine the long-term trend. For commodities like copper, you have to focus on factors such as mine supply and scrap on the supply side, and GDP forecasts, restocking and index demand on the demand side. But gold is different. It's stored, not consumed in the traditional sense. Hence, basically all the gold ever mined can come back to the market
Real interest rates are the only metric that is correlated with the gold price. If you can hold U.S. dollars via Treasury bills, notes or bonds and they are paying a positive real interest rate that is not being inflated away, then why hold gold that doesn't pay anything?
However, it is not a linear relationship. Instead, gold prices tend to significantly increase only if real rates become negative. The current bull market in gold that started in 2001 corresponds to U.S. three-month Treasury bill real rates falling below 0%.
That's why I like to state that gold is money—money that offers no yield (a negative yield after taking into account storage and insurance) and which is continually valued against fiat currencies that offer a yield.
During times of low to negative real interest rates, gold reclaims its traditional role as money, with investment demand the prime driver of the gold price.
During the summer, the gold price in U.S. dollars stagnated as the three-month nominal rate was flat. Then starting in September, the three-month yield started to fall as inflation expectations (as measured by The University of Michigan one-year inflation expectations) rose, meaning real rates went negative and gold price went higher.
TGR: Using the real interest rates measurement, is that a price where gold overcompensates for negative real interest rates? What is that price?
CS: Real rates are a measure to identify the long-term trend of the gold price, not a short-term trading tool. And there is not a specific gold price that compensates for a specific real rate. Look at the trend and focus on when real rates go negative.
Given the U.S. dollar's role as the world's reserve currency, I look at U.S. interest rates. The gold price starts to rise when three-month real rates go negative (when rates are positive, you're getting paid to hold dollars whereas gold doesn't pay anything). However the gold price really takes off when 10-year real rates go negative. That's what happened in 1979 and very briefly at the end of 2007. The 10-year real rate is positive right now, around 1.6%. As the three-month rate is negative, it's positive for the gold price but if the 10-year real rate goes negative and stays in negative territory, look out. The gold price could really spike.
TGR: Given the tremendous increase in metals prices, why can't most mining companies greatly increase profits?
CS: Some producers have been able to increase free cash flow. But in general, for the gold miners, up until the past year, prices for the inputs used in building and maintaining mines rose faster than the gold price. On average, these inputs, such as labor, steel, diesel and increased over 15% annually. However since peaking in 2008 these costs have come down and should flow through to the bottom line once higher cost inventories are worked through.
In addition, foreign exchange has had a big impact. In general, cash costs have increased for mines operating outside the U.S. as the greenback has declined.
Another factor that is rarely discussed is decrease in average grade—in order to produce the same amount of ounces each year, companies have been moving an ever-increasing amount of rock.
Of course, even if earnings and cash flow increase, they won't necessarily on a per-share basis given the large amount of share issuance, for example in early 2009.
TGR: Pinetree invests in junior exploration and development companies because they represent superior returns, but with that comes higher risks. How does Pinetree minimize these risks?
CS: Our portfolio consists of a large number of holdings diversified among stage of exploration and/or development, commodity focus and geography.
TGR: Can you comment on some of the holdings in Pinetree's precious metals portfolio?
CS: The three largest positions as of September 30, 2009 were Queenston Mining Inc. (TSX:QMI), Colossus Minerals Inc. (TSX:CSI) and Evolving Gold (TSX.V:EVG).
Queenston Mining is a gold explorer focused on the Kirkland Lake camp in northern Ontario. On the west end of the camp it has a joint venture with Kirkland Lake Gold Inc. (TSX:KGI) as well as 100%-owned ground. KGI is in production and has had great exploration success with the discovery of the high-grade South Mine Complex, which trends onto QMI's ground. On the eastern side of the camp, QMI is advancing four gold deposits towards production: Upper Beaver, McBean, Upper Canada and Anoki.
Colossus Minerals has a 75% interest in the high-grade gold-platinum-palladium Serra Pelada project in Brazil. It's a very unique project that was mined in the 1980s by garimpeiros. Colossus has reported phenomenal grades and widths, such as 70.7 metres of 53.59 g/t gold, 20.77 g/t platinum and 31.30 g/t palladium.
Evolving Gold is a gold explorer focused on the Rattlesnake Hills project in Wyoming. It's still relatively early but they've produced intercepts that indicate the rocks were subjected to a large gold mineralizing event similar to the Cripple Creek mine in Colorado. Quinton Hennigh, EVG's president and chief geologist, previously worked at Newmont and is a great geologist.
All three companies have healthy cash positions and provide great gold price and exploration leverage.
TGR: Pinetree is bullish on base metals (copper, nickel and zinc) because of the growth in China and India. On your website you comment on copper's supply issues related to outages and strikes spiking the price of copper. If the supply issues are choppy, doesn't it make investing in this sector choppy as well and if so, are you trading in and out of this sector to maximize the spikes in copper prices? Any base metal company in your portfolio you care to comment on?
CS: Pinetree's mission is to identify long-term trends then invest in small-cap companies that can benefit from such trends. We're a long-term buy and hold investor.
In regards to copper, we're focused more on companies exploring for copper, not producing it. The biggest factor driving the share price of a copper explorer is exploration results. Short-term fluctuations in the copper price don't generally have a correlation to the share price of an exploration company.
Also, you can miss out on the potential gains from investing in the long-term trend by getting cute and trying to time short-term reversals. That's not our objective.
Pinetree has been involved in Noront (NOT-TSXV) for a while. The company is advancing its Eagle Nest nickel, copper, and platinum group metals (PGE) and Blackbird chromite projects in northern Ontario. A big challenge to mining these deposits is infrastructure as they are located in a very remote region. Noront recently failed in its hostile takeover of Freewest Resources and its nearby Black Thor chromite project to Cliffs Natural Resources. However, we think it's positive for Noront and all the other companies active in the McFaulds Lake region that a large company like Cliffs, with its deep pockets, is moving into the camp as it could help address the infrastructure challenges. However Noront's Eagle Nest project is the lynchpin in developing the camp as it will likely be the first deposit to be mined, due to its higher rock value than the chromite deposits, and hence will drive and fund the camp's initial infrastructure. Also, Noront is much farther along in working and consulting with the First Nations communities in the region, who will be very important in getting these deposits developed.
TGR: In your view, where are we in the base metals cycle? Does your answer depend on the particular base metal?
CS: We're in a very long-term cycle whereby metal prices are supported by factors that have become well known over past few years: demand from emerging markets, especially China; limited exploration and resulting discoveries of large deposits over the past few decades; and the secular downtrend of the U.S. dollar.
We focus more on a company's management and its projects, only taking the outlook for the commodity into consideration after this.
TGR: Craig, thanks for your time. Much appreciated.
Other holdings in Pinetree's Precious Metals portfolio, as of Sept. 30, 2009:
African Gold Group (AGG:TSXV), Bear Lake Gold Ltd. (BLG: TSXV), Caledonia Mining Corp. (CAL:TSX), Canaco Resources Inc. (TSX-V: CAN), Commander Resources Ltd. (CMD:TSXV), Gold Canyon Resources Inc. (GCU:TSXV), Latin American Minerals Inc. (LAT:TSXV), Mega Precious Metals (MGP-TSXV) , Merrex Gold Inc. (MXI:TSXV) , Metallic Ventures Gold Inc. (MVG:TSX) , NioGold Mining Corporation (TSX-V: NOX) (otc: NOXGF.pk), Nortec Minerals Corp. (NVT:TSXV), Ontex Resources Limited (ONT:TSX), Redstar Gold Corp. (RGC:TSXV), Rye Patch Gold Corp. (RPM:TSXV), Silver Quest Resources Ltd. (TSX-V:SQI), Solitario Exploration & Royalty Corp. (SLR:TSX), Temex Resources Corp. (TSX.V:TME) (FSE:TQ1), TNR Gold Corp. (TNR: TSXV) and Unigold Inc. (UGD:TSXV).
Craig Stanley, Vice President, Research joined Pinetree Capital (PNP:TSX) in January 2009 as Resources Analyst. Pinetree is a diversified investment, financial advisory and merchant banking firm focused on the small cap market. Pinetree's investments are primarily in the resources sector: Uranium, Oil and Gas, Precious Metals, Base Metals, Potash, Lithium and Rare Earths. Stanley is responsible for aiding the management of Pinetree's existing portfolio as well as researching and analyzing new investment opportunities. Prior to joining Pinetree, Craig worked both as a buy-side and sell-side analyst, the former at a firm with over $1 billion in mining investments in actively managed mutual funds, exchange-traded closed-end funds and flow-through limited partnerships. Craig holds a Master of Science in Geology from The University of Western Ontario and is a member of the Society of Economic Geologists, the Society for Geology Applied to Mineral Deposits and the Prospectors and Developers Association of Canada.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Expert Insights page.
DISCLOSURE:
1) Karen Roche, of The Gold Report, conducted this interview. She personally and/or her family own none of the companies mentioned in this interview.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Queenston Mining, Colossus Minerals and Evolving Gold, NioGold Mining Corp. and Noront.
3) Craig Stanley—See Pinetree Capital's disclosure policy http://www.pinetreecapital.com/investments/disclosure_criteria
