The Gold Report: South African platinum group metals (PGM) miners have been plagued by a 21-week strike, which has cost those companies an estimated $2 billion in lost revenue. Is there an end in sight?
David H. Smith: It's the end of the beginning rather than the beginning of the end, because this is a systemic issue between the miners and companies. The companies are trying to recoup their costs because they are producing PGMs below the cost of production, whereas the miners are still not getting much money for doing a dangerous job. During that five-month strike the mining companies were losing 5,000–10,000 ounces (5,000–10,000 oz) per day of production. It certainly didn't help the supply side of the equation for PGMs.
TGR: Spot platinum prices have witnessed steady support above $1,400/oz since January and roughly $1,450/oz more recently. Would an end to the strike bring with it price weakness?
Pretium Resources Inc. is one of the most exciting exploration stories in the world."
DHS: Yes, because it's a buy-the-rumor, sell-the-fact situation. On the day that the strike was said to have concluded, PGM prices dropped $40-50/oz because that was the expectation. I look at it as a buying opportunity for people who believe the PGM story has upside. Both platinum and palladium are in a deficit situation but platinum is still more than $400/oz from its five-year high, whereas palladium penetrated its five-year high a few weeks ago. Of the two, palladium has a higher percentage profit potential, in my view, given that it can be substituted for so many of platinum's uses and yet sells for $500–600/oz less.
TGR: You have written on what you call "The Precious Metals Four." As part of that you see platinum and palladium being the frontrunners in the eventual price rebound in precious metals. Tell us more.
DHS: The precious metals four are gold, silver, platinum and palladium. Investors interested in precious metals should focus on all four even if they don't hold all of them because of how they relate to each other and how their chart patterns correlate.
My premise is that platinum and palladium—and this has been documented by Sprott Asset Management, Rick Rule and several others—are going to be in a long-term supply deficit because the primary producers in South Africa and Russia are not going to be able to ramp up production any time soon, whereas catalytic converters, exchange-traded funds and individual PGM purchases (physical metal, jewelry) continue to sharply move demand. Meanwhile, gold and silver have been in a three-year cyclical bear market until just a few weeks ago when they made a large reversal on high volume in what looks to be the start of the next leg of the secular bull market in precious metals.
TGR: But the PGM market is relatively small, so one new producer can instantly change the market.
DHS: Yes, the PGM market is about 7 million ounces (7 Moz) annually for both platinum and palladium, whereas the gold market is about 80 Moz annually. The PGM market is infinitesimal, yet those metals have a lot of critical uses. It may take a little longer than I would like to reach a certain target, but the bull run in precious metals is underway and I think it's going to last a long time.
TGR: How do investors get in on the run? Is it about being in bullion or equities or both?
DHS: I have worked for more than a decade with David Morgan at The Morgan Report and he suggests buying the physical metal first. Once you're comfortable with your allotment of physical precious metals, then start looking at equities. Shares can offer two or three times the upside potential on a percentage basis to the metal, but some go bankrupt and others underperform. Look at producers and royalty companies first, and if you have some money left over, buy a couple of exploration stocks with the hope of 10 or 20 times gains, knowing that they also represent a potential 100% risk to the funds you commit to a given position.
TGR: What are some names of companies developing PGM projects in South Africa?
DHS: I'm a shareholder in Robert Friedland's Ivanhoe Mines Ltd. (IVN:TSX), which is developing a platinum project there. Platreef is a few years from production and may cost $1–2B to develop, but it's a wide vein deposit that's relatively shallow and should lend itself to automated harvesting. When that comes into production it's going to be a game-changer for South African PGM production.
TGR: Is that a case of "Freidland's done it again?"
DHS: I think so. Friedland has three world-class projects—Platreef, the Kamoa copper project in the Democratic Republic of the Congo (DRC), and the Kipushi copper-zinc mine in the DRC. How many people come up with one world-class project in their life? Friedland has done it a number of times including in Mongolia with the Oyu Tolgoi copper-gold deposit, which is absolutely stunning. He's a legend.
TGR: You mentioned that producers are mining PGMs below the cost of production. How do you sort the good from the not-so-good?
DHS: It's a matter of philosophy. I would only invest in one PGM company in South Africa and we discussed it. In the Western Hemisphere Stillwater Mining Co. (SWC:NYSE) is the only major producer—about 4% of global production. I currently hold a small long position in that company.
A few projects are years away. One in the Yukon that I have visited twice, but could be four or five years from production, is Wellgreen Platinum Ltd. (WG:TSX.V; WGPLF:OTCPK;), formerly Prophecy Platinum. That's a very interesting project. The stock has dropped 95% from where it was a few years ago, but it could be something that has great potential. There is quite a bit of PGM values in the ground there and that removes some of the risk. This company is part of the suggested holdings in The Morgan Report, as it was a spinoff from Prophecy Coal Corp. (PCY:TSX; PRPCF:OTCQX; 1P2:FSE) for early investors. We still follow the company and provide updates to our members.
TGR: What are your near- and medium-term forecasts for platinum and palladium?
DHS: It's really difficult to put a time and price on any commodity. It's more important to look at the risk/reward ratio. Over the next two or three years, in my opinion, the risk for having a platinum/palladium position is probably about one and the reward is four or five. I like those metrics.
If people are looking for a certain price target in a given timeframe and it doesn't happen, they lose faith and believe that the premise is wrong. The premise might still be accurate; it just may take more time to get there. For example, for some time I believed we would see a breakout in PGM prices. It took longer than I expected, but the premise was valid. The same thing is going to happen with uranium. It's taking longer than most people expect, but when it happens I think it's going to be a very powerful breakout.
TGR: Are there other PGM development plays or are there some producers that are producing PGMs as a byproduct?
DHS: There are some, most notably in South Africa but, frankly, due to country risk I don't follow them. (Interestingly, in looking at Russia's massive Norlisk project, the primary metals harvested there are nickel and copper—with palladium as a byproduct!) My primary interest is the gold and silver market, but I'm also interested in PGMs in the sense that their chart patterns will inform us as to how gold and silver will look when they move into a public mania phase.
Some years ago palladium went to $1,090/oz after Ford Motor Co. (F:NYSE) bought a lot of supply. At one point, as David Morgan has stated publicly—at the time he was involved in that futures market—the exchange demanded two times the total value of a palladium contract as margin money, a 200% margin call. That's eventually what we could see in all four of the precious metals.
TGR: Does the current precious metals rally have legs?
DHS: Over the last few weeks we have seen, in some cases, a record volume turnaround in the physical metals and the buying of mining shares, which started about a week or two before metals prices turned. We have touched this area twice before over the last year or so and each time it's held. Anything is possible. We could see weakness and surprise announcements that could cause new lows in gold and silver, but I think they'll be short-lived. I think the risk/reward ratio is very favorable. If you're trying to find zero risk, you're not going to be involved. With great reward there's always great risk. It's how you manage that risk that determines how well you do.
TGR: Another big theme is China's growing influence on the gold market. Tell us about that.
DHS: China always has a long-term strategy. China's gold strategy involves several aspects, one of which is thought to be a gold-backed yuan. Another is to diversify out of U.S. dollars in its trade account balances, if for no other reason than currency diversification. If there's a rift between China and the U.S., China doesn't want to have its money hostage in U.S. Treasuries. And China is going to keep acquiring gold and silver, most of it under the radar. State-owned enterprises have bought some major gold companies, and last week China established a trading office in Vancouver to expand its reach into the mining sector.
There's a Chinese game—the Japanese call it Go—that's played with black and white stones on a table. The object is to surround your opponent and keep him or her from moving. That's what the Chinese are doing—but for them it's not a game.
TGR: Some recent news reports suggest China plans to introduce vending machines so that Chinese people have better access to gold.
DHS: That shows how widespread the idea of gold ownership is. Last year China was the world's largest gold consumer but India will probably retake the top spot this year. People buy gold in Asia for different reasons than you or I. They're not trying to sell it when it goes up $50/oz. They look at it for the accumulation of wealth and for security.
TGR: You also see it as an extension of central bank gold buying.
DHS: Yes. China is still an authoritarian society and if the government said tomorrow that it's illegal to hold gold and that Chinese citizens must turn it in, most Chinese people would. I think this is a kind of Plan B for the central bank, if it is indeed trying to accumulate as much gold as possible—and all indications point to that.
TGR: At about this time last year you told investors to set aside some money for what you called "stupid cheap" prices. Are there some equities in the gold space that you consider stupid cheap?
DHS: It's time to look at prices in relation to where you think they'll be in a few years. A few weeks ago, the prices were stupid cheap. Alexco Resource Corp. (AXR:TSX; AXU:NYSE.MKT) has traded for less than $1/share a couple of times over the last six months. Another good one is Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE), which is above $5/share now, but it had dipped below $3. Gran Colombia Gold Corp. (GCM:TSX.V) has moved out of its sideways base, has moved up sharply, but still probably has not moved up as much as one might expect for its potential.
The idea of setting aside extra money is not only for stupid cheap prices, but also for something that comes out of the blue that is undervalued in relation to everything else. Having the money and courage to take advantage of those opportunities is what I call psychological capital. If you lose that, you can actually lose your ability to trade effectively.
TGR: Gran Colombia has some production and exploration assets in Colombia. What's your view on Colombia?
DHS: I don't think you can eliminate country risk. Colombia is a much better place to do business than it was a few years ago. Investors have to continually look at where they are investing and ask: Am I willing to accept the risk in relation to the reward that I hope to get from holding stocks in that country?
TGR: In the May edition of Silver Investor it was suggested that Goldcorp Inc. (G:TSX; GG:NYSE) is hunting for other production assets after losing its bid to buy Osisko Mining Inc. Detour Gold Corp. (DGC:TSX) was mentioned as a possible target but what else could suit Goldcorp's needs?
DHS: Any target that would have substantial proven resources in a safe jurisdiction. Goldcorp has great cash flow, money in the bank and sufficient credit to set its sights on a larger target. Goldcorp also hasn't made too many large mistakes, which can't be said about some of the other major gold producers.
TGR: Are there other large-cap equities near the top of your list?
DHS: Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) is a tremendous company. Yamana is making major acquisitions in Argentina because management believes, and I agree, that Argentina will be a much more friendly place to do business in a few years. Argentina is one of the most prospective areas in the world to explore for and produce precious metals. I think that when the country starts doing things that make more economic sense, we're going to see renewed interest in companies operating in Argentina. The country needs a new president, which it will probably have sometime in 2015.
TGR: Are there other projects in Argentina that you're following?
DHS: Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) has the Navidad project in Chubut province, which is probably the world's largest known silver deposit. That operation could potentially get underway within the next few years. The company is currently working on producing silver with smaller amounts of cyanide to comply with stronger environmental regulations. Navidad could really provide a boost to this economically depressed region, made more so by the eruption of a Chilean volcano a few years ago, which coated the region with ash and destroyed a lot of grazing animals.
TGR: What are some other precious metals names?
DHS: One of the most exciting exploration stories in the world, in my opinion, is Pretium Resources Inc. (PVG:TSX; PVG:NYSE) in British Columbia. It has incredible grades. These are not long veins, but the grades and intercepts are amazing. It's in a mining friendly jurisdiction where the environmental impact can be controlled. And the management is top flight. When Pretium collapsed last year it didn't bother me much—I bought it after it lost half of its value. It has reclaimed all of that and is hitting new intermediate highs.
Another story I like is First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE), a silver name in Mexico that produces a fair amount of gold as well.
I feel that Sandstorm Gold Ltd. (SSL:TSX; SAND:NYSE.MKT) is going to be a really surprising performer. Other royalty companies like Royal Gold (RGLD:NASDAQ; RGL:TSX) and a few others are bigger and more widely known, but don't forget that Sandstorm's management team put together Silver Wheaton Corp.'s (SLW:TSX; SLW:NYSE) silver streaming concept. These people know what they're doing. They have suffered a few bumps but they're going to do just fine. I'm very comfortable with my position in that company.
TGR: Sandstorm is up about 65% this year. Should investors expect more of the same?
DHS: In this game nothing is a certainty. Sandstorm should hold most of those gains. We're certainly going to see a lot more volatility. We've seen large gains evaporate in even some of the best companies after several rallies during the last year. Those are disheartening, but I believe this bull run has turned a corner and we're going to start seeing higher highs and higher lows. The greatest risk now, in my considered opinion, is selling too soon and not being able to get back in.
TGR: Do you have any parting thoughts for precious metals investors?
DHS: The last three years have been incredibly difficult. No one, myself included, thought it would take three years to spin out of this. I still believe the potential is so large over the next few years that a modest position in the better precious metals stocks and holding some of the physical metal will result in outsized gains for people who really understand what's driving this market. This is a global bull market. The one in 1979–1980 was largely confined to North America. Asia wasn't even a component. Asia is driving this market and at some point everybody is going to be on that bandwagon, as David Morgan and Doug Casey and a few others have said. Investors willing to accept the volatility with what's going on are going to be very happy they did.
TGR: Thank you for talking with us, David.
David H. Smith is senior analyst for The Morgan Report, as well as a professional writer and communications consultant through his business, The Write Doctor Inc. He is a regular on HoweStreet.com. Smith has visited and written about properties in Argentina, Chile, Mexico, China, Canada and the U.S. He is an investment conference/workshop presenter at gatherings in Canada and the U.S. His work for subscribers can be found on www.silver-investor.com and for the general public at Silverguru.
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DISCLOSURE:
1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Pretium Resources Inc. Goldcorp Inc. is not associated with The Gold Report. Streetwise Reports does not accept stock in exchange for its services.
3) David H. Smith: I own, or my family owns, shares of the following companies mentioned in this interview: Ivanhoe Mines Ltd., Stillwater Mining Co., Wellgreen Platinum Ltd., Alexco Resources Corp., Endeavour Silver Corp., Gran Colombia Gold Corp., Pretium Resources Inc., First Majestic Silver Corp. and Sandstorm Gold Ltd. I personally am, or my family is, 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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