Brien Lundin: Gold Revival

Source: Karen Roche of The Gold Report 09/08/2010

In this exclusive interview with The Gold Report, Brien reveals how the November elections will be pivotal to gold and why President Obama’s policies could provide a big boost to the yellow metal. He also shares some of his favorite producers in the sector.

The Gold Report: Recent reports are signaling that consumer confidence and sentiment are up and that the balance sheets of U.S. corporations are stronger. Yet, gold is going up at the same time. What’s happening with the gold market right now?

Brien Lundin: It’s a bit deceiving that some sentiment surveys show what appear to be dramatic increases because they’re still at very low levels, historically, and have been for months and even years. A sentiment index goes up a couple points compared to the previous month and it makes for headlines in the financial media. However, the smart money recognizes the fact that there hasn’t been the level of increase in consumer sentiment that will lead to any kind of an economic rebound. 

TGR: Could these small, incremental increases be a precursor to a larger recovery?

BL: They could be. The economic environment is really unique right now, because it’s sharply split between the bulls and the bears. There’s no clear trend. Positive economic indicators point toward a rebound and the stock market will soar. Then the next week, sentiment takes a 180-degree turn and the market heads in the opposite direction. 

There’s been talk recently of the “Hindenburg Omen”—an indicator said to predict stock market crashes that uses 52-week stock highs and lows and the moving averages of the New York Stock Exchange. This technical anomaly, or pattern, was triggered a few weeks ago. That’s precisely what the Hindenburg Omen is meant to highlight—a situation in the market wherein sentiment is sharply split. 

Essentially, this is a trendless market defined by very brief trends that are cut off and reversed periodically. So, it’s a tough investing environment. The good news for gold investors is that no matter what happens, no matter which way the economy heads, there’s a very good argument for significantly higher gold prices.

TGR: Most arguments that favor gold hinge on inflation caused by an economic rebound, or due to quantitative easing (QE) devaluing the dollar. If we are in a trendless market with the economy essentially moving sideways, are we in a so-called “growth recession?”

BL: Yes, and it’s possible we will remain in a growth recession wherein the economy is growing so little it isn’t enough to overcome the economic friction of inflation or enough to improve people’s quality of life. But right now, the economy is on a razor edge with the potential to fall rapidly on either side of the equation. I really think that this trendless market is going to break one way or another fairly soon.

TGR: What will cause it to break?

BL: It just can’t keep muddling along as it is. At some point, the government has to jump-start the economy. The Federal Reserve may panic and expand the money supply dramatically through more QE, which will produce a powerful growth in the amount of currency and a corresponding rise in gold prices. 

There’s another tactic that Fed Chairman Ben Bernanke hinted at during the Fed’s Jackson Hole conference in August. He suggested unlocking excess banking reserves that are now sitting at the Fed earning about a quarter-point interest. 

It’s been difficult for banks to loan their reserves out, given the severe banking regulations that have come down. But the Fed can force their hand by taking the interest rate it’s paying on the nearly $1 trillion in excess reserves. The Fed can cut the interest rate from about 0.25% to 0% and, in the extreme, can impose a holding charge. There can actually be negative interest rates on those reserves. If the Fed does that, I think money will come scurrying out of their coffers and back into banks to be put to work in the market. The end result would be a shot of adrenaline into the economy. I think there would be a dramatic effect on inflation rates and gold prices, as well. 

TGR: Are we so far down the line that the only result is a high inflation rate? 

BL: The current level of spending, the debt already baked into the cake, is too large to “grow” our way out of. That leaves the time-tested option that governments have always resorted to—inflate away the debt. If there is a 10% rate of monetary inflation, for example, then that debt is cut in half in about eight years. I think that is the only option remaining for the government. Even if Washington doesn’t opt for more stimulus and spending, we could see significantly higher inflation rates purely as a result of the debt load that’s already been amassed.

TGR: Could the U.S. experience hyperinflation like that experienced in the Weimar Republic of Germany in the 1920s?

BL: I don’t think there will be hyperinflation in the U.S. There are really two types of inflation—price and monetary. Price inflation is not the cause, but rather the symptom of monetary inflation—just too much currency out there chasing too little goods. We don’t need to have as high a level of price inflation as we had in the 1970s to see commodities and gold rise in value. In fact, I don’t think there will be that level of price inflation because, unlike the 1970s, we have export economies like China, Thailand, Vietnam and India with very low labor costs that are restraining the Consumer Price Index (CPI). We can go to Wal-Mart or Costco and buy items at much lower prices compared to the options available to us in the 1970s. That directly impacts price inflation. 

TGR: What effect will an export economy like China’s have over the next year or two? 

BL: I think China will have a significant and prominent influence. The rebound in Asia has been a remarkable story. The rest of the world caught pneumonia in 2008, but Asia seems to have had only a few sniffles. 

China has also highlighted some new themes and trends in Asia. China is just beginning to experience a relative shortage of cheap labor, which is driving up wages and benefits across the board. While this has removed some of its economic advantages as an exporting nation, it’s also correspondingly building greater domestic demand in China. Domestic consumer and business demand are going to become important drivers for China and other Asian export economies.

There will still be bubbles inflating and popping here and there in Asia, but I don’t foresee these economic engines suffering major collapses in the near future. I think Asia is going to be a continuing story for commodities and particularly for base metals, including copper.

TGR: We are entering the Indian wedding season, China is motivating its population to buy gold coins and the holiday season is coming up. What’s your prediction for gold in the fourth quarter?

BL: It is the traditional season for demand in precious metals to ramp up, but this type of demand is price sensitive. Seasonal buying, particularly in India, will dampen if gold prices go much higher than they are now. Previously, I think I predicted gold would be $1,350–$1,500 an ounce by year-end. Now, I think $1,500 is a long way to go from here. It would require a weaker dollar and some indication that the Fed’s going to undertake additional quantitative easing to get gold prices to those levels before the end of the year. 

Asia will still have demand for gold and that will support prices. In order to drive the market ahead, however, it’s going to be a story of what’s happening with the Western economies and will there be more monetary and quantitative easing. The good news for gold investors is that type of monetary and quantitative easing is very likely. 

TGR: How do you think the November elections could impact the timing of any monetary and quantitative easing?

BL: In my view, the upcoming midterm elections in the U.S. actually represent the greatest near-term risk to gold. I believe the country is going to experience a dramatic backlash toward the conservative/Libertarian side of the political spectrum. Therefore, the markets are going to factor in restraint in spending, restraint in Keynesian stimulus policies and the type of gridlock in Washington that has proven positive for business and the economy. A short-term reaction will likely be a stronger dollar and weaker gold. 

Long term, there are other political risks that I think will be positive for gold. There will be a lame duck, unaccountable Congress that could force through some dramatic spending and social plans. President Obama could go into full campaign mode; he’s already campaigning, but you haven’t seen anything yet. He’s really going to be campaigning toward 2012. I think he is married to a political and economic philosophy that will end up being very good for gold and probably very bad for the U.S. economy. 

They say it took President Nixon to go to China in the same way it took President Clinton and a Republican Congress to reform welfare, balance the budget and cut taxes. But Obama hasn’t shown any inclination to triangulate like the more pragmatic Clinton. He’s a true believer in a world where government runs the economy and picks the winners and losers. He’s not going to back down, and he’ll retain control of the Treasury and, to some extent, the Fed. Obama will still be able to cause some economic mischief, and he’ll try his hardest to do so. For gold bugs, at least, that’s going to be a good thing because it’s going to lead to higher gold prices over the long term. But investors need to look at those midterm elections in November as being a stumbling block for gold along the way. 

TGR: Gold prices have increased substantially since the beginning of August. You said in one of your alerts that, even though gold’s low price may be behind us, junior resource stocks have yet to respond. Why are the juniors lagging?

BL: One refreshing thing about this summer is that a sense of normalcy has returned to the gold market. It’s been a couple of years since that happened. Historically, gold prices bottom somewhere between mid-July and mid-August in a bull market. Juniors follow along a little bit later in August or September. 

Interestingly, some shares have started to wake up since I wrote that the juniors had failed to respond. In fact, some have begun to soar. I really see a turnaround in the market. There are some bargains that remain, but they’re not as prevalent as before. 

Some examples that I have recently been talking about in our alerts are the rare earth (REE) companies. We recommend three rare earth plays: Rare Element Resources Ltd. (TSX.V:RES; NYSE:REE), Tasman Metals Ltd. (TSX.V:TSM; Fkft:T61; OTCPK:TASXF )and Quest Rare Minerals Ltd. (TSX.V:QRM). 

These stocks have all more than doubled from their mid-summer lows. Part of this is in reaction to China’s dramatic increase in rare earth export quotas recently. China had previously cut those quotas back by as much as 70%. Prices for the underlying commodities have soared in reaction. It’s also a result of progress at these individual companies. Rare Element and Quest are both poised to deliver preliminary economic assessments on their respective deposits. Tasman has drilled its Norra Kärr Project in Sweden. It’s preparing a resource estimate and is about to begin drilling its next project. Plus, being located in Europe, it has certain advantages on the corporate and M&A fronts, which I expect it will take advantage of. All three of these companies are buys near current levels. 

TGR: One of the arguments that I’ve heard posed for rare earth plays is that the winners will be those that can get to production first and be low-cost producers because there is more than enough metal out there. What’s your viewpoint on that?

BL: The market for these metals will grow strongly. There will be a period over the next three or four years in which there may actually be a shortage. The best cure for a supply shortage, of course, is high prices, and the market will eventually return to equilibrium or, more likely, to oversupply at some point. But investors aren’t buying these junior rare earth plays for 10- or 20-year investments. They’re buying them for the next two years, three years at the outside. In that timeframe, I think these companies have the potential to absolutely explode in value.

TGR: Are Rare Element, Tasman and Quest just a good value right now, or are they leading the REE sector?

BL: They represent a good value, but Tasman probably represents a little better value. There will be a couple of headlines out of China, and these stocks will jump as much as 20% or 30%. That’s not the time to buy. The time to buy is when sentiment for rare earths fades. You buy these companies on the dips. I recommend that because it is such a volatile area. Investors should have a core holding that they maintain and add to on dips, but also maintain a trading position. Investors can play these cycles in rare earth companies with a trading position and leverage their profits.

TGR: Could there be supply saturation in three years?

BL: I don’t know that it would happen in three years. It could take two or three years before these deposits are even brought into production. A lot of it depends on Molycorp Inc.’s (NYSE:MCP) Mountain Pass deposit and how quickly that production is ramped up. It’s a moving target. I do think we’re in the sweet spot for investors the next couple of years as these companies develop and expand their projects and as rare earth metals prices increase.

TGR: What are some of the junior plays in precious and base metals that represent a good value?

BL: I like Brigus Gold Corp. (TSX:BRD; NYSE.A:BRD), which is the result of the merger of Linear Gold and Apollo Gold. The new management team, whom I’ve known for many years, has really begun to take effect there. Their production, operating costs and revenue numbers are already nicely improved. The company is beginning to attract the attention and respect of the market. I think that company has a great future ahead. It’s a buy at current levels. 

Inter-Citic Minerals Inc. (TSX:ICI), a gold exploration company, has the large and growing Dachang Gold Project in the Qinghai Province of Western China. It’s run by a management team that also has big plans to match the project. This team recognizes that development projects often lose the attention of investors as they go past the discovery stage and into the development phase. They’re working on ways to keep the exploration potential of this very large project front and center. I think it’s got its best days ahead of it. It’s a strong buy. 

Great Panther Silver Ltd. (TSX:GPR) is one of the best silver plays. Production is set to ramp up dramatically during the next couple years. It’s spending the money that’s necessary on a historic Mexican silver project that’s been worked for literally centuries, but which has never had the benefit of modern mining methods and exploration techniques. I think there are great things ahead as production, reserves and resources expand. 

Pediment Gold Corp. (TSX:PEZ; OTCBB:PEZGF; FSE:P5E) has the San Antonio Gold Project in Baja California. They had a historic resource on the project’s Las Colinas zone. Then they made a big discovery a few years ago with the Los Planes zone north of that historic resource. The company went back and recognized some geologic faulting between those two zones that offsets the mineralization, and it’s beginning to connect that. It’s drilling and getting good results. There could be some significant resource expansion over the next couple of months as drilling progresses and it moves toward the development stage. It’s a very exciting stage for the company. It represents a very good value right now. 

I also like what’s going on in the Yukon. Kaminak Gold Corporation (TSX.V:KAM) has been one of our big success stories. We were the first newsletter to recommend Underworld Resources and its big discovery sparked the new Yukon gold rush. Kaminak has already strung together a few zones with great drill results, which could develop into a project that will dwarf what Underworld had discovered at the time it was acquired byKinross Gold Corp. (TSX:K; NYSE:KGC). But the share price has soared to the extent that I recommend investors wait until the dark, long, cold days of winter, when these plays go silent on exploration news and share prices typically fall back. Investors should wait for that type of pullback for Kaminak.

TGR: Should investors also wait for share prices to settle during winter for the other companies you mentioned? 

BL: Companies that work in environments where they can’t operate year-round often begin to see a decline in share price when the news flow stops in winter. There is also some tax-loss selling at the end of the year. The problem with some of the more successful plays is that the share prices don’t come back due to tax-loss selling because people have gains in the stock. You see an opposite effect where the stocks may come back a little bit in the beginning of the New Year as people try to defer their capital gains.

TGR: You mentioned investors in the rare earth sector should try to play with trading positions. Would you also recommend that with the junior gold sector?

BL: I would recommend it in companies that are somewhat cyclical. For example, a company that has some projects in the northern latitudes and goes silent for a while in the winter. But if investors have a good company with a good deposit that stands to grow, they don’t want to be too smart by half. Investors should maintain a core position in these top-quality companies for the long term—so they can maximize returns by holding it through the cycles—until the ultimate takeout or realization of gains. That said, investors can have trading positions in these companies, and I think it’s important for them to distinguish between the two positions. Perhaps take risk profits off the table, but don’t sell it all out—maintain a core position. If you’re an active investor and you watch the market on a daily basis, you can have trading positions in these stocks that also can be very profitable.

TGR: Are there other juniors that are particularly interesting at this time?

BL: Golden Predator Corp. (TSX:GPD) is run by Bill Sheriff, who made his fame and fortune in the uranium boom taking a junior explorer and getting it up to the NYSE. He’s doing that again with his gold play, Golden Predator. It has about a half dozen very good projects that it’s actively drilling in the Yukon. I think there’s a very good chance they’re going to come up with some results that will take the share price higher. I’ll look for those results to begin coming in over the next few weeks. 

TGR: You organized and will be speaking at the New Orleans Investment Conference, which is coming up on Oct. 27. Can you tell me what you hope investors will learn there?

BL: This is a crucial stage in the gold market. I tried to develop an agenda and a roster of speakers at this year’s event that will prepare investors for the new renaissance in the gold market and the dramatic changes going on both geopolitically and in the economy. There will be speakers like Newt Gingrich, former Congressman Dick Armey and political commentator Charles Krauthammer. Charles is one of the smartest people in Washington and knows what’s going on in Congress and the administration that dramatically affects private wealth and the economy. David Walker, who is a former U.S. comptroller general, will be there to discuss the effects of our exploding debt. Eric Sprott, arguably the most successful gold investor in the world during this bull market, is speaking this year. This will be an opportunity for investors to hear firsthand what Eric likes about the market and what stocks he is buying. 

This is a different kind of investment event than most people are familiar with. At the New Orleans Conference, there’s a sense of being among the most sophisticated investors and experts that can be gathered in one place on the topic. Our speakers save their best picks and really work their hardest on their presentations for the New Orleans Conference. As a result, some extraordinary winners have come out of this event. We’re talking stocks that will multiply 4x, 5x—even 10x after the event. It’s a place to really find those hidden treasures and tomorrow’s winners. Kaminak was a $0.50 stock when it was recommended at last year’s conference by me and several other speakers. Investors who bought then have multiplied their money nearly eightfold. That is the type of winners that are typically found every year at our event. 

TGR: It sounds like an excellent educational opportunity. Thanks for your time today, Brien. 

With a career spanning three decades in the investment markets, Brien Lundin serves as president and CEO of Jefferson Financial, a highly regarded publisher of market analyses and producer of investment-oriented events. Under the Jefferson Financial umbrella, Brien publishes and edits Gold Newsletter, a cornerstone of precious metals advisories since 1971; he digs into not only small caps of every type but also macroeconomics and geopolitical issues that ultimately affect every resource investor. Brien also hosts the New Orleans Investment Conference, the oldest and most respected investment event of its kind, which each year brings the giants of investing, economics and geopolitics. On the agenda for the 2010 conference—scheduled for October 27-30—is another star-studded array of speakers that includes a lot of names very well known to the Gold Report crowd: Mary Anne and Pamela Aden, Gary Alexander, Gene Arensberg, Dick Armey, Andrew Barron, Thom Calandra, Doug Casey, David Coffin, Brent Cook, Adrian Day, Marc Faber, Dennis Gartman, Steven Hochberg, Frank Holmes, Charles Krauthammer, Stephen Leeb, Ian McAvity, Robert Meier, Bill Murphy, Chris Powell, Robert Pretcher, Lawrence Roulston, Rick Rule, Jeff Siegel, Mark Skousen, Eric Sprott, Frank Trotter, David Walker and—of course—Brien Lundin.

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DISCLOSURE:
1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in this interview are sponsors of The Gold Report: Great Panther, Rare Element, Inter-Citic, Brigus and Pediment.
3) Brien Lundin: I personally and/or my family own shares of the following companies mentioned in this interview: Rare Element Resources, Tasman Metals, Inter-Citic Minerals, Kaminak Gold Corp. and Golden Predator. I personally and/or my family am paid by the following companies mentioned in this interview: None.