Michael Berry: Gold Reacts and Mining Sector Benefits

Source: George S. Mack and Karen Roche of The Gold Report 10/25/2010

In this exclusive interview with The Gold Report, investor, mathematician and former fund manager Michael Berry, PhD, tells us he is bullish on gold, which he expects will double or more in price in the not-too-distant future. In the meantime, with organizational skills developed in a previous career as professor of investments, Berry has created a 10-point “Discovery Investing” (DI) model by which all stocks in his universe are graded. For his own portfolio and as well as his Morning Notes newsletter, he has staked out plays on several small- and micro-cap mining stocks that he expects will perform quite well through either price appreciation on discoveries or takeover.

The Gold Report: As part of a short-term plan to sell $66 billion in debt, the U.S. Treasury recently auctioned $32 billion of three-year Treasury Notes at an all-time record low rate of 0.57%. Why is this negative for the economy?

Michael Berry: The deficit problem is very significant. Deficit spending is not working. So, ultimately, we have to grow out of this economic malaise, but right now organic growth doesn’t look like a plausible solution to the problem. I think the Obama administration has realized this. I’m not sure the Republicans have a better approach. In fact, in a way, I hope they don’t win the House back because I’m not sure they have a plausible solution. From an investment perspective, people are seeking assets other than Treasuries in which to invest.

TGR: Fed Chief Ben Bernanke is saying that inflation is too low. It’s obvious that he’s going to do something. He can print a trillion dollars via electronic transfer of funds if he wishes. Does that scare you?

MB: Well, yes, it does in a way that probably is not too traditional. I don’t think quantitative easing will have much impact. We’re talking about the idea of quantitative easing here, or increasing the money supply and reducing interest rates. But right now we’re not seeing either the velocity of money or the multiplier picking up. We’re not seeing enough lending. So I don’t think the easing, or monetary approach, is an adequate solution to the problem now. I believe most of my colleagues agree at this stage of the game. So the question, the real question, is how do you stimulate demand? The kind of inflation that’s being stimulated now is cost-push inflation rather than demand-pull inflation. What Chairman Bernanke really wants and needs is demand-based inflation, but it is not evident in the economy at this time. That’s what he really wants.

TGR: Is there a solution to this problem?

MB: Yes, there is a solution to the problem. The solution is a very painful one but not a terminal one. It is painful because we must reduce our deficits. We have no choice. We may have to cut Social Security, which will be painful for people my age. Obviously, we are certainly going to have to pull back on entitlement spending. Fiscal programs such as government spending are not the solution. The monetarist approach of manipulating the money supply is no longer a solution. I think it’s going to be a matter of cutting entitlements and balancing the budget; but these are all very painful approaches to the problem, and they take time. So there’s no immediate solution to this problem. That’s why unemployment is stuck at 9.6%. Underemployment is 18.6% and it’s not coming down. That’s why the Democrats may lose control of one or both of the houses of Congress in this year’s elections. 

TGR: Recently the Commerce Department reported that the trade deficit expanded to $46.3 billion in August due largely to our big competitor, China. Imports for the month jumped 2.1%, while exports rose only 0.20%. Is China waging economic warfare against the United States with its pegged currency?

MB: That’s a great question. There is no doubt that fiat currencies and floating exchange rates are manipulated. There is no doubt that China manipulates its currency. There is no doubt that the U.S. is manipulating its currency now by continually depreciating it. But is China waging war? I don’t think so. This is a question that President Obama has to answer in the next few days at the G20 meeting because he has to declare that China is or is not a currency manipulator. So it’s a very delicate political question. But basically, I do not think China is waging war against us in the sense of the currency system. 

Americans have become addicted to Chinese goods and that’s a tough addiction to kick. China is also addicted to exports. I think the war they are waging is a war to sustain their economy, not necessarily to impinge on or damage ours. We do have to remember that they hold several hundred billion dollars worth of our debt and that tally is growing. So presently we need them and they need us. I don’t know how this problem will be resolved. It’s interesting; however, if you look at moves in the Chinese currency, you’ll see that in the last couple of weeks they have allowed the yuan to begin to appreciate. Of course, it’s not nearly enough to suit Washington, but it means they are listening to us. No, they are not waging a currency war on the U.S. economy. They simply realize that if they allow the yuan to appreciate to a large degree, it will have dramatic negative impact on the Chinese economy and they’re not going to let that happen.

TGR: How undervalued do you believe the yuan is?

MB: Relative to the dollar right now it’s probably 30% to 40% undervalued. So it’s significantly undervalued. I read recently in The Economist where a Big Mac in Beijing is 40% cheaper in dollars than a Big Mac here in New York.

TGR: Do you see anything coming out of the G20 meeting [Editor’s note: the G20 meeting took place a few days after this interview] in November, specifically regarding the Chinese and their currency?

MB: No, I really don’t. When it was the G5 that ran the world, we had the Plaza Accord in 1985 and the Louvre Accord in 1987. Then the world allowed the U.S. to depreciate its currency and get out of a similar but much smaller bind. That was because the U.S. at the time was the strongest of the five or six strongest countries in the world. Now we have 20 countries, both developed and emerging, trying to agree. They all want either import controls, in the case of the emerging countries, or to have the U.S. dollar depreciate because it is the reserve currency of the world. So I don’t see how there could be any serious agreement at the G20 meeting later this month. What eventually will happen, I think, is that a completely different currency regime will materialize out of the G20. I don’t know whether that will be backed by a commodity basket or gold. Ultimately this new currency regime will be much less dependent on the dollar. The best thing that could happen to our dollar would be that it loses its reserve currency status, and I think it must happen within the next decade.

TGR: I believe six to nine months ago you had an 18- to 24-month target for gold hitting $1,500. Is that still your target?

MB: Yes. I guess I haven’t really revised my targets. We got there a lot faster than I thought we would with gold trading at roughly $1,338 and silver trading in the $23 to $24 range. I think this is very characteristic of a world concerned with fiat currencies, devaluations and depreciations, and once again it properly identifies gold and silver as real money capable of storing value and assets in which Americans ultimately place their confidence. But I’m not suggesting that they will be used as a currency backing. It’s interesting to learn that J.P. Morgan and other banks in New York City are actually rebuilding old vaults to store physical gold and silver because demand for physical gold is so strong. Yes, I could see $2,000 to $2,500 gold, and I could see $30 or $35 silver. 

TGR: What’s your longer-term upside to gold? Also, what about silver, platinum and uranium?

MB: I don’t do point estimates very well, but it’s possible you could see $3,000 gold in the next five years. I think that’s very possible. I also believe it’s possible that you could see $50 to $75 silver in the next five years. Having said that, I hearken back to October 2002 when we had $5 silver and we were hoping it would rise to $6. Nobody dreamt it could be $24. Similarly with gold when it was trading below $400 in 2004, nobody dreamt that it would be $1,300 or $1,400. People thought “gold bugs” were fools. No longer. Platinum and palladium are both also industrial in character, and the emerging world is rebuilding. So I think there’s upside in both of these metals and of course they’re significantly higher. Uranium is going to increase because even though the United States is not building out its nuclear industry quickly, the rest of the world is. So I think we could see $70 or $80 uranium in the next two years quite easily.

TGR: What is “Discovery Investing”? Is it small stocks? Is it a company philosophy? 

MB: Well, let me explain a little bit of the history behind its development. I was a mutual fund manager for Heartland Advisors in the 1990s. As a value investor, I bought stocks that were out of favor, those with low P/E multiples. What I found out was that whether you’re investing in growth or value, small or large cap, these disciplines all experience times when they excel in performance and times when they underperform. So, I decided that I would build a fundamentally different investing philosophy that would focus specifically on discovery and would not go out of favor nearly as often as value investing. I carefully designed this strategy over the last decade. 

The central thesis is that all great wealth is created through significant discovery. This discovery can be in natural resource exploration and development, it can be in food stocks, or it could be in a cancer cure, for example. If you have one great discovery, and if you have accumulated a diversified portfolio of these discovery opportunities, you’re going to do very well over time. In fact, we have done well. We’ve had some great successes, and we’ve also had some failures in the Discovery Investing world. But there is much less downside than upside and it’s caught on with a lot of people. Overall we’ve done very, very well at wealth creation. Finally Discovery Investing is, in effect, a socially responsible investing strategy strictly from the perspective that discoveries in health care or natural resources improve the quality of life for our citizens.

TGR: Tell us more about how it works.

MB: I divided DI companies into three different categories. First, companies who have not yet made a discovery but are in the process of exploration. I call these “Incubator stocks.” I love them. They sell for pennies. They’re looking for new gold mines and uranium mines, or a cure for ALS or a new technology. We just had one Incubator company, a lithium play called Salares Lithium, that was taken out by Talison Lithium Ltd. (TSX:TLH), the world’s largest producer of lithium, which supplies 75% of Chinese lithium minerals. Incubator companies are small and illiquid, and they are very risky. You don’t invest unless you’re willing to wait a long time and possibly lose your investment, but some of them will graduate into what I call Mature discovery stocks once they have made a discovery. An example is Underworld Resources in the Yukon, which at one point was an Incubator stock, but then made a gold discovery in the White Gold camp. They got great drill results. It was also taken out in a merger-acquisition transaction last year. Then we had one called Western Silver, which became Glamis and ultimately Goldcorp Inc. (NYSE:GG; TSX:G), which is in the third classification, a Legacy discovery company. Even though one such as GG is a large-cap stock and one’s a micro cap, they still have the discovery philosophy embedded in their model. It’s been a lot of fun. For some people, that’s been a very productive part of their portfolio. I don’t recommend more than a 5% to 10% allocation to the portfolio, but these stocks often add significant performance.

TGR: So you would still consider Goldcorp to be a discovery stock? Even at that market cap [$31.5 billion]?

MB: Absolutely, absolutely. They’re still drilling at Peñasquito, which was the big Mexican gold and silver deposit in Zacatecas that Western Silver, under Tom Patton and Tom Turner, discovered. They’ve accumulated a billion ounces of silver and 17 million ounces (Moz.) of gold, but they might double that. Because it’s more fully valued, the leverage isn’t as great as a much smaller Incubator stock. But it is absolutely a Legacy discovery stock, yes. 

TGR: Do you think of Goldcorp as part of the safety portion of your portfolio?

MB: You could, but I prefer to cast everything in terms of discovery. Let me point out another example. A group of oilmen from Texas called me about a large shale gas discovery play called the Eagle Ford Shale in South Texas. The Chinese, China National Offshore Oil Corporation (CNOOC), just bought into this through Chesapeake Energy Corp. (NYSE:CHK) for $2 billion. They’ve asked me to invest. But this is an LLC, not a public company, so the discovery doesn’t have to be a public stock that trades— it could be a private project. Some of the best discovery investments start out this way.

TGR: I’m looking at a one-year return of 353% on Terraco Gold Corp. (TSX.V:TEN). I don’t know whether you would call it fully valued or overvalued, but it certainly has performed. I think you may still own some of this stock yourself. Can CEO Todd Hilditch squeeze more out of this, or do we have to see a dramatic correction first?

MB: Well first of all, Todd Hilditch is one of the new young stars in the mining industry and the natural resource space in Canada. He put together Salares Lithium, which, as I mentioned, was taken out by Talison Lithium for $430 million. So there’s a lot of confidence in Todd’s abilities. 

Our Discovery Investing model has a 10-point grid on which we rate companies, and one of the most critical things that we look at is management strength. So Todd Hilditch right now has garnered a lot of confidence in the marketplace. A lot of people believe that he will make Terraco Gold into a Mature discovery name. He’s got two or three properties, and one, Moonlight, sits right above Midway Gold Corp.’s (TSX.V:MDW; NYSE.A:MDW)Spring Valley property near Lovelock, Nevada. Midway Gold has discovered over 2 Moz. of gold. So Terraco will be drilling soon at Moonlight. Todd held back during the bleak days of 2008 and 2009 and waited for the Midway situation to develop, which it has. He also has the confidence of the Canadian investment banking community, who believe in Terraco. Any stock can correct, but I think it’s ultimately a $0.50 stock from here, but it could correct in the meantime. I think Terraco is an up-and-coming gold play that will do very well. I do own Terraco, and I do advise Todd Hilditch on a number of issues as well.

TGR: Speaking of your 10-point grid, your son, Chris Berry, has just done an analysis ofAntioquia Gold Inc. (TSX.V:AGD), and he made the case for its Cisneros Property where they are drilling for a minimum 200,000 ounces of high-grade deposit. Why is this stock only trading at a $23 million market cap?

MB: Well, that’s a question that everybody asks about Discovery stocks from time to time. Why is my stock not trading higher? I can tell you that Antioquia is looking for a deposit much larger than 200,000 ounces. The big mining companies wouldn’t be interested in anything under 3 Moz. or 4 Moz., and so the ultimate goal of Antioquia is a much larger ore body. But to start off, I think Antioquia will possibly want to mine 20,000 to 30,000 ounces a year, which would provide them with a stronger balance sheet and working capital. Exploration is extremely expensive and is a long-term process. So I think the 200,000 ounces represent only the beginning of their search to build a portfolio of gold assets in Colombia. I’ve actually been to visit their Cisneros Property, and it’s high grade. They hit on every one of their 64 holes, I believe. But as in most Discovery processes, it’s going to take more drilling. When they do start mining, whether that’s next year or the year after, you’ll see the stock price start to react to that. Chris is following Antioquia very closely.

TGR: What other gold stocks are interesting for you right now?

MB: Well, there are several that I’ve been following very closely with my 10-point Discovery analysis. There’s a big gold area play in the South American country of Guyana that I’ve been down to visit. One company, Sandspring Resources Ltd. (TSX.V:SSP), was a $0.75 stock a year or so ago, and it has appreciated as high as $3.00. They have about 4 or 5 Moz. of gold in resource now. Another one is Guyana Goldfields, Inc. (TSX:GUY). I think Guyana Goldfields will be taken out. But the company I’m interested in at about $0.45 per share—up from $0.15 just two or three months ago—isGMV Minerals Inc. (TSX.V:GMV). GMV Minerals has a very large Guyanese land position, and they just completed a bought financing with eight major investors in Toronto. They will be drilling their properties in Guyana very shortly. I think they have an excellent chance to make a discovery. They are working with the Alphonso family, one of the top families in Guyana, and that family is mining significant alluvial gold off of the properties as we speak. GMV’s CEO Ian Klassen is excellent, also an up-and-coming young executive in the Canadian mining industry. I think this could be a very interesting stock, with appreciation similar to Sandspring’s over the last year.

Another Discovery company is Geologix Explorations Inc. (TSX:GIX). They have two very highly regarded prospects in Mexico, one in Sonora and one in the south near Mexico City. They took a group of analysts on a mine site visit down there recently. Their stock has gone from $0.22 to $0.60 in the last two months. I think they’ve got considerable discovery upside, and I think they’ll ultimately be mining their Mexico property.

TGR: What about Talison?

MB: Interesting you should ask. Last night I had a conference call with the Talison CEO from Perth, Australia. Talison is not an Incubator stock, but it’s actually more of a Mature discovery company. Talison has well-established contracts with the Chinese and in fact, supplies 75% of China’s lithium minerals. Just think about that. They know the Chinese demand picture intimately. As I said, Talison bought out Hilditch’s Salares Lithium in a reverse merger. They have very large, high-grade, hard-rock lithium resources, almost 4%, in Western Australia. I think you’ve got significant discovery upside potential. Talison is very mature and could be a Legacy discovery company shortly or it could be an acquisition target.

TGR: Talison has a large enough market cap that small-cap mutual funds can own it, right?

MB: Absolutely.

TGR: Avalon Rare Metals Inc. (TSX:AVL; OTCQX:AVARF) has a $304 million market cap. Also interesting?

MB: Yes. No question about it—both Avalon and Talison are good companies, and I’ve been to see Avalon’s Thor Lake project. It is a big deposit, but there are still some hurdles to overcome in terms of metallurgy. They are coming along quite well and I will meet with CEO Don Bubar in December. Everyone in Washington worries that the U.S. needs access to rare earth elements, and of course Beijing knows that as well. I think both those companies have significant upside from even the $3 to the $5 level that they’re sitting at now. So I’m not afraid to recommend either of those as continuing Mature discovery investments.

TGR: Do you have another idea to share?

MB: One other company I would mention is Quaterra Resources, Inc. (TSX.V:QTA, NYSE.A:QMM) that has an 85 Moz. silver discovery in Mexico. They own 50% of the Nieves project. I think that the silver resource at the Nieves could increase to 150 to 200 Moz. of silver. If so, this will be an open-pit mine, and there are very few primary silver open-pit mines anywhere. They are typically lower cost and quicker to get into production. So I think someone is going to want to acquire this deposit—I’m talking about the Nieves property, not the company. You can get an open-pit mine into production in a couple of years, and for a lot lower capital cost than an underground mine. So it will be very attractive in the next 12 to 18 months to a bigger player. I own Quaterra Resources and really think President and CEO Tom Patton is superb.

TGR: This is something of a philosophical question. Would you differentiate the terms clean energy and green energy?

MB: Well, yes. I have to tell you honestly I don’t believe in green energy because if you’re building windmills, each windmill needs tons of copper. So for wind energy you’ve got to mine the copper. Same sort of thing for solar energy. So I’ve always had a little bit of a problem with the word “green.” But certainly there’s no doubt that electricity produced from passive systems like windmills and solar panels is cleaner than electricity produced from coal, which gives off all kinds of contaminants, including radioactive contaminants. I would classify nuclear energy as clean in the sense that there are no carbon dioxide emissions. Essentially, there are no contaminants resulting from nuclear energy production. It is true, however, that we must find a cure for our addiction to fossil fuels, but that I am afraid is a few decades away.

TGR: Mike, I have really appreciated the time that you have given us.

MB: Thank you.

Michael Berry was born in Colombia and raised in Canada but has lived in the U.S. for 36 years. A mathematics 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. He also published a case book, Managing Investments: A Case Approach during that stage in his career. Michael 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 complimentary 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 has developed. He also writes occasionally for Forbes.com. Mike lives in New Jersey, but now travels the world with his son, Chris, looking for discovery opportunities to make the global quality of life better and to provide wealth creating opportunities for his readers. 

He owns shares in Goldcorp, Talison, Terraco Gold, Quaterra Resources, GMV Minerals and Geologix.

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) George S. Mack of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report or The Energy Report: Antioquia, Avalon, Geologix, Goldcorp, Guyana, Sandspring, Talison and Terraco.
3) Michael Berry: I personally and/or my family own shares of the following companies mentioned in this interview: Goldcorp, Quaterra Resources, Terraco Gold, Geologix Exploration, GMV Minerals, Sandspring, Talison. I personally and/or my family am paid by the following companies mentioned in this interview: Antioquia Gold.