Wayne Atwell: Mideast Mayhem to Drive Gold Higher

Source: Brian Sylvester of The Gold Report 02/25/2011
As Casimir Capital Managing Director Wayne Atwell sees it, further political unrest in the Middle East could push gold higher while inflation risk and sovereign debt issues in Europe are longer-term price catalysts. He also shares a few up-and-coming gold juniors that Casimir covers in this exclusive interview with The Gold Report.

The Gold Report: In a recent interview with Bloomberg you said, “Gold’s gotten stronger because it’s no longer weak.” Can you explain that concept to our readers?

Wayne Atwell: Commodities and securities tend to trade on momentum. Gold had been exceptionally strong, but a lot of investors became nervous because gold appeared too strong and people started taking profits. Then the dollar strengthened and we received some more good economic news, which drove gold down again. Gold has corrected about 7% from its high late last year. Once it breaks through its support level, it could go meaningfully lower. It was in a negative technical pattern and once there is a certain technical pattern on the charts investors start dumping gold and go short. Some people don’t believe it, but many people invest based on charts and technical patterns. If enough people invest enough money, then it works.

Gold was on the verge of breaking down further when the Middle East uprisings began and investors became a bit anxious. So far, the citizens of two Arab countries have overthrown their governments. It’s been relatively peaceful, which is great, but you can envision a scenario in which it wouldn’t be peaceful. Saudi Arabia is likely to have some difficulties that may or may not result in a change of government, and now we’re hearing about protests in Iran. The probability is high that both those countries are going to have additional issues. They may not, but unrest in the Middle East has turned the gold price around.

TGR: That parallels what you’ve described in the past as an “event-driven market” for gold. Would further unrest in Arab countries push the gold price back above $1,400/oz.?

WA: I tend to think so, I guess it depends on what form that unrest takes. Obviously, the government changes in Egypt and Tunisia were relatively peaceful. But the uprising has already spread to Yemen and Saudi Arabia—and now there’s talk of revolts in Jordan and Iran. Saudi Arabia, as you’re probably aware, is responsible for about 11%–12% of global oil production. God forbid that country has a problem—that could cause a real crisis. Fighting in the Middle East is certainly an event that could push gold meaningfully higher. You will remember what happened in October 1973 when the Arabs cut off oil to the West and the oil price went through the roof. It caused massive anxiety and a very serious recession.

TGR: What are some other events that you anticipate could move the gold price this year?

WA: In terms of events, I’m worried about the sovereign debt situation in Europe. The European Union (EU) has dealt with liquidity issues for both Iceland and Greece into 2013, but it hasn’t solved the underlying problem; it’s just dealt with the short-term issue. Unless these countries start balancing their budgets, which is unlikely—come 2013, the same problem will resurface. A sovereign default in Europe is highly probable. Spain has an unemployment rate of +20%, which is just huge. That’s an issue, too.

In the U.S. a number of municipal governments are very deeply in the red. They haven’t funded their pensions and healthcare for their municipal workers. There’s a reasonably high chance that one or more of these municipalities could fail, which would cause a high degree of anxiety and force investors to dump municipal bonds, which again would result in investors’ flight to gold as a safe haven.

TGR: In an interview with BNN, you talked about the Chinese and American economies “laying the groundwork for inflation.” How are these countries doing that and what do you believe is the timeframe for dramatic inflation increases in both countries?

WA: I’ve been going to China for 30 years and I have seen a phenomenal change. I’ll just throw out a few numbers to put the country in perspective. China consumed about 3%–4% of the world’s commodities in 1985 and now consumes 35%–45% of global commodities, which is astounding. To put that in context, from 2000–2010, global steel consumption grew at a rate of 5% a year. Chinese steel consumption has grown at a compound rate of 17%. So, in 2000, China actually produced 127 million tons (Mt.) of steel; in 2010, it produced 626 Mt. of steel. Basically, the country grew its steel industry by 500 Mt. in 10 years, providing the bulk of global growth.

On average, commodity-consumption growth averages 2.5%, yet here we have steel growing at 5% over a 10-year period and China’s steel consumption growing at 17%. It’s unprecedented. That, in turn, has caused a shortage of metallurgical coal. Met coal is breaking out and will probably reach a new high shortly because China has gone from being an exporter to an importer. Iron ore is now within about $10 of its all-time high. About 10 years ago, China was about 70% self-sufficient in terms of iron ore; now it’s 30% self-sufficient, so China is driving up the iron ore price, as well.

TGR: It’s a similar story with copper.

WA: Yes, copper made a new high last week and China consumes 38% of the world’s copper; it’s only 15% self-sufficient, so 85% of its copper comes from offshore. The rapid growth in China is being driven by the need to move people from the country into the cities, and the country consumes a lot of material when it constructs new buildings, rail lines, power facilities, bridges and ports. China is transforming from an agrarian to an urban society, having moved about 15 million people per year into cities over the last 15 years. It’ll likely have to do that for another 10, maybe 20 years.

China is only 43% urban but it will likely become at least 60%, maybe even 70% urban within 20 years. This is putting a strain on the global supply of industrial materials—prices for many of which are at or close to all-time highs, which is inflationary. The mining industry has a pattern of looking for new mines and developing new properties but when you grow at a rate that’s faster than the historical norm, it puts extra strain on the industry. We’re not going to run out of these materials but we must go look in more remote locations to find the materials.

TGR: What about inflation in the U.S.?

WA: Here in the U.S., the government is out of control. Our government spending is frightening. Last year, we had a $1.6 trillion deficit. It’s coming down a bit this year, but it’s still going to be very high. The deficit is about 10% of GDP; historically, it peaked at 4%. Government spending is about 25% of GDP. We haven’t seen these numbers since the end World War II. We’re in uncharted territory—the government is spending too large a share of our GDP. The interest on our debt, as forecast by government budget office, is going to go from $350 billion this year to $900 billion within five years. Forget healthcare, social security, Medicare or Medicaid—we’re going to add +$500 billion to the interest expense. This will drive the dollar down and result in serious inflation.

In the case of China, industrial demand is pushing up commodity prices and creating inflation. As far as the U.S. is concerned, you can’t have this pattern of government spending in the reserve currency of the world without causing serious problems. There is every reason for investors to go into the gold market to put a certain percentage of their assets in gold for protection against super inflation.

TGR: Do you think these factors will push gold to an all-time nominal high in 2011?

WA: Gold made a new high late last year. It has made a new high 10 years in a row. We think it will make a new high of $1,600 this year and $2,000 within the next one to three years. We suggest buying on a correction; it probably won’t go much lower. We believe holding 5%–10% of one’s assets in gold makes sense.

TGR: Among other financial services, Casimir Capital puts together financings for companies, many of which are junior miners. Why does Casimir focus on the junior mining segment of the market?

WA: I wrote a piece on the junior gold industry recently, which makes a number of points. One is that the denominator is obviously much smaller for the gold juniors. If both Newmont Mining Corp. (NYSE:NEM) and a junior gold exploration company find a 1 million-ounce (Moz.) gold deposit, it’s going to have a much more significant impact on the junior explorer’s share price. Both Newmont and Barrick Gold Corporation (TSX:ABX; NYSE:ABX) produce 5–7 Moz. gold annually, so only about 5 out of every 100 exploration discoveries is really of interest to them because most of the very large gold properties have already been found.

It’s extremely difficult to find an exciting new gold property. So, if you’re spending money on gold exploration, the probability is you’re going to find a small gold deposit. But in many cases, the gold majors are prospecting for new exploration properties in their corporate finance department. They’re looking at and frequently buying intermediate or small gold companies with substantial gold deposits that the majors can develop themselves.

TGR: Yes, the gold majors essentially use the junior explorers as their exploration arm.

WA: Exactly. It’s like their exploration department. Gold deposits will be in production anywhere from 5–20 years. They’re generally small. Majors have to replace their depleting resources, plus people expect growth. It’s very expensive for a major to go out and find, and then develop gold properties. If, however, a junior develops a 0.5 Moz. deposit, it doesn’t have to build as much infrastructure. Developing a property as a junior is just a lot less expensive than it is as a major.

TGR: But they’re selling the gold for the same price.

WA: Exactly. The index we put together last year showed the juniors appreciated about 49% in 2010, whereas the majors were up roughly 27%.

TGR: Could you tell us about some of the companies you’ve recently helped finance? There are a number of promising gold companies on that list.

WA: Eastmain Resources Inc. (TSX:ER) is a name that we cover. None of us owns it, as it’s a banking client. The company’s located up in Canada and has 12 different deposits. It’s going to spend maybe $9 million on exploration this year. Eastmain published some data late last week on its drill results, which was exciting. The company’s been a little slow to announce new resources, but it’s due to provide an NI 43-101 here shortly. When you look at what the company’s announced and connect the dots, it’s likely that several of these deposits will turn into something pretty exciting.

Eastmain’s goal is to find a resource, start the environmental permit application process and sell; it’s not going to develop these deposits. It’ll simply define, develop and sell the property. One scenario could be that Eastmain gets acquired, spins many of its assets into another company and starts all over again.

TGR: Much like Virginia Mines Inc. (TSX:VGQ) did a few years ago when it sold the Eleonore gold deposit in north-central Quebec to Goldcorp Inc. (TSX:G; NYSE:GG).

WA: Exactly.

TGR: What are some other companies you cover?

WA: Golden Predator Corp. (TSX:GPD) is pretty interesting. Again, it’s a banking client and none of us owns it. It’s a very exciting company with a number of deposits in the Yukon, which is a rather new territory for gold exploration in the sense that the Yukon has not had the money spent on it that a lot of the places in North and Central America have. I don’t want to say it’s virgin territory but, to some extent, it’s undiscovered. In the Yukon, there’s a lot of what we refer to as “placer gold.” If you have a gold deposit and it gets worn and weathered, the flakes and pebbles roll into the creeks and rivers. Then miners and prospectors mine the gold out of the creeks.

The point is that if it’s in the streams it came from somewhere else. So, they follow the riverbeds and find out where the gold stops being attractive and chances are that’s pretty close to where it came from. A lot of deposits are being “reversed engineered” by virtue of the gold in the streams. Golden Predator has uncovered some very exciting properties but it’s early days for the company. It’s got some huge properties that have a great deal of potential. Golden Predator is a pretty exciting company.

TGR: Golden Predator has some royalties, too.

WA: Right. Golden Predator has a number of properties that it’s sold or made available to other miners on which GPD gets paid a royalty. That’s going to provide some nice value for the company, as well.

TGR: What are some other names you cover that you believe have some promise?

WA: We think Richmont Mines Inc. (TSX:RIC; NYSE.A:RIC) up in Canada is pretty interesting. It’s not a banking client; it’s an older company that’s been mining gold since the 1990s. The former management wasn’t very aggressive, so growth was modest at best. The story wasn’t too exciting. The company now has new management and some pretty interesting drill results. It has about three or four irons in the fire.

It’s just put out some numbers on one property called Wasamac that look pretty interesting. With Wasamac, we think Richmont could add meaningfully to its resource base. If it could double or triple the resource, we think it’ll put that into production. It’s a pretty small company with 85,000 oz. (Koz.) of production. With the Wasamac discoveries, there’s a reasonably good chance the company could ramp-up to 150 Koz. And Richmont’s board has set a goal of adding a 100 Koz./year acquisition. So, here’s a sleepy company that hadn’t been setting the world on fire but now has new, more aggressive management and numerous irons in the fire. We think one or two of those will turn into something pretty exciting. It’s quite a good story that hasn’t gotten a lot of attention.

TGR: Before we let you go, could you give us your outlook for gold over the next few months?

WA: Let’s go back to the event-driven motivation for moving the gold price. The events we don’t yet know about will likely determine the direction of the gold price. The underlying momentum is positive when you look at the U.S. budget, government spending and Europe’s sovereign debt problems. And the problems that governments have created will only get worse as populations age and Social Security obligations become greater—that’s certainly a problem.

We’re all aware of those slower-moving issues, but I think what drives gold in the short term are events in the Middle East and any sovereign debt default. Unless there’s a major unexpected event, we’ll probably see the gold price break out to a new high in the second quarter. We’re roughly halfway through the first quarter now, so we look for the gold price to be rangebound the next two to six weeks before breaking out in the second quarter. But it’s subject to material impact by unexpected events, which always have a way of happening.

TGR: Thank you for talking with us today, Wayne.

Mr. Atwell has more than 35 years of experience in the field of investment analysis for the metals and mining industries. He currently serves as a managing director of Casimir Capital L.P. From 1991–2006, Mr. Atwell was a managing director at Morgan Stanley where he was the Global Group Team leader in equity research and built and managed a 12-member global metal and mining team of analysts. From 1983–1991, Mr. Atwell was a VP at Goldman Sachs covering the metals and mining industries. He was also a VP and principal in the privately held Davis Skaggs, a regional research firm, from 1977–1983. And from 1969–1977, he worked for Merrill Lynch as a senior metals and mining analyst. Mr. Atwell has toured 200 mines and 300 steel mills on six continents. He was selected as one of the 10 best buy-side stock pickers by Institutional Investor magazine several times and was rated as one of the top analysts in metals and mining by Institutional Investor and Greenwich Associates for more than 20 years. Mr. Atwell graduated from Pennsylvania State University in 1969 with a degree in mineral economics. He earned his MBA from the Stern School of Business at New York University in 1974.

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DISCLOSURE:
1) Brian Sylvester 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: Goldcorp and Golden Predator.
3) Wayne Atwell: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.