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Good Reason for Optimism in Industrial Metals Investing

Commodities / Metals & Mining Apr 03, 2009 - 07:29 PM GMT

By: The_Gold_Report

Commodities Best Financial Markets Analysis ArticleLeonard Melman, prodigious writer (The Melman Report) and leading authority in the metals and mining arenas, sees opportunity for some "really good moves" and "fabulous returns" on the horizon, citing vibrant charts on random juniors whose values have multiplied during the last six months. Also noting the possibility of some "good price pops" in the metals themselves, Leonard considers the price of the base metals as a real key to the future of the economy. On the other hand, he shares some serious concerns about the economy in this exclusive interview with The Gold Report. For example, he is alert to several "ominous red flags" that warn of the potential for devastating hyperinflation and worries that the Humpty Dumpty of savaged financial assets may be beyond repair.

The Gold Report: We're finally seeing some good economic news. Have we hit the bottom?

Leonard Melman: As far as the general economy is concerned, I'm not exactly prepared to make a clear statement. I've been checking news headlines from around the world and still see a lot of dismal information. Japan's export economy dropped by 50% this February compared to February of 2008. Their car sales have collapsed by 43%. Toyota is talking about cutting worldwide production by half, which will just drive their economy nuts. We're getting stories out of Germany that are very negative. Czechoslovakia has just ousted its prime minister; they're in a state of chaos. Latvia and Hungary have currency problems. Poland's economy is contracting. I could go on and on. So while the United States is starting to report some good news, there's still a lot of gloom and doom, so the picture is in flux.

As far as the metal side of things, I'm getting more and more encouraged. Gold is behaving beautifully. That last decline stopped at about $860, which is still well above long-term up-trends. We're back in the $930 range again, so there is support out there. With money creation going on at the rate it is, you have to feel good about that.

Virtually every base metal—nickel, copper, zinc, lead—has risen quite dramatically since last fall's lows. So I think there is good reason for optimism on the metal side and a balanced outlook on the economic side.

TGR: Given that scenario, what should the investors be looking at?

LM: I think there is the opportunity for some really good moves. I've been looking at several charts of junior companies just at random. While some still have some difficulty to overcome and they're still fairly close to their bottoms, others quite surprisingly have doubled and tripled during the last six months. The two most widely followed mining indices, the XAU and the HUI, have broken out to relative highs for the past four to five months. So there is a chance for some very substantial gains.

TGR: So some juniors appear pretty promising.

LM: Yes, and there's always the great advantage the junior mining shares have when it comes to the total investment picture. They're very thinly traded in comparison, say, to a stock such as IBM or GE. It takes substantial sums to move those shares significantly, but it only takes a few thousand to move junior shares. With some of those junior shares dropping so far during the last year, say, from 80 cents down to 7 or 8 cents, it takes very few $1,000 investments to drive those shares higher. If you're prepared to stand the risk that the scenario may not play out quite as you want, I think there are significant potential returns over the next year.

TGR: You say a few thousand shares can drive the price up; the same can be true for driving it down.

LM: Absolutely.

TGR: What are the baseline economics that this will rise over a year or two?

LM: Even though I don't agree with the basic economic concept of all this stimulation, there is an excellent chance it will work in the sense of creating at least a boomlet—if not a full-scale boom, at least an improvement in the world's economic picture over the rest of this year. If that happens, demand for all natural resources will go up and that specifically is going to include the base metals, which are in demand for virtually any kind of manufacturing. In turn, that could cause good price pops in the metals themselves. If that happens, of course, the metal shares would likely participate on a very leveraged basis.

My problem is whether this boomlet will create increased business activity looking out a year and a half or farther. If the increased business activity behaves as it has in the past, it will stimulate demand, stimulate price increases, and with the trillions of dollars involved in stimulative and rescue programs over the last year, inflation could heat up very quickly should business conditions improve substantially. If inflation heats up, by nature that would drive interest rates higher. And rising interest rates could cut short the boom.

So I think we're playing with a fairly short-term timeframe when it comes to improving the economy dramatically. Beyond a year and a half, I really do get concerned about the potential for a hyperinflationary burst, which could create real economic and social disorder. But I hope that's a long time away if it's going to happen.

TGR: Let's hope it doesn't happen.

LM: Exactly. But some of the preliminary things that in the past have led to hyperinflations are taking place: The unlimited creation of fiat currency, the tendency to concentrate a great deal of economic authority in a few central hands. These are ominous red flags for me looking farther down the road.

TGR: It's very scary.

LM: It is. Even scarier is that in previous occurrences of hyperinflation—France during and immediately after the revolution, 1789 to 1795; Germany in 1922 and 1923; Zimbabwe today—happened to single nations, and they were nations that didn't dominate the world's economic scene. If the United States currency lapses into hyperinflation… imagine the implications of a postage stamp going from 50 cents to a dollar, then $5, $10, $50, $100—or, as happened in Germany, from 4 deutschmarks for a single postage stamp in 1920 to 50 billion deutschmarks for a single postage stamp in 1923—what happens to the world's economic structure?

TGR: What must the American government—and other governments—do to make sure it doesn't happen?

LM: If I were looking for what government should do, in my personal belief, it should try to reduce the intrusiveness of government into the production of natural resources and manufactured products to make them more efficient and increase the wealth of the country that way. It should also diminish the creation of unlimited amounts of fiat currency. And some long-term plan should be put into effect for governments to begin to accumulate gold and silver holdings, which would give an underlying value basis for their currency.

I'm a political realist. I know right now the political background does not seem conducive to those things, but I think society should work toward those directions.

TGR: Do you think the population will protest some of the currently announced government programs plans as they start to look at an inflationary environment? And would their protests act as a brake to hyperinflation?

LM: You've hit upon a terrific point. I believe we're starting to see that happen. If you notice, President Obama has changed the direction of his emphasis quite dramatically in the last several weeks. He's now talking about reining in deficits in the future. He's talking about putting programs on a sound financial basis. In the late stages of his campaign and the early stages of his presidency, he simply talked about all the wonderful things his government would do. But I notice a real advancing pattern of discussion of economic reality and I think that's been brought about by the public reaction to the staggering array of bailout rescues and dollar-creation programs.

America is a strange nation. Nobody thinks the public is very knowledgeable about these things, but they have a tradition of free enterprise and thinking that government should mind its own business, so to speak, and let the marketplace have its way. I think the public was aroused to a real danger in the direction of the first two months of the Obama administration. They're starting to speak up. So I think the public is aware and they are starting to let those feelings be known.

TGR: So in your mind there is some hope that some of this will get reined in, particularly the unlimited fiat currency.

LM: I do believe that's true. I also think there is the simple economic reality that, while America is still definitely the number-one economy, the relative position compared to 1960 or 1970, when they absolutely dominated the world scene, is that they are no longer the be-all and end-all of the world economies.

And messages are coming from other countries that something is going dreadfully wrong with America. The Director of the National Bank of China just blankly stated that they are very concerned about the future of their holdings in America because of this escalating monetary creation.

TGR: Let's go back to the junior mining shares. You mentioned that some of the juniors are still close to their bottoms and others have tripled since their lows. Can you share with us what differentiates juniors that have tripled from those that are still bouncing along the bottom?

LM: I think there's a very great distinction. Some of the companies were so hard hit during the past year or two that they have simply run out of money or their treasuries are down to near zero. They don't have the capacity, at the moment at least, to generate new discovery programs. They're just sort of lingering on hold to see whether they're going to survive. Those are the ones that are sitting back.

Others still have a sound treasury and the capital to conduct further investigations, to build reserves, and to participate in any big rally that comes in. So I think the market is taking those and saying, “Hey, they've been beaten down by 90%; let's start buying them.” That's why some of them are doubling and tripling off their bases and it looks very, very encouraging.

So I think that's the distinction. If they either have the cash on hand or the clear ability to raise new cash, the market is interested. But I think for the time being the market is avoiding those that simply have reached a care-and-maintenance situation.

TGR: So the balance sheet is driving investor sentiment rather than property or potential discoveries.

LM: Very definitely. If a company doesn't have the money to conduct further investigation, they have nowhere to go at the moment. But the outlook could be very promising for those that have money, which can be identified by a study of their balance sheets.

TGR: To what extent do metal prices have to stay where they are or increase for the juniors that have risen two to three times from their lows to remain successful over the next year?

LM: It's vitally important. Take copper, for example. It plunged from a high of $4.20, I believe, all the way down to the upper $1.20s. In the upper $1.20s, it's very unlikely that any mining production can take place and show a good profit. We're now almost at $1.80 for copper and at $1.80, suddenly the outlook is infinitely brighter.

If this economic boom does take place over the next year and a half, I believe it's reasonable that we could see copper go to $2.50 to $3 a pound. In that case, some of these holdings in the ground that are proven reserves could become valuable mines. On the other hand, if copper were to fall back into the $1.20s or below, the prospects for a profitable mine would be virtually nil. So the price of the underlying metal is of considerable importance. That's why we keep a real close watch on those trends.

TGR: So investors who are dabbling in the juniors market should be watching metals prices carefully as a signal of when, potentially, to take profits.

LM: Exactly. And there's an additional point. The markets always tend to look ahead and the base metals are no different. So if the price of the base metals starts to rise unaccountably, that's also a positive indication that this economic recovery or boomlet will indeed take place. So the price of the base metals is a real key to the future of the economy—at least it's a good solid indication. And the precious metals are also historically very good indicators of monetary stability or instability. So price is a vital consideration.

TGR: Can you share with us some of the juniors you track that are good examples—with good balance sheets and good properties and poised to take advantage of the price in metals as it goes up?

LM: There are several categories within base metals and precious metals, but also specialty metals. One company I have studied at some length is Commerce Resources Corp. (TSX.V:CCE) (PK SHEETS:CMRZF) . One particular advantage Commerce has is that they raised considerable cash during the time when their stock was much higher, which was a very, very advantageous thing to do. The cash raised was then used to conduct a very substantive investigation program throughout 2008. They've recently reduced their burn rate, the rate they're using up their capital. They still have more than enough work for their geologic team to thoroughly analyze all the drilling they did last year and put together plans to advance the property, which is located near Blue River, British Columbia, toward production.

By the way, the two metals that Commerce is concerned with are tantalum and niobium and a great number of new uses for those metals are being developed. So they have the potential to move forward because they have cash reserves on hand. If I had to pick a number, I'd say they probably have $11 or $12 million Canadian still in their treasury. That's a good example of a balance sheet working in favor of a company.

TGR: What are some of the uses of tantalum or niobium?

LM: In general, tantalum and niobium are suitable for applications requiring hardness, resistance to extremely high temperatures, and the ability to store and release electrical charges quickly, so they're ideal for aircraft, motor parts, cell phones, and particularly for capacitors where electricity changes in fluctuation very rapidly. And, as mentioned, new uses are being discovered and coming forward very rapidly.

TGR: Do you think there will still be a demand for these metals if we face more economic downturn?

LM: There is a moderate demand. Because of the economic slowdown, a lot of manufacturers have cut back production. I'm thinking as soon as it appears clear that the economies are going to advance, there's going to be a great deal of catch-up on the part of these manufacturing companies to rebuild their inventories of tantalum, niobium and other specialty metals. So I look forward under those circumstances to a very sharp increase in new demand to come into the market.

And there's something else very interesting about tantalum. Much of the supply that has been entering the market for several years has come from the Democratic Republic of Congo, or DRC. But the DRC right now is afflicted with huge social disorder and so there's an uncertainty about the future supply from there. Also, DRC production is being carried out in an anti-environmental manner. For those reasons, many of the end users of tantalum are specifically looking for a good North American supply and that's where Commerce Resources' reserves in British Columbia could become very advantageous.

TGR: I know you've also been following some silver companies and a lot of them were in Mexico. We're getting a lot of press now about Mexico, specifically all of the drug wars and kidnappings and such. If you're reading resource papers, you're hearing a lot about Mexico's depleting oil supplies and a potential pending economic situation there. What's your feeling about investing in companies that have properties in Mexico?

LM: As it happens, I travel to Mexico quite frequently and, for example, I've been able to visit the Orko Silver Corp. (TSX.V:OK) property in Durango State. There are areas of social concern for Mexico; there's no question about it. I have had the unfortunate experience of being in a vehicle headed out on a highway which was suddenly pulled off to the side of the road by the Mexican Military Police and being searched for any indication of drug traffic while soldiers hold rifles turned on you. It's unsettling, you're standing there by a road with an armed soldier pointing a rifle at you, but they're doing that to control the drug traffic.

But in terms of mining, Mexico has had good reliable laws that have supported the industry. Heck, the mining industry in Mexico goes back 400 years, right back to the Conquistadores and even before that to the Aztecs. Qualified geologists have reported that the geology of Mexico looks excellent, the production facilities in Mexico are of a high order and, as I say, the mining law is very solid and reliable.

One important question is whether the Mexican economy will hold together, as it is being negatively affected at present by two factors. First, there is ongoing depletion of their petroleum reserves and the resultant diminishment of cash flowing into the country from those reserves and, second, for quite a while Mexico has relied on the inflow of American cash from expatriates living in the United States. That's been a big staple of their economy and with the U.S. economy declining; the flow of such cash into Mexico has been diminishing.

So they have some economic problems that are serious along with the drug problem. That has to be weighed by investors. On the other hand, the geology is favorable, the production facilities are generally of a high quality, and the law is good. So it's a balanced equation and investors would have to determine their own level of risk.

TGR: You said you visited Orko Silver. Can you give us an update on what you saw there?

LM: They have a very prospective new area under exploration called the Martha Zone. It lies in a relatively flat plain with excellent ease of access compared to many reserves that are in very mountainous terrain and can be investigated only with great difficulty. Orko is building their reserves, they're also planning an updated resource estimate and obviously, the goal is to bring the property into production at the earliest possible time. According to company geologists; the quality of the reserves appears to be very substantial, perhaps six to eight ounces per tonne silver, and they are working with the goal of attaining profitable mining down the road.

TGR: Are there other silver plays there you can tell us about?

LM: As a matter of fact, right in the very same area as Orko is Avino Silver & Gold Mines Ltd. (TSX.V:ASM) (OTCBB:ASGMF) . It's quite a story. They went into silver production back in the 1960s and produced until the 1990s. They had both open-pit operations and underground mining and then finally shut the operation down because of low silver prices. In the last few years, they have gone back into the underground areas, reinvestigated and found an entire new zone of silver. They are refurbishing the plant that's still onsite and their goal, of course, is to bring the whole property back into production as fast as possible. Their aim is to re-start production by the end of this year, or early 2010 at the latest.

TGR: You're also following Hawthorne Gold Corp. (TSX.V:HGC) ?

LM: Hawthorne is a very exciting play as far as I'm concerned. They have two different projects under development. The one east of Quesnel in British Columbia is called "Fraser Gold" and is strictly a development property right now and they are advancing it as fast as possible. The other one, the Table Mountain project, is of particular interest. It's an area in the far northwest corner of British Columbia near the town of Cassiar. You'd have to be a mining nut to know where Cassiar is, located about 100 kilometers below the Yukon border. That area has been developed before. A company called Cusac owned it and then Cusac finally ceased mining when the economics no longer worked.

Hawthorne took the property over, they have reinvestigated it, they have sufficient cash on hand to continue development and there is a mill on the property that requires only minimal refurbishment. With the price of gold at close to $1,100 an ounce Canadian, company geologists believe the economics appear to be working well. So that is a very interesting prospect.

Hawthorne's properties also include the Taurus area, located adjacent to Table Mountain where a NI 43-101 compliant resource estimate shows a million-ounce resource, which appears to be amenable to open-pit mining. If a potential investor wanted to hedge against the spectacular rise in the price of gold, that kind of property is certainly well worth investigating.

TGR: That's an interesting way of thinking about it. Do you have any other interesting junior mining companies you've been following that have some exciting stories?

LM: It's hard to pick any off the top of my head. Let me put it this way: if the price of gold were to do something really spectacular like go to $1,500 or $2,000 an ounce, some properties could literally come back from the dead.

TGR: Stranger things have happened.

LM: Yes, this is a time like no other. It's one of the wildest times I can recall. I've been involved with money since 1966, and I have never seen anything like the last 12 months, nor anything like the present. We've always had recessions, even deep ones as in 1973 and 1974. But never before have we seen a Citibank drop from $55 to under $1 or General Motors lose more than 90% of its value in one year. And when I say “never,” I'm even including the Depression. You can take any example you want. We have never had this kind of savaging of financial assets in history. It leads to a great number of questions whether Humpty Dumpty can be put back together again on a sound basis.

So it is a fascinating time of flux. Good Lord, I can tell you, I'm 67 years old and I wake up every morning with the awe and wonder of a child, so to speak, thinking “What in the world's going to happen next?”

Leonard Melman is a leading metal exploration, mining and investment authority who’s been writing about precious and base metals for a quarter century. At the upcoming April 4-5 Calgary Resource & Clean Energy Investment Conference, he will serve on the “Eye Opener” panel and present the “On the Road to Hyperinflation” workshop. Early in his career, Leonard gained valuable knowledge and experience as manager of multi-million dollar consumer lending operations and as a securities and commodity broker. In 1985, he started contributing a monthly column on precious and base metals to ICMJ's Prospecting and Mining Journal (and its predecessor, California Mining Journal) and also writes a monthly column entitled "Speculations" for Resource World Magazine.

By 2003, alert to the potential for an enormous bull market, he decided to write full time and recently launched his own website, The Melman Report aims to provide top-quality, objective and factual information—“not ‘buy’ or ‘sell’ recommendations but information from personal observation and from reliable sources.” Aside from magazine articles that are specifically company-related, Leonard says that his goal in writing is “to apply the world of economics and politics to the world of metals and mining, and take the influence of one and project how it will affect the other.”

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