By Lawrence Roulston
Resource Opportunities

       The investing world is even more uncertain today than it was a few months ago. Commentators and analysts are focused on the negatives. As we all know, there is no shortage of negative news.
       Analysts and the media tend to focus on the near-term. We are always hearing about what is happening today and what happened yesterday.
       But, to understand what is going to happen tomorrow, it is very useful to step back for a moment and look at the bigger picture.
       The longer-term trends are more important to investors than the day to day events.
       Amid all the uncertainty and fear that we face at this moment, there are some tremendous investment opportunities. The best part is that there are investments that provide long-term security at the same time as they offer growth potential.
       Let’s start with gold. With all the uncertainty, it’s not surprising that gold is near an all time record high.

       Gold is up 10% this year. It is up 25% from a year ago. Yet, the gold companies are not reflecting those gains. There are companies that have made big advances in their projects over the past year, but are trading at lower prices than a year ago.
       The main reason for that disconnect between bullion and gold companies is risk aversion. At this time, investors are buying gold as a safe haven. They want to avoid risk. The mining companies are seen as risky.
       Another very important factor is that a lot of the interest in gold recently is coming from China. In the first quarter, that country was the most important in terms of investment demand and second only to India in terms of gold jewellery demand.
       Chinese investors – at this time – have little understanding of the global mining industry. They are buying bullion because that is what they understand.
       Over time, the values of the gold companies will come back into alignment with the bullion price. To understand why that is so, let’s look at some basics of the gold industry.
       The gold mining industry pulls more than 80 million ounces of gold out of the ground every year. Just to stay even, the gold mining companies must replace more than 80 million ounces of reserves every year. Much of the new reserves come from small exploration and development companies.
       In spite of a concerted effort by the gold industry to boost production, the amount of gold mined each year is now about the same as it was a decade ago. The gold price has increased 5-fold, yet production is practically unchanged.

       Gold mining has changed dramatically in recent years. In the late- 1960s, the average grade of a gold mine was 12 grams per tonne. Today, the average grade of a gold mine is just 1.5 g/t.
       That decline in gold grade argues for a continued high gold price, because the mining industry will continue to struggle to maintain production. The declining gold grade has another important implication.
       A little company called Richfield was just taken over by a larger company for a half billion dollars. That deal gave a 9-times return to shareholders in one year.
       What is really interesting is that the half billion dollar deposit has a grade of just 1 g/t. It will require conventional milling and the deposit is lo Located in the mountains of British Columbia. A few years ago, a one gram gold deposit was interesting – if it was in Nevada and it was heap leachable.
       Even one year ago, Richfield’s deposit was given little value by investors. Today, it is worth a half billion dollars. Most investors and analysts do not yet understand this new reality in the gold mining industry. There is a shortage of deposits, and the grades are lower.
       Investors don’t need to bet on a rising gold price. Instead, you can look at the long-term strength in the gold market and recognize the intense need for the gold mining industry to replace reserves. The potential gains in the small companies can far outweigh the moves in the metal prices.

        I have talked here in the past about the lifecycle of junior mining company shares. The biggest gains come with the initial discovery. However, only a small number of companies will be successful in making a new discovery.
       There are companies that have already made a discovery... Or, they have acquired a deposit at some time in the past. A lot has changed in the past few years: huge gains in the metal prices, advances in technology and improvements in infrastructure. Deposits that were ignored in years gone by are now extremely valuable. Many are now in the hands of juniors.
       By focusing on the companies that have a metal deposit in hand, you avoid the discovery risk. You still have the potential for enormous returns.
       At Resource Opportunities, we like to focus on this sweet spot: The company has a deposit in hand, yet it can still achieve huge returns by advancing that deposit toward production.
       In previous talks here, I described how the value of a gold company rises as it achieves milestones on the path toward production. Investing in these companies provides exposure to the long-term gold market. At the same time, you gain the benefits of a company that is increasing in value. You can see here that the gain in value can be ten-times or more.
       It is important to understand that exactly the same principles apply to other metals. Let’s look at silver.
       People look at the big decline in silver last month and think that the story is over for silver. Looking at the longer term, the silver price is 100% higher today than it was a year ago. It is more than 5-times higher than a decade ago.
       Silver has rejoined gold as a safe haven investment. The silver market has been greatly expanded by exchange traded funds and other funds that focus on silver and silver companies.
       The disconnect between the silver price and silver companies is even greater than it is for gold. Silver is up 100% in a year, yet many of the companies are trading at lower values than a year ago.
       We could debate where the silver price will go from here. I really don’t know. The key point is that many of the silver companies are now being valued at huge discounts to a silver price half of where it is today. Silver investors at this time are focused on bullion.
       I would encourage you to look at silver companies in the same way as gold companies. Own silver companies that give you exposure to the longer-term silver market... but focus on those companies with strong management teams that are adding value to projects as they move them toward production.
       Now, let’s look briefly at the base metals. The base metal markets are grossly misunderstood by most investors. For most people, the base metals are seen as a play on the metal price. They think that if the copper price, for example, is not going to rise in the near-term, there is no reason to own a copper company.
       Yet, exactly the same situation applies as for precious metals. The mining industry has a pressing need to replace reserves. There is a constant need to build new mines in order to offset depletion and to keep up with demand. Therefore, the play is to look at the juniors which are finding and developing new metal deposits.
       The economies in America and Europe are growing only slowly. Even with minimal growth, those areas haven’t stopped using metals: they are simply using about the same amount of metal as in prior years.
       While people are focused on the economies of the developed world, those regions are not the most important factors in the metal markets.
       China, the second largest economy in the world, is by far the biggest user of metals. That one country uses a third of the global copper and other base metals; it uses more than half of the global iron.
       China and other developing economies use much more metal per unit of economic activity. Infrastructure development is an important part of those economies. Also, consumer demand is growing strongly. China is already the largest market for automobiles. It is also the largest market for luxury goods. There are 300 million nouveaux riches in China and they are just beginning the life-long pursuit of consumer goods.
       Throughout the decade-long emergence of China as a superpower, there have been naysayers. Think back to the continual stream of comments from the naysayers and then look at the continued strong growth.
       At present, the skeptics talk of so-called “ghost cities” as the latest example of why the growth of China cannot continue. Remember, 20 million people a year have been relocating. It is only natural that there will be some examples of poor urban planning.
       Instead of relying on anecdotal evidence, largely generated by people far removed from the scene, consider this: A recent comprehensive report on the Chinese housing market from the highly respected Economist Intelligence Unit concluded:
       “Despite rapid growth in house prices in China, the real estate market is not a bubble about to collapse. The government’s tightening measures directed at the property market will, at worst, lead to a short-lived downturn.”
       The report notes: “China is not facing a major housing bubble... Between 2011 and 2020, we expect China’s urban population to increase by ...over 160m people.”
       “Burst housing bubbles, for example in Japan and the US, occurred in countries with stable demographics and without strong longer-term growth prospects.”
       Another interesting tidbit from the Economist report: “Indian residents, numbering over 1.1bn, enjoy less than one-half of the total living space of their Chinese counterparts.” This suggests that the other emerging power also has considerable room for growth.
       You can get the whole report at Economist.com.
       Recently, headlines have reported that growth in China is slowing. Let’s put this in perspective. The government is intent on slowing the rate of growth to control inflation. The second largest economy in the world is going to slow down to only 8.5% annual growth. That is hardly a basis for concern. Especially as that growth will come on top of the larger base resulting from last year’s growth.
       It is important to clarify here that I am not arguing for higher metal prices. Quite frankly, I don’t know if metal prices will be higher or not. I am simply saying that global demand for metals will remain strong.
       Even with no growth in demand, the mining industry constantly needs to build new mines. Therefore, we don’t need to speculate on higher metal prices. The investment play is on the exploration and development companies with good projects and good management that will advance the projects toward production. Those companies have potential to generate big returns for shareholders.
       Instead of speculating on metal prices, we can invest with the certainty that the mining industry will build new mines. Therefore, look for the companies that are most likely to find and develop new metal deposits.
       Most of us in this room have lived through at least a couple of cycles in the mining industry. The metal price goes up; new capacity gets built; the market is then oversupplied and the prices fall. Having lived through that a couple of times, it is only natural that people expect a similar pattern.
       This time, things are very different on both the supply and demand side.
       Never before have we seen 3 billion people go through a period of modernization. There are many years left in that modernization process.
       The supply side for metals is not well understood. Economists simply don’t understand geology.
       Look at the gold industry. The gold price has been rising for a decade, and is now more than five-times higher. Yet, production today is the same as when the gold price was under $300 an ounce.
       If the gold mining companies could have expanded production, they would have. They simply don’t have enough good deposits available to be able to replace depletion and grow their production level.
       Two, three, four decades ago, there was a surplus of good metal deposits. That is not the case today. There are deposits available, and many of them will be developed. But, most of those deposits are more remote, deeper and lower grade. Furthermore, mines take longer to permit, longer to finance and longer to develop.
       When we look at the growth in demand, and look at the mines now in development, it is very clear that it will take many, many years to bring enough new supply into the market to catch up to demand.
       A typical mine has a life of about 20 years. That means that the industry needs to replace about 5% of its production capacity every year just to stay even. Long-term growth in demand has averaged about 2% a year.
       Using copper as an example, in order to replace depletion and keep up to demand growth, the mining industry needs to build new production capacity equivalent to 2.5 billion pounds of annual production capacity each year. Let’s put those figures into perspective. Ivanhoe’s Oyu Tolgoi project in Mongolia is now in development. That project will be one of the largest copper mines ever built. It will produce 1.2 billion pounds of copper a year. That means that the mining industry needs two Oyu Tolgois each year.
       It doesn’t matter whether the metal prices go up or not. It is very clear that the mining industry will continue to acquire metal deposits from smaller companies. Those small companies will continue to generate huge returns for shareholders.
       Another very important element is seasonality.

       On average, prices in this sector decline in May and June, and then rebound over the course of the year. ThE chart shows the Toronto Stock Exchange Venture Index. It is broader than mining, but is an indicator.
       This year has followed the pattern, except that it was more severe than prior years. The sharp drop in silver in early May and the declines in other commodities pushed the prices of the companies down severely.
       On average, over the past 10 years, prices have bottomed over the summer and then rebounded strongly over the balance of the year. The better companies rebound long before the average moves higher. To sum up: The mining industry needs new deposits. Juniors that deliver those deposits will generate big returns for shareholders. And, here we are at the low point in the seasonal cycle. Clearly, this is a time to begin buying, on a selective basis.
       Editor’s Note: Renowned mining industry expert, Lawrence Roulston, brings you a wealth of mining insights in his mining investment newsletter, Resource Opportunities, 1510 – 800 West Pender St., Vancouver, BC V6C 2V6. 1 year, 20 issues, $299. Includes Instant Alerts on breaking mining company developments.
       With more than 25 years of hands-on experience in the resource industry as a consultant and independent mining analyst, Lawrence is uniquely positioned to provide you sought after mining industry and mining stock insights first. He has an impressive track record for identifying the potential of emerging companies in the mining sector.
       Mr. Roulston is a sought-after guest speaker at industry conferences and events, and can be heard on popular business television and radio programs.
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