Lawrence Roulston: Gold Prices Will Trend Higher

Tag : Copper Additive

The Gold Report caught up with newsletter writer and analyst Lawrence Roulston of Resource Opportunities . In this wide-ranging interview, Roulston gives us his thoughts onthe outlook on the economy and what factors impact the gold marketand all the other metals. He says, "the pattern I seecontinuing is gold trending higher with spikes and pullbacks."
TGR: Gold has made a pretty substantial move, but yet the juniorshaven’t; in fact, some of them have gone backwards. Why doyou think the juniors have not done as well as, say, a producer orthe price of gold?

LR: Earlier this year when Bear Stearns was on the brink, and thencollapsed, there was a lot of concern throughout the financialcommunity around the world that perhaps a number of other bankswere going to fail, and perhaps the whole banking sector was goingto come crashing down. Because of that fear, a lot of investorsstarted buying up gold as a hard asset, a long-term store ofwealth.

Gold has always had this role as a sort of safe-haven investment.So there was a huge amount of investment in gold because of thatfear about the banking sector and concern over paper investments ofall sorts; a huge concern over subprime mortgages. People were justplain scared, so there was a huge move into the gold market.

When the government bailed out Bear Stearns and when it becameapparent that the U.S. government was going to do whatever wasrequired to prop up the economy and the banking sector, a lot ofthose investors who had gone into gold realized they didn’tneed their gold. At that point, gold came back on the market andthe price has come back down.

That move into gold was based on fear. A junior mining company isconsidered pretty risky, and they didn’t participate in thatrally. The ironic thing is that as the government props up BearStearns and the economy, it is very positive for gold in the longterm. Gold came on the market in the short term, but long term itwas just one more indication that the U.S. dollar will continue totrend lower, and that the gold price is going to trend higher.

So it’s just a matter of time. I think we’re seeing itin the market today, with the gold price coming back up again.People recognize that the gold price is going to trend higher, andwhen they get more comfortable with the long-term trend, I thinkwe’re going to see that movement come back into the juniors.

TGR: One of your articles mentioned that part of the reason metalshaven’t appreciated is because they’re all tied to theU.S. dollar. If the dollar continues to depreciate, would you stillexpect gold to trend higher or just a lag before anyone realizesit?

LR: A number of factors have an impact on the gold market and all theother metals. In the Western world, we use the U.S. dollar as ameasure for most commodities, and as the value of the U.S. dollardeclines, the apparent value of the metals increases as measured inU.S. dollar terms. So that is one contributor to the nominal risein metal prices.

But superimposed on that – whether we’re talking gold,silver, copper, cobalt, zinc or any of other metals – overthe last few years there’s been a very significant increasein real terms as the demand for the metal increases at a fasterpace than the mining industry has been able to deliver metals.

TGR: So give us your overview on precious metals and base metals.

LR: My view on the gold market is that the value will trend higherbecause of the continuing debasement of the U.S. dollar anddebasement of other currencies over time, as has been the casesince the beginning of time. On top of that, we have an increase inreal demand for gold and precious metals because of growing concernaround the world over stability of the U.S. economy, the U.S.banking sector and paper currencies – and just a growingawareness that holding some hard asset like gold provides somestability to an investment portfolio.

So we’re seeing a huge increase in gold demand and it’sreflected in the ETFs and the other means that have made it easierfor investors to own gold over the last few years.

TGR: Where do you put silver?

LR: Silver largely mirrors the movement of the gold price, but inreality, the silver market and the gold market are very, verydifferent. The primary use for gold is as an investment or as anornament. The markets for silver are different in that the primaryuses for silver are industrial. So in the gold market, virtuallyevery ounce of gold that has been produced by mankind is availableat the surface and could be brought back onto the market. Insilver, it’s very different.

Over the past two decades we have seen the enormous stock of silverthat was built up over thousands of years being used up inindustrial applications, so it is no longer available.

TGR: Isn’t there a fair amount of silver recycling going on?

LR: The biggest component in silver recycling is in photography, andto a large extent, photography is a closed loop. The chemicals usedare recovered in the developing process and go back into making newfilm and new other components as well. But a lot of products– mirrors, for example, and thousands of electronicproducts– employ very small amounts of silver in eachapplication. And that silver is lost to the world forever.

TGR: Could it be argued that silver would appreciate more becausethere’s a bigger gap between supply and demand?

LR: The demand for silver is increasing steadily as more and moreapplications are coming about, and a lot of these applications arein high-tech situations and high-value products where the value ofthe silver is insignificant compared to the value of the finishedproduct. The flip side of it, though, is that there’s a lotmore silver to be mined and silver coming out of mines isincreasing. It’s coming out at a pace that moderates theupward movement in the silver price. I believe that will continue.

It is entirely possible that we could see a very substantialshort-term spike in the silver market, but there is enough silverin mines that it will moderate the upward movement of the silvermarket in the longer-term context.

TGR: So is the larger influence of silver based on gold? When gold wentover $1,000, didn’t silver get to $21 or something like that?

LR: That’s right. And in the short term, the silver price ismirroring the gold price. But it’s not a perfect match. Thereare variances.

TGR: Do you see something that would cause decoupling at some point?

LR: It’s entirely possible at some point – whetherit’s a week from now, next month, or a number of years. Butat some point the above-ground stocks of silver are likely to runout. For most of the last two decades, in fact fully two decades,the amount of silver consumed in industrial applications plusinvestment demand have exceeded the mine supply. So above-groundsilver has been run down steadily over the last two decades.

There’s a lot of debate about how much silver might stillremain at surface. We don’t know, but at some pointwe’re going to hit the wall on the amount of silver availableon surface. There’s going to be a short-term spike, butthere’s also a lot of activity within the mining sector,especially the junior sector, toward an increase in production. Asthe silver price moves up, there will be more and more activity tobring old silver mines back into production and develop new silvermines.

TGR: What should our readers be thinking about in terms of the basemetals, particularly copper?

LR: Copper is the biggest of the base metals, but in my mind is likeall the other base metals, and I will make some general comments.As the developing world has developed, demand for base metals, oil,food and every commodity on the planet has been escalating at apace that nobody thought possible. So when you look at the basemetal prices, most of them are up several times, 10 times in somecases, from where they were at the start of the decade. Thisreflects the fact that demand for the metals has been increasingmuch faster than the industry has been able to increase itsproduction capacity.

There’s a perception that the base metal prices are going tocome back down in the near term because of concerns about theslowing U.S. economy. In many investors’ minds, and even inmany analysts’ minds – which is surprising –there’s a perception that a slowdown in the U.S. economy willslow down the rest of the world, and that in turn will slow thedemand for metals and the prices will come back down. The realityis that this idea of the U.S. economy slowing has been out there along time, and the base metal prices are still holding at very highlevels.

China is by far the largest consumer of every metal. There’sstill a perception that the Chinese economy is dependent on exportsto the United States, but the reality is that exports to the U.S.represented only 2.1% of the Chinese economy last year. So if theU.S. economy slows by a couple of percentage points from where itwas last year, it will have no noticeable impact on the Chineseeconomy or on other parts of the world.

Chinese exports to the oil-exporting nations grew by 45% last year,and exports to the other BRIC nations – Brazil, Russia andIndia – grew by 60% last year over the year before, and infact are still growing at that pace. So the developing world hastaken on a life of its own, independent of what is happening to theU.S. economy.

Now, if the U.S. economy were to disappear from the face of theplanet, of course, it would have an impact on the rest of theworld. But nobody is suggesting that. We’re talking aboutgrowing at a couple of percentage points, and now perhaps shrinkingby a couple. That kind of change in the economic activity in theU.S. will not impact what’s happening in the rest of theworld.

So in my mind there’s an enormous investment opportunitybecause of the perception that the U.S. economy will slow and bringdown metal prices, and the reality being an incredible demand fornew metal deposits. I wouldn’t advocate anybody go out andspeculate on what the copper price is going to do tomorrow –or the cobalt price or the nickel price – because too manyvariables affect those. I am not convinced that they’re goingto go higher in the near term.

But having said that, the real play in the commodities market orthe metals market is not betting on what’s going to happennext week to the metal price. The real play is to recognize thefundamental shortage of supply and to invest in the companies thatare going to fill the supply gap. That means these little companiesthat are finding and developing metal deposits that will becomemines in the coming years. In our newsletter we have had enormoussuccess identifying companies that hold deposits, and seeing thosedeposits evolve and develop and in many, many cases being bought bylarger companies and developed into new mines.

I am continuing to see that as being the greatest investmentopportunity of the decade – identifying companies withtangible metal deposits that are being enhanced in value and beingadvanced through the development stage to the point where they aresold off to other companies or being developed in their own right.

TGR: On that note, we'd like to hear about some specific stocksyou’re currently following and recommending in yournewsletter, but we realize that out of fairness to yoursubscribers, you don’t wish to talk about specific companyrecommendations.

LR: That's right. We would be happy to send anybody a sample copy ofthe newsletter, and you can request one on the website .

TGR: So going back a bit. . . We talked about China and how if the U.S.goes into a recession or a prolonged slowdown. What if it’sworse? What if there is a confidence crisis? I can’t rememberexactly what Doug Casey calls it – the re-depression or thedepression. What does that do to the rest of the world? We talked alittle about China, but what about the other BRIC economies? How dothey fit in?

LR: That’s a long, complex question. I feel very strongly thatthe U.S. economy is not going to suddenly collapse and be reducedto a pile of smoldering ashes. We have heard such forecasts in the12 years I’ve been following this sector from thisperspective, and I’ve been hearing some of the same peoplemaking the same forecasts for that entire period.

The U.S. economy is extremely strong, extremely resilient, and itis facing a very difficult time. There is a transition going onright now, and many people in the United States don’t have aclue. In fact, I would say very few people in the U.S. have a clueas to what’s going on in the rest of the world. They view theentire world through this myopic perspective of what is happeningin the U.S. Now, that’s fine; the United States’economy, in my opinion, will muddle along. It will be a long timebefore we see the kind of growth in the economy that most peoplewould like to see – you know, 3% to 4% annual growth in GDP.It might be years before we get to that level.

We debate whether the economy is growing by 1% or shrinking by 1%.Are we officially in a recession are we not? Is it a period of slowgrowth or is it a recession? In terms of the rest of the world, whocares?

But your question was, will something more serious happen? Iseriously doubt it. The government has made it clear that they willdo what it takes to prop up the economy. They will keep printingmoney; they will prop up the consumers; they will keep loweringinterest rates and bailing out banks that have made stupidinvestments. Plus the fact that there’s enormous strength inmost of the companies in the economy.

If you look over the S&P 500, some are up and some are down. Ithink you will find that some of those companies are doingextremely well – growing their earnings and growing theirrevenues, and those are the ones that are looking outside the U.S.Companies like Boeing that are selling airplanes to places like theUnited Arab Emirates are doing very well; other companies that aretoo myopic to look outside the U.S. are hurting. General Motors hadno clue, it would appear, that the oil price was going to go up andthat gas price was going to go up and they would have to startintroducing more fuel-efficient cars; they seem to have been caughtby surprise on that.

So it’s company by company, but there are enoughforward-looking, visionary companies within the U.S. economy thatit’s hard to imagine that it’s going to collapse anddrop into a hole in the ground. Certainly, banks like Bears Stearnsmade absolutely ludicrous investments in subprime mortgages, and asit turns out, some people within the organization knew that some ofthose investments were stupid. We’re seeing criminalprosecutions beginning in that regard.

But there’s strength in other economies and overall the U.S.economy is going to muddle along because there are enough companiesthat take a global perspective. If my pension depended on thesuccess of companies like General Motors and the U.S. banks, Iwould be worried. But, remember, we’re talking aboutcommodities, and metals in particular. So, the question is, whatimpact will further slowing, or a prolonged slowdown have on themetal prices.

Credit Suisse addressed that issue earlier this year and looking atthe copper market in particular, they said, if the U.S. economycontinues at the current pace and the rest of the world continuesto grow, even if somewhat slower than they’re going, thecopper price would rise from the current level near $4 to $6. Theirdownside scenario was that the U.S. would go into a seriousrecession and other economies around the world would slowsignificantly to the point where overall growth in the world wouldbe severely curtailed. In that worst-case scenario, they predictedthat the copper price would come down to $2.60 a pound.

I am not holding my breath on seeing copper anywhere near $6 in thenear term and certainly not factoring that into any analysis. But alot of thought went into the Credit Suisse analysis, and I thinkthat’s a pretty good indication of how to see it.They’re saying the worst-case scenario is $2.60; long-termprojections on the copper price now being used to value juniorcompanies are on the order of $1.50 a pound. So anything over a$1.50 a pound represents investment potential on any of thesejuniors.

TGR: It’s fascinating how all this fits together. There may be agap in my understanding that you can fill in. You said earlier thatthe world economies are generally doing fine, and even if the U.S.goes into a slight recession, the BRIC countries will be fine. Alsothat we have this potential of above-ground gold reemerging in themarketplace as the investors become more relieved that the world isnot going belly up. If all of that is true, should we see anyincrease in gold over the next five to 10 years?

LR: Some commentators out there are talking multi-thousand dollars fora gold price, and I am not holding my breath on that; I am not evendreaming about that. But looking at what the gold market has donegoing back to 2001, when there were some fundamental changes, andbringing it up to the current level, I would say that six years ofactual real-world experience is the best proxy for what’slikely to happen over the next one or two or even four years. Thatis – more investment demand for gold and continuing demandfor gold in the ornaments market.

Gold production has been flat during that period; a lot of old goldmines have been falling off. South Africa is still the largestproducer, but gold production in South Africa has been decliningsteadily for years. China has now emerged as the second-largestgold producing nation, and its gold production is now coming from15,000 tiny little mines. All of these factors are happening in thereal world, and they’re all going to continue to unfold.

The net result is that the gold price is trending higher, not onlyin U.S. terms, but also in real terms. There’s been anynumber of times that the gold price has spiked up, as it didearlier this year to over $1,000, and dropped back down. So thepattern I would see continuing is gold trending higher with spikesand pullbacks. Investors using the short-term swings to advantageprobably will do quite well in the long-term context. Butunfortunately what happens so often is the majority of people buyat the top of the market and sell at the bottom of the market.

TGR: If you’re expecting the U.S. dollar to continue to devalueagainst other currencies, and maybe many other currencies devalueas well, would actual gold be a hedge against the value of thedollar?

LR: In the long term, all paper currencies have declined in value.That’s just a given. The U.S. dollar has declined morequickly than other currencies over the past four or five years– in a significant way declining more rapidly. Whetherit’s going to continue to debase at that level, over timeit’s likely to continue to devalue. Therefore, certainly goldprovides some stability in that regard.

But I would not own gold. I have never owned bullion; I probablynever would own bullion just because you don’t get theleverage you get by investing in a gold equity. Companies that areinvolved in the gold sector, whether they’re exploring ordeveloping or producing, provide a great deal more exposure to thegold market than you would have by merely buying ounces of gold.

TGR: You were talking earlier about the base metals and the developingcountries, and the infrastructure being developed in differentcountries. Are there some base metals that have less likelihood ofsupply meeting demand? You said there was a lot of silver thatprobably would eventually even out. Do you look moreopportunistically at some base metals because the supply is notthere?

LR: I think the market has already beat us to it, in effect. A yearago I would have said cobalt. The cobalt price was $50 a poundrecently, up from a few dollars not too many years ago. I thinkwe’re seeing other people – speculators, analysts– who have kind of looked through and already pushed up theprices. So if we’re looking for a metal where there might bea short-term speculative spike because suddenly investors becomeaware of it, I can’t see anything directly. I don’tmean to sidestep your question. If I had one, I would love to pileonto it.

But just to reiterate my fundamental investment philosophy, ifyou’re looking for a metal that might spike in the short termor even the longer term, you’re just speculating on acommodity price. And there are so many variables that reallyit’s speculation. Whereas if you look at a particularcompany, you’ve got a much greater opportunity foridentifying situations where there’s a greater likelihood ofthe value increasing as the companies execute their business plans.

TGR: I was listening to National Public Radio program where they weretalking about a precious metal being used as a fuel additive forjet planes. They sell it in very, very small amounts, andit’s more precious than gold.

LR: Platinum has been used. It is used as a catalyst in the catalyticconverter in every automobile in the western world. Palladium andrhodium are used also. You can achieve that catalytic effect andget better combustion if you take nanoparticles of platinum and mixthem in with the fuel. It increases the burning, and it’sbetter to get that in the combustion chamber than in the catalyticconverter. The only trouble is that it’s enormouslyexpensive. It makes no sense economically.

TGR: Even for a jet plane?

LR: No.

TGR: This other metal – they were looking into it and using itand potentially it could make a difference. I think they weretalking about the way the engine is made. It burns much hotter,which causes fuel consumption to be more efficient.

LR: Well, I imagine if you line the cylinder with platinum, you wouldget more combustion, but can you afford to do that? Another metalthat is even more useful – and again in incredibly smallamounts in catalytic converters – is rhodium. Rhodium sellsfor just under $10,000 an ounce right now. Maybe some extremeexamples would need that kind of extraordinary performance, butit’s hard to imagine these things being used on an ongoingbasis.

TGR: Are you familiar with beryllium?

LR: Yes, it’s a fairly common element.

TGR: Isn’t it good for heat and used in rockets and satellites?

LR: I am not aware specifically, but there are a lot of specialtymetals. Indium is another one that is valued at nearly $1 millionper tonne, or $1 per gram, and it’s found as a byproduct in alot of zinc mines.

TGR: This has been terrific. I appreciate your giving us theopportunity.

Resource Opportunities , which Roulston has published since 1998, provides objectivecommentary on the resource industry and emerging resourcecompanies. Lawrence is a geologist, with engineering and businesstraining, and more than 20 years of hands-on experience in theresource industry. Lawrence conducts frequent property visits aspart of his due diligence and has toured mining and explorationprojects in many parts of the world. He has worked in various rolesfor mineral exploration companies. Since 1997 he has been aresource industry consultant and independent mining analyst.