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 Tue Aug 30, 2011
Kaiser Research Summary for August 7-27, 2011
    Publisher: Kaiser Research Online
    Author: Copyright 2011 John A Kaiser


Kaiser Research Summary for August 7-27, 2011

Understanding the Gold Bullion-Equity Disconnect

If you were a speculator exclusively focused on resource sector juniors and limited your horizon to TSXV listings, you would quite correctly observe that that resource juniors have been in a downtrend since February 2011 and that everything worsened during August 2011. The TSXV market trend chart above shows that not only did net decliner days outnumber net gainer days, but days when net gainers exceeded 200 TSXV listings were few and far between compared to brutal down days when losers exceeded gainers by more than 200 listings. Furthermore, since late April new lows have substantially outnumbered new highs, hovering above 20 listings while daily new highs dwindled into the single digits. How bad is the situation?

Well, given that the TSXV Index, which was up 181% from its post-crash low of 814.19 on November 20, 2008, is down only 23% from its 2010 close, one should view the 2011 slump as merely a correction for a rather sharp V-shaped recovery that began in April 2009 and left many prudent investors stuck in cash or cash-equivalent bogs like Kobex Minerals Inc (KXM-V: $0.72), which is trading at the lowest price since its cash-rich predecessors were shotgunned into marriage in late 2009. Among the more vocal spokespersons of those stranded on the sidelines has been former brokerage firm proprietor Rick Rule, who has spent the past couple years on the speaker circuit warning audiences that the 2008 meltdown was merely a warmup for what was to come, which was why he was keeping much of his powder in low risk forms such as cash even though it was earning a negative real return. His stance has been that in an asset deflation environment the purchasing power of cash expands, vastly exceeding the negative returns calculated via measures such as the CPI which are geared toward the cost of goods and services rather than the cost of assets. "Cash is King" has been the motto of value focused bears, as opposed to the short-sellers who have had a field day during 2011 injecting volatility into the market by setting up short positions and triggering "flash crashes" designed to stampede nervous longs into selling or trap less sophisticated traders trying to navigate the labyrinth of options, futures, ETFs, indices, currencies and plain old equities in search of arbitrage or momentum opportunities. The effect of this market mayhem orchestrated in no small part by high-frequency trading algorithms whose linkup to the electronic order book has been facilitated by stock exchanges who have jettisoned their legitimizing purpose as a price discovery mechanism in favor of an online cash harvesting video game, has been to chase ordinary investors out of the market into treasury bills, bonds and bank deposits. The irony is that rather than boosting liquidity, high frequency trading has thinned out the order book as value investors learned the hard way that open orders above or below the trading range can be cleaned out for reasons unrelated to the fundamentals of the equity (see the widely circulated comment on HFT by Nanex.

None of this has been particularly helpful to Rick Rule, whose style is to buy very cheap and make all his money selling too soon. Furthermore, the asset class in which he has historically had the most interest, namely commodity development assets, has not yet undergone the degree of price depreciation he may have been seeking. Although base and specialty metals prices have retreated somewhat from their recent peaks, they remain far above nominal historical averages. With all the macroeconomic concern about a double dip recession for the global economy, there would appear to be considerably more downside in store for resource juniors if commodity prices do succumb to slumping physical demand. With junior resource equity prices down a fair bit so far this year, one can imagine value bears such as Rick Rule rubbing their hands in anticipation of a major market washout during the final quarter of 2011.

Bottom-fishers like Rick Rule, however, may have been patient in vain. While the market's focus has been on the 23% decline in the TSXV Index and the corresponding negative impact on the paper value of resource junior portfolios, a much more disturbing trend has been the drastic decline in the value traded on the TSXV. The average daily value traded on the TSXV during January 2011 was $260 million, but the average during the last week of August had slumped to $80.7 million, down 79% from the January average. What we have witnessed is not so much a panic driven sell-off as we saw start in July 2008, but rather a gradual evaporation of buying interest and an apparent willingness among shareholders to ignore their paper losses and hold positions for the long run, at least in stocks with good projects. This does not bode well for the opening up of a meaningful liquidity window allowing bottom-fishers to soak up paper dumped by shareholders in financial distress. Whatever selling is taking place is "optional", which is what makes 2011 very different from 2008 when hedge funds loaded up with illiquid "marked to model" securitized mortgage paper experienced redemption runs that forced them to liquidate everything else in their portfolios, of which "hard assets" such as resource sector equities were the first to be sold.

Another key difference affecting the resource juniors is that in 2008 US Treasury Secretary Hank Paulson launched an attack on commodity price inflation in early July which caused a sharp sell-off in resource juniors during the summer that prompted sophisticated investors to go bargain hunting in late August and early September, only to be blind-sided by the bankruptcy of Lehman Brothers in mid-September which caused substantial collateral damage to commodity based portfolios. What these sophisticated investors thought were half price bargains turned out to be falling knives and anvils that lost another 50%-80% by the end of 2008. The carnage was so bad that 55% of Kaiser Research Online's universe of 1,800 Canadian listed resource stocks traded below a dime by the end of 2008. Because nowadays nobody dares believe "this time is different", sophisticated investors have held back during the 2011 slump, wary that another 2008 style meltdown lurks just around the corner. So what is missing from today's equation is the potential for a massive wave of liquidation by recent bargain hunters suffering severe buyer's regret.

Sagging volume and value traded goes hand in hand with a cyclical bear market, just as we saw in 2004 and 2005, and which has historically been described as the "summer doldrums" whose anticipation generates the "sell in May or earlier" phenomenon. Periodic uncertainty about underlying macroeconomic drivers and natural market corrections to rallies would explain the sorry performance of resource juniors so far in 2011. But what makes this a very difficult time for resource junior speculators is the uncertainty created by the dysfunctionality in Washington which the July "debt ceiling" debacle made very clear, and the intractable problems of the EuroZone that put it on course towards disintegration. There is an uneasy sense that this time is different, if the global economy goes down, this time it will be down and out for a very long time in the style of the Great Depression during the 1930's, except this time the existence of nuclear weapons with pinpoint deliverability potential rules out war involving the major economies as a source of economic stimulus.

While this unease about prolongation of the current recession (only statisticians talk about a double dip, or second recession) explains why so much capital has fled into bank deposits and bonds which are yielding next to nothing - in some cases banks are charging very large depositors a fee to hold their cash at zero interest - it is a real head-scratcher that resource juniors with exposure to gold and silver are not booming. Last week gold made an all time nominal high of $1,910 ($1,878 for the London Fix) which is not far off from $2,192, the inflation-adjusted price for the $850 peak achieved in 1980. With the latest CPI inflation at only 3.7%, and the most important asset class, real estate, still on a deflationary trajectory, gold's march into the $1,700-$1,900 range from the $260 low in 2001 has been achieved with only modest inflation of the absolute cost structure for the production of gold (per unit costs have risen largely because lower grades are being mined). In fact, if you take $400 per oz gold as the post-1980 bubble base at which gold settled after Paul Volcker tamed inflation, gold should only be $1,032 per ounce. The current $1,800 price represents a 74% real gain from the equilibrium price at which gold settled after the structural adjustment during the seventies. Admittedly 74% is not on a par with the 500% real gain gold delivered with $400 in 1980 from the $35 base in 1970, but for number-crunchers who are plugging current gold and silver prices into discounted cash flow models based on recently generated capital and operating cost assumptions, the implications are astonishing. And yet, the market is largely shunning gold and silver equities, maintaining a disconnect that started to emerge in December 2010.

The long term chart above and the short term chart below featuring KRO gold producer and non-producer indices reveals that gold equities did best during 2002-2004 when gold emerged from its abyss, and as a collective group from late 2008 until December 2010 during which gold repeatedly achieved new nominal highs. The 2002-2004 rally reflected how badly beaten up juniors with gold deposits had been, in a way similar to the way the KRO Rare Earth Index erupted in late 2009 coming from a very depressed stock price base. The 2009-2010 rally was broader based and largely tracked the post 2008 Crash uptrend in the price of gold. Although gold has continued to trend higher since the start of 2011, gold equities decoupled from the gold price and got stuck in a downtrend. Only since July when gold's uptrend accelerated have some of the gold index groups re-established an uptrend. The group that has responded best is the intermediate gold-producers, producing 100,000 to 500,000 ounces of gold annually. The major producers, producing more than 500,000 ounces gold annually, have responded only modestly to gold's flirtation with the $2,000 mark.

The sluggish response by the majors reflects the fact that these larger, more established gold producers already carry a gold "premium" which gold's performance is finally vindicating. So here we are, 30 years after the Aden Sisters and their hard money peers predicted imminent $2,000 gold, finally knocking at the door of $2,000. But where is the champagne, the irrational exuberance in which the gold bugs should be awash now that they are finally right? It has been deferred until the arrival of $5,000 gold, nay $10,000 gold! That is when everybody will wish they had loaded up on the major gold producers such as Barrick and Newmont.

We should, however, take our cue from the intermediates, which have responded because they were not carrying a gold "premium", carrying instead a risk "discount" related to their dependency on one or just a few gold mines. Most of these intermediate producers are unhedged, and consequently the benefit of the higher gold price flows directly to the bottom line. They are trending up because the market respects cash flow and because it expects the intermediates to be swallowed by the majors. The junior producers, producing less than 100,000 ounces annually, have responded half-heartedly because their production scale is too small to attract sophisticated investors, and their target audience, mom & pop style investors, are too terrified by the macroeconomic outlook to have their money anywhere but government guaranteed bank deposits.

The groups that have been truly disappointing are pre-production "ounce in the ground" juniors, and here I will argue lies the greatest opportunity for bottom-fishers and spec value hunters. Many of these "non-producers" are at an advanced development stage and have published at least preliminary economic assessment level reports (PEA) which outline the likely capital and operating cost structure of the mine. The higher gold price has allowed the mine engineers to apply lower cutoff grades to deposits amenable to open pit mining, which has allowed the juniors to scale up their proposed mining plans. But where these projects have been handicapped is in the application of base case prices of $1,300 gold or lower. The conservative rule of thumb in the mining industry is to use three year average commodity prices for the revenue side of the discounted cash flow valuation model, which for gold and silver are $1,152 and $20.68 per ounce respectively. The exception to the rule is when the three year average is higher than the spot price, as was the case with nickel during the past few years. Mining industry valuation methods are biased toward the pessimistic price outlook, and in the case of gold and silver, the market during 2011 has sided with the pessimism. Is this pessimism justified?

The pessimism is directly related to the primary narrative that seeks to explain the interest in gold and silver, which is that gold is a safe haven for capital for a financial and possibly political apocalypse looming on the horizon. The world's advanced economies have significant accumulated debt as well as entitlement related future debt. This would not normally be a problem in a world where populations are increasing and the deployment of technology is boosting the standard of living. However, there is a substantial wealth gap between the billion residents of advanced western economies and the 3 billion residents of the emerging economies which translates into a serious competition gap between the average cost structure per worker in these different jurisdictions. The advanced economies also have unprecedented demographic distortions on the horizon related to longevity arising from a higher standard of living during the past half-century, improvements in medical technology, and the promise of government funded healthcare for retirees.

The unspoken political debate in the United States revolves around the question as to whether citizens with accumulated wealth should subsidize the health of retirees with zero or marginal financial net worth. Since it is game over for any politician to suggest that the best solution to the entitlement related debt problem is for retirees with insufficient personal wealth to simply hurry up with dying and enjoy whatever eternal bliss their creed promises, and since there so far does not appear to be an industrial policy enabling young workers in western economies to compete in overall wealth creation with young workers in the lower cost jurisdictions of emerging nations - American job growth seems to lie mainly in servicing the needs of retirees -, the only coping strategy available for governments is to inflate their way out of the accumulated debt so that it does not compromise their ability to generate future entitlement related debt. Short of hard decisions to mete out suffering to the "losers" within the modern meritocracy, running the printing press is the only option for whomever ends up in political power. Gold is thus sought as a hedge against inevitable inflation, as well as possible political turmoil leading to the collapse of government, financial and even social systems if indeed policies are implemented which take the axe to insolvent retirees or sufficiently enrage younger people who see their future shriveling away.

The trouble with this gold narrative is that normal people do not wish to see its apocalyptic vision become reality, and they can certainly visualize community, business and political leaders eventually suspending their ideological agenda in favor of working together to come up with real solutions, for hyper-inflation does not really solve anything. So there is an intuitive inclination to pay attention when experts talk about gold being in a bubble that will soon pop and disappoint everybody. If gold is up because all these bad things are going to happen, and gold will go down when in fact these bad things do not happen, then of course everybody wants to believe that gold is indeed a bubble that will soon pop, sending the price crashing back below $1,000 per ounce where few of these "ounce in the ground" deposits being advanced by the non-producer gold juniors will be economic. There is, however, another way to look at gold and silver which has enormous positive implications for gold and silver juniors, producers and non-producers, and it does not require one to believe that making a lot of money requires the worst gold bug fears to become reality.

The prevailing gold narrative posits gold as money, and in doing so pits it against "fiat" currencies, the paper money printed by central banks. The discourse thus quickly deteriorates into a debate about which is a better store of value, gold or paper money? That debate quickly polarizes into an ideological disagreement about what is a better organizing principle for civilization, a laissez-faire free for all that pits each unit against every other unit with a winner take all dynamic, a static system centrally managed by wise units obligated to serve the optimal interest of all units, or a dynamic system whose policies are determined through the periodic victories arising from a perpetual power struggle between units and various unit alliances and which generally serve the interests of the victorious units. The first group are the libertarians, the second are authoritarian regimes which ground their legitimacy in prescriptive axiom sets, and the third are what we call democracies which derive their legitimacy by preventing either of the other two social orders from becoming dominant.

Gold bugs are typically proponents of the libertarian principle, for which they secure support by refusing to treat "units" as anything but individuals. Who doesn't thrill at the idea of raw individualism? The problem with the libertarian approach is that successful competition results in the emergence of clustered units, sometimes controlled by a particularly dominant individual unit, the arch-villains of James Bond fantasies, but usually they become hive-like units guided by a drive to pursue a collective interest. They thrive best when "us-them" conflicts focus their energy. Over time what emerges is a competition among tribes, nations, religions or corporations, all of them devoted to maximizing their constituency's interests. Eventually, left unchecked or not undermined by "natural disasters", we end up with the second system, an authoritarian order which in theory pursues the interest of humanity, but in practice becomes pre-occupied with controlling its internal power structure, usually at the expense of the beneficiaries of its legitimizing axiom set. These are called theocracies when their axiom sets have metaphysical components, dictatorships when they rely only on "values". The tragedy of humanity is that scarcity prevents the construction of a perfect value set that does not encounter contradictions where a unit must make a decision that benefits one unit at the expense of other units. The Greeks understood this, and Nietzsche codified it for us.

The super-tragedy is that most people, and this includes people who call themselves religious, individualist, socialist, humanist or anything asserting moral legitimacy, do not understand that their moral compass is flawed. An all-encompassing moral code remains philosophy's holy grail, though some argue that as long as scarcity, and by extension the individual unit, characterize reality, this quest is futile. The trouble with "authoritarian" orders is that they tend to assert moral completeness and consistency, but I guarantee you that even an ordinary individual such as myself can produce a "thought experiment" that forces any moral code to make a "tragic" decision that turns one unit into a winner and another into a loser according to the terms of the moral code. The polarization in American politics is due to the fact that people have forgotten what the founding fathers understood, that nobody is completely right nor completely wrong, and that the so-called self-evident principles are merely a starting point to negotiate a going forward strategy that does not result in the destruction of this very starting point.

The inherent inconsistency of all authoritarian orders and the tendency for authoritarian orders to become focused on preservation of the internal power structure inevitably generate tension among the losers which transforms authoritarian systems into totalitarian police states, the antithesis of the libertarian principle. A democracy based order seeks a balance between the libertarian impulse to maximize self-interest to the point where only one "unit", an authoritarian system, remains, and the impulse of larger units to universalize their adopted axiom set at the expense of competing axiom sets (substitute "moral codes" for "axiom sets" if you wish). This preserves the creative impulse of the libertarian principle, cultivates the development of richer and hopefully less inconsistent moral codes, and prevents the petrifaction of dominant units into stultifying control systems. Rather than worry about who is right and who is wrong, this "democratic" middle road demands that every action or policy be accompanied by an analysis of whose interests are hurt or benefited by the policy, that decisions are based on the outcome that involves the least contradictions, and that the final decision be made with a full awareness as to who is stuck with the losses, an awareness that constitutes a "tragic" mode of being for which there is no redemption and which strips the decision-maker of any claim to righteousness. This is the burden that libertarians and authoritarians prefer not to shoulder, but it is the burden carried under the banner of pragmatism by a vast majority of people residing in the advanced economies which are now facing a collision between scarcity and ideals.

I embarked on this philosophical detour because I believe that gold has been unfairly hijacked by these libertarian and authoritarian extremes, which has compelled the large majority of pragmatists to dismiss gold as a "barbarous relic" because its proponents seek to tie paper money to the existence of physical gold. Gold is not money, and to understand why that is so, consider a desert island devoid of any gold. The island does have a variety of natural resources including fresh water, fertile soil that supports a reasonably complex mix of vegetation which in turn supports a complex eco-system. Rather than ditching its passengers into frigid waters after hitting an iceberg, the Titanic wanders off course, manages to get stranded on a sandbar off our desert island, and while the passengers are all onshore, a cyclone drags the Titanic back out to sea, leaving 2,223 passengers marooned on our desert island without anything more than the clothes they are wearing. And, courtesy of a message in a bottle that floats ashore, they are lost on an island that has been designated a forbidden zone for the rest of humanity.

Will this community of former Titanic passengers with zero assets in the form of physical things or the power that comes with "unit" connectedness to a now lost world establish a self-sustaining economy, or will they starve to death because they have no money? Or, to create money, will they push themselves to the brink of extinction expending energy in the quest for gold or some other fairly scarce metal? Of course not. An impromptu credit system will evolve for the exchange of goods and services, which will initially be a straight barter system. Pure barter systems have poor liquidity because it is difficult to match my need with what another person might be able to supply. Eventually the barter system evolves from straight exchange to the creation of a promise, an oral "IOU", whose primary property is "time", a key element of debt. Once an economic transaction achieves portability in the time dimension, it is a small step to deal with memory problems by adopting some physical form of record-keeping such as IOU's scratched onto bark peeled from the palm trees at minimal effort. Before we know it, our desert island has a thriving economy based on nothing more than "bark" money. Assuming "tragic liberals" allow a fruitful oscillation between the libertarian and authoritarian impulses that keeps either from petrifying the island economy, these refugees from the Titanic might eventually put one of their children on the moon.

Money is an information system that keeps temporal track of debits and credits in a transaction based economy, and eventually becomes the basis for which the price of a good, service or "asset" is negotiated. Key to money systems is the element of trust that the money is created through the "production" of a good or service, not just by peeling some bark off a tree and scratching numbers on it. In advanced economies this "production" becomes a promise that matures in the future. Gold, in contrast to money, is very scarce and difficult to concentrate into an exchangeable form. Real money is not a store of value; it is an abstract signifier of a social order's obligations. After Pizarro murdered Atahualpa, leader of the Incan Empire, in the 16th century, he hauled back to Spain a hoard of gold taken from the Incas by force, a "force" that was less physical than mental. In securing and transporting this gold to Spain Pizarro invested nowhere near the energy invested by the Incas to mine this gold, and, predictably, the sudden influx of this "stored wealth" had quite an inflationary impact on the Spanish economy. Had Pizarro stolen and transported wheelbarrows full of "paper" money from the Inca leader's vaults, the claims on Incan "assets" it represented would have been worth nothing in Spain. Money is intrinsically worthless because as soon as its validating framework evaporates or becomes inaccessible, money ceases to represent a claim on anything. Gold, unlike money, signifies itself, and as such cannot become worth less than the energy required to conjure up an equivalent physical amount. It is misleading to denigrate paper money by declaring that it is not a "store of value" in the style of gold. Money is a temporally extended claim on real assets such as land, the means of production, raw materials, intellectual property, and the servitude of workers. Real value is stored in the ownership of these assets, ownership which ultimately relies on a legal system defining and enforcing title and contracts. Gold, precisely because it is "timeless", is not money.

Gold is sometimes denigrated because it apparently does not generate a return, as do raw materials when mobilized into applications, land which generates usage rent, and production capacity which generates profits. Even money, whose essence is its temporal dimension, generates a return in the form of interest. But what "tragic liberals" tend to ignore is that gold, through its natural scarcity, compactness, fungibility, and portability, is capable of paying an abstract dividend in the form of insurance against the collapse of the social systems that sustain title and money systems. Only a fool would dispute that bags of money in a vault would reduce to worthless paper if the confidence system to which its units point were to collapse. Nothing can change the fact that gold bars and coins in your vault are gold bars and coins. While some gold bugs are motivated by a simplistic vision of buying a bunch of gold at a low US dollars per unit price and exchanging it for US dollars at a substantially higher price than might have been expected after adjustment for inflation, and then going out and buying up lots of goodies with old-fashioned paper money, the more intelligent type of gold bug is not speculating on possible capital gains that will be taxable without accounting for inflation. Instead, this type of gold bug, and I think he and she are the dominant buyers in the current market, is doing nothing more than parking some surplus wealth into an asset class that would survive currency debasement, debt default, and the collapse of property title enforcement systems. The goal is not a short term capital gain; the goal plain and simple is ownership of a portable asset that is reasonably exchangeable for other concrete goods and services by virtue of the fact that it is not hard to discover how much work is required to produce a new ounce of above ground gold, and to compare that effort with what it costs to provide the desired good or service.

That gold ownership can be contemplated without reference to an ideological agenda is alien to the gold bug discourse we generally hear on the conference circuit where the wisdom of owning gold tends to be linked to apocalyptic visions of the future. A typical "buy gold" exhortation spawns visions of traditional gold bug survivalists, among whom the bullfrog hunter and avowed libertarian Mickey Fulp is more than happy to count himself. But this vision alienates the majority of people who despair at the idea of surviving in some squalid bunker, chowing down on dried food and bullfrog legs, while their children and possibly grandchildren are somewhere out there in a society gone haywire. And while they may own a gun and have practiced shooting it on the range, and even accidentally dropped dead a deer that strayed onto their property, they dread the idea of using it to defend their gold against Billy Bobs scouring the countryside with a list of gold show delegates in hand. These less than dedicated gold bugs probably own ETF gold in their retirement account where gold avoids the nasty "collectible" capital gains treatment it garners when sold for a profit in its physical form. Yet when they hear gold bug purists denigrate the SPDR Gold ETF as no better than fiat money, in effect making the libelous claim that the warehouse allocation of gold to the SPDR ETF is fraudulent, even though this instrument was sponsored by the World Gold Council, a lobby group for the gold mining industry whose mandate it is to generate new demand for real gold, it is no wonder that while they stick to their guns in owning gold for the long haul, they grit their teeth for the humiliation predicted by gold bears warning about gold being in a bubble. Everything the gold bugs do to promote their cause seems designed to conjure skepticism about gold as a legitimate long term asset class, and in this role the old-style gold bugs have perhaps unwittingly declared war on resource sector juniors with exposure to gold.

The same scorn seems to have been generated by silver bugs, who also confuse silver with money, and often invoke biblical arguments in support of silver. After decades of being supposedly suppressed by a cabal of COMEX traders and end users who screwed silver producers (as secondary silver producers they maybe did not care about the cheap price) and institutions who for some reason felt compelled to have exposure to silver even if it consistently helped lower the fund's performance, silver has hit the nominal high achieved in 1980 and is now trading at a level generating huge cash flow for primary silver producers that the market has yet to acknowledge. Although silver is largely an industrial metal, the offset to the demand destruction underway in response to the tenfold price increase from the below $5 rut of the past couple decades is not coming from North Americans in search of a hedge against financial catastrophe. Silver has become the gold of the "poor man", who is not to be understood as the gun-totin', crystal meth smokin' Billy Bob tenant of the trailer park at the far side of town, but more so as the hundreds of million hard working citizens of emerging economies who have even less reason than Americans to trust their political leaders, and want to squirrel away something tangible bought with their meager savings, which the lofty price of gold does not allow but silver in the $30-$50 range still makes feasible.

Even though investors appear willing to buy gold and silver in physical or ETF form as a long term hedge against the future going badly wrong, they are very reluctant to shift any capital into gold and silver resource sector equities that have gold/silver production or are pushing a gold/silver project through the development cycle. When you look at the 40 year annual price charts for gold above and silver below several things immediately stand out. One is that gold and silver had tremendous price spikes in 1980 to peaks of $850 and $49 respectively. The second is that after the 1980 bubble collapsed, gold and silver spent two decades in fairly narrow trading channels well below their peaks, 40%-60% i9n the case of gold, and 80%-90% in the case of silver. Both saw uglier lows just before uptrends developed during the past decade. The third is that the price trajectories for gold and silver since the 2008 Crash have an exponential pattern of the sort that everybody has learned is never sustainable and consequently should be feared as a bubble in search of a pin. Never mind that the earlier Gold and Silver in Perspective graphs show that the real price of gold from its $850 peak in 1980 should be $2,192 while the real price of silver from its $49 peak should be $120 per ounce. The current gold price is admittedly not that far from the inflation-adjusted peak, but silver is sill a long way off, though admittedly the 1980 peak was due to a manipulative attempt by the Hunt brothers to corner the silver market.

In respect of the principle that "what goes up must come down", anybody following gold and silver has to be conscious of the possibility that gold and silver prices may plummet. Such a setback may be temporary in terms of the long time horizons set by gold and silver bullion owners, but a gold retreat below $1,000 and silver below $20 would be devastating to the profitability of gold and silver producers, and to the economics of gold and silver development plays. While the gold and silver "bubbles" might lose 50%, the corresponding value of gold and silver deposits with a cost of production above $1,000 or $20 would be zero. The downside risk for such gold and silver equities, especially the development plays, approaches 100% in the event of a popped gold or silver bubble.

So we cannot dispute the poor "bubble" optics presented by the gold and silver price charts. But what about the lengthy price rut that afflicted gold and silver after their 1980 bubbles popped? If gold and silver would suffer a similar malaise after their current "bubble" pops, gold and silver equities will never recover from their accompanying setback. It is thus better to avoid them entirely, which thinking is definitely a factor in the market disconnect between gold and silver bullion prices and gold-silver equity prices.

The concern about an extended gold price slump after a major pullback from the current "bubble" is misguided because the production circumstances that prevailed in 1980 are drastically different from today. Gold inflation adjusted from $36 in 1970 would have been $77 in 1980. The post-bubble equilibrium price was $400 with a 25% high-low range during the eighties. That $400 price was more than 400% higher than the $77 inflation adjusted price, which represented a major real price gain over the price assumption that had guided all gold mine development decisions prior to Nixon's decision to unyoke the US dollar from gold. For major gold producers such as apartheid South Africa and the Communist Soviet Union this real price hike was a huge boon that generated much needed hard currency. Elsewhere in the world mining companies ramped up exploration of gold targets which had been hopelessly out of the money at $36 gold. As the annual gold production chart above shows, gold production fell during the seventies even as the price of gold rose, largely due to cost inflation and uncertainty about what the long term price for gold would be. The same was not the case with silver, which was mainly a byproduct of zinc and copper mines, and later gold mines that came on stream. The mine development cycle requires 4-6 years from discovery to production when there are no permitting problems, so there is always a supply lag in response to price. Because the prefeasibility and feasibility stages are expensive and require several years, these stages do not generally get underway until there is confidence that higher metal prices are here for the long term.

In 1980 it was estimated that the above ground stock of gold mined during the past 5,000 years was about 3.2 billion ounces. Thanks to the dramatically higher real price, new exploration and mining technology, and the desire for hard currency by authoritarian nations well endowed with gold deposits, the mining industry produced 2.1 billion ounces from 1980 through 2010, boosting the world gold stock to 5.3 billion ounces. On top of this 71% increase in the gold stock since 1980, the market had to adapt to a structural ownership change as central banks liquidated their gold holdings, a process that went out of control during the late nineties when an inverse relationship developed between the price of gold and the strength of the US dollar that spawned a gold carry trade heavily exploited by major gold producers such as Barrick. Gold production peaked in 1999, and did not resume an uptrend until 2009. As both the gold and silver supply charts show, CPM projects gold and silver production to climb significantly during the next five years in response to recent price increases. However, even though annual production is projected to hit 104 million ounces by 2016, the percentage it being added to the above ground gold stock is 1.7%-1.8%, which is the level that has prevailed since the late eighties. The market will not have to absorb a glut of new supply. Silver is a trickier situation because the higher silver price will spawn new supply from primary producers while demand from industrial users declines. Much hope is pinned on the historical price relationship between gold and silver, with gold expected to support a high silver price.

What is usually missing from the gold narrative is any explanation of what constitutes a reasonable long term price for gold and silver when treated as a special asset class whose "return" resides mainly in the form of long term security against systemic financial and political collapse. The uptrend is also usually explained as the market gradually becoming aware of the inherent rottenness of fiat currencies and seeking to escape the consequences through ownership of gold and silver bullion. In so far that the gold bugs control the narrative, it is usually tinged with ideological recommendations of a libertarian or authoritarian nature (we must return to the golden age when a gold standard prevailed, before liberals, socialists, and communists got hold of the political process). There is also a masochistic strain of America bashing whose insincerity is evident in the unwillingness of gold bugs to link the rise in gold to a narrative of America in decline which is associated with liberals and anybody who dares to declare gold as being in a bubble. However, the charts above and below reveal that in terms of relative importance in the global economy expressed in terms of nominal GDP, the United States has been in decline since the end of the dot-com bubble, with China, now the world's second biggest economy, the big gainer at American expense. The IMF projects this trend to continue, though it does make assumptions that the United States will continue to undergo positive economic growth. The concern during the past few months is that such assumptions have become questionable, and so the big question is whether a slowdown in the United States will drag China and other emerging economies with it, or force them to expand on their own while the United States deals with its debt problems by shrinking its economy.

The US dollar is the world's reserve currency and that fact is not going to change overnight. But it is highly doubtful that a mature economy such as the United States which lacks an industrial policy that supports the creation of manufacturing jobs can stay relevant in a global economy. With a population base of less than 350 million people, it is inconceivable that the United States can remain the largest economy as a ten times larger population in Asia develops a middle class consumer society. This also calls into the question the sustainability of America's huge military budget which is devoted mainly to keeping peace in the world and supply channels open that increasingly serve America's competitors. From an international investor's perspective the next 20 years are fraught with danger because there is no obvious stable replacement for the United States. The domestic dysfunctionality revealed by the debt ceiling fiasco further weakens the odds that the United States will pull itself out of what appears to be an economic and social death spiral. American gold bugs may be buying gold for ideological reasons, but the rest of the world, and this increasingly includes central banks, are buying gold as a hedge against the chaos associated with the demise of a hegemon. But even if the United States adopted strategies which justified a gentler phrasing such as the transition of a hegemon into a more balanced relationship with the rest of the world, this would not change the risk that one or more of the aspirants to the position of biggest economy may thrash around like an unwitting bull in the china shop. If one accepts as an inevitability that the United States is transitioning away from its role as the dominant super power in the wake of the collapse of the Soviet Union, then it becomes much easier to dismiss talk about gold and silver being in a bubble.

The chart above makes the assumption that the value of the above ground gold and silver stock has a structural relationship to global gross domestic product expressed in nominal US dollars. The stacked columns show global GDP in green, the value of the gold stock based on the average annual gold price in yellow, and the value of the silver stock in grey. Each year the gold and silver stock has been adjusted to reflect that year's mine production. GDP is assumed to be a measure of the world's wealth, and the gold stock is treated as a claim on the global wealth. The concept I wish to introduce is that of the value of the gold and silver stock presented as a percentage of global GDP. The average gold stock value is presented in red, while the pink lines represent the value range based on the highest and annual gold price (London Fix). The dark blue line represents the value of the silver stock, while the light blue represents the value at the annual high price. What this chart shows is that in 1980 the value of the gold stock at $850 gold was 25.7% of GDP, while the silver stock at $49 silver was 14.1%. At the average 1980 prices gold was 18.6% and silver 6.0%. For gold the valley occurred in 2001 at 3.9%, while for silver the valley was 0.5% in 2002. During 2011 the recent $1,878 peak the gold stock represented 14.7% of GDP, while the $49 silver peak represented 3.3%. These are still a far cry from the percentages associated with the 1980 price peaks.

The current gold average price of $1,468 for 2011 makes the gold stock worth 11.5%, while the silver stock is worth 2.4% of GDP at the average $35 price. I do not know on what basis one could argue that a specific percentage represents an equilibrium level for gold or silver. But when I look at the 40 year history of this GDP percentage figure, take into account the long term uncertainty about the viability of various asset classes as the United States undergoes relative decline within a growing global economy where its currency gradually loses its singular reserve status, consider that its ability to project itself as the supreme military power diminishes, and contemplate no escape from the ideological warfare in its political process, the gold stock value as 10% of GDP and the silver stock as 3% of GDP, strike me as a reasonable balance between the high associated with the extreme uncertainty of 1980, and the low associated with the nineties when the United States emerged as the undisputed victor of the Cold War. In the gold chart above and silver chart below I have converted these percentages back into gold and silver prices based on the GDP projected by the IMF and the cumulative gold production projected by CPM, expressed as the red line for the gold price and the blue line for the silver price, and added 10% buffers to reflect an annual trading range. On these terms I would expect gold to trade in a range of $1,390 to $1,699 by 2016, and silver to trade in a range of $47 to $58 by 2016.

These price projections may not be very exciting for gold bugs, but they have tremendous implications for gold and silver resource equities because they make a case that recent price levels, far from being bubble prices, represent the new reality for gold and silver prices. Bubble prices remain to come; if gold were this year to achieve the 25.7% of GDP peak of 1980, it would have to hit $3,282. For silver to hit its 1980 peak of 14.1% of GDP, it would have to trade at $205. These are numbers grounded in history and an economy linked pricing model, not random numbers tossed out by Rob McEwen. More importantly, these numbers to not include massive inflation or serious US dollar decline against other currencies. The global GDP figure is based on individual country GDP projected in domestic currency and converted by the IMF at consensus exchange rate projections. Depending on the ripple effect of a US dollar decline, total GDP would rise, but the gold stock would not, which means a corresponding boost in the gold price. If central banks get out of control with the printing press, the resulting inflation would swell GDP but not the gold stock, which again would reflect higher gold prices. Where would gold and silver end up if indeed they are in a bubble that pops and sends the GDP percentage back to the low of the past 40 years? Gold at 3.9% of 2011 GDP would be $485 per oz while silver at 0.5% of GDP would be $7.27 per oz. That would be a disaster for the gold and silver resource equities. Much as I might wish the global outlook to be so calm and soothing that gold and silver would collapse back to these levels, I simply cannot visualize how global circumstances can change during the next five years to bring about such conditions. It seems much more likely that gold will flirt with $3,000 before settling back into a long term trading range of $1,500-$2,000, while silver flirts with $100 before settling back into a $40-$60 long term range. This sort of price action can come about because the people who are buying gold and silver are doing so for the long haul and are not interested in flipping it for a capital gain; gold and silver can spike to $3,000 and $100 because there will be no sellers, and because there is no evidence of a political will within the United States to avoid instability during the runup to the 2012 elections. But most importantly, these spike are not necessary for the disconnect between bullion and equity prices to resolve itself in favor of a powerful upwards inflection in the sentiment toward the gold and silver equities who offer 5-10 times upside leverage simply as a result of the market concluding the current gold and silver prices are here to stay.

Above Bottom-Fish Range Within Bottom-Fish Range Below Bottom-Fish Range Recently Closed Out
Updated this Week New 2 Year High New 2 Year Low New Bottom-Fish High New Bottom-Fish Low

Bottom-Fish Recommendations made from August 7, 2011 to August 27, 2011
Company Date
Price Recommendation Action Net
Gain New Status
Search Minerals Inc 8/9/2011 $0.40 BF Priority Upgrade to Medium
$0 2,041 -18% BF MP Buy $0.30-$0.49
First Point Minerals Corp 8/22/2011 $0.70 Confirm Good Relative Spec Value Buy
$0 1,818 27% Goold Realtive Spec Value Buy @ $0.70
Mountain Province Diamonds Inc 8/24/2011 $4.95 Confirm Good Absolute Spec Value Buy
$0 658 226% Good Absolute Spec Value Buy @ $4.95
Empire Mining Corp 8/26/2011 $0.25 Confirm Good Absolute Spec Value Buy
$0 1,923 -52% Good Absolute Spec Value Buy @ $0.25

New Comments
Volume High Low Close Chg Status
Empire Mining Corp (EPC-V)
1,073,400 $0.320 $0.200 $0.250 ($0.030) Good Absolute Spec Value Buy
First Point Minerals Corp (FPX-V)
2,135,700 $0.860 $0.670 $0.750 ($0.120) Good Relative Spec Value Buy
Mountain Province Diamonds Inc (MPV-T)
591,400 $5.150 $4.100 $4.860 ($0.120) Good Absolute Spec Value Buy
Search Minerals Inc (SMY-V) 1,336,600 $0.500 $0.390 $0.450 $0.055 New BF MP Buy $0.30-$0.49

Bottom-Fish Action Report for August 7-27, 2011
Search Minerals Inc (SMY-V: $0.40)

Bottom-Fish Comment - August 9, 2011: Search does deal with Votorantim on starved acid leach technology

Jim Clucas is still threatening to turn Search Minerals Inc into Canada's first rare earth mine, but on August 9, 2011 he gave shareholders the first concrete sign that the "starved acid leaching technology" (SALT) developed by him and David Dreisinger is making progress. The privately held Brazilian conglomerate Votorantim has signed a deal which effectively give it exclusive rights to SALT in Brazil in exchange for delivering a proof of concept through a pilot plant study. Although the agreement was only recently signed, Votorantim has been working since the start of 2011 on the study. Clucas expects a final report by November 2011, at which point Votorantim will have three years to "exercise" an option to acquire a 50% interest in the Brazilian patent if and when it is granted. Clucas estimated Votorantim will have spent as much as $1 million on the study, which is supposed to demonstrate that saprolite hosted nickel mineralization high in magnesium and silica can yield 55%-60% recoveries at considerably lower residence times and acid consumption than conventional methods that target 80%-85% recoveries. The exploitation target for SALT will be deposits deemed sub-economic under existing process technologies. If Votorantim is happy with the study it may apply SALT to the tailings that come out of its Niquelandia sulphide nickel mine as well as its undeveloped Cipo saprolite nickel deposit. Should this happen Search will be entitled to an annual $500,000 advance royalty on a 0.25% NSR, though more importantly it will be able to point to these operations as examples of commercial application of SALT. The stock actually went down on tiny volume when this news came out, probably because the terms of the agreement are unclear or do not seem to leave much for Search other than a 0.25% NSR. However, the agreement applies only to Brazil, with Search retaining 100% rights outside of Brazil. Clucas, whose background is the nickel sector, will be seeking to acquire "sub-economic" saprolitic nickel laterite deposits elsewhere in the world where he can profitably apply SALT. On the rare earth front Clucas indicates that he expects initial 43-101 resource estimates for the 100% owned Fox Harbour project in Labrador's Port Hope Simpson area and for the Red Wine project joint ventured 50% with Great Western by the end of Q4 2012. This will be an important milestone because the rare earth cycle is reaching a point where pure exploration plays are out of the running unless they deliver an off the scale discovery such as the market thought it saw at the Warm Springs project of BE Resources before it was revealed that there was much wrong with the news release including the decimal in the wrong place. He also estimates that with the current budgets Search Minerals should have about $3.6 million working left by the end of 2011. Given the progress Search has made advancing its SALT technology from concept to pilot plant demonstration by a major third party, I am upgrading Search from a low priority bottom-fish buy to a medium priority buy in the $0.30-$0.49 range.

First Point Minerals Corp (FPX-V: $0.70)

Spec Value Hunter Comment - August 22, 2011: Cliffs triples 2011 Decar program to 14,000 plus metres

First Point Minerals Corp announced on August 22, 2011 that Cliffs Natural Resources Inc has expanded the original 4,000 m 2011 drill program at the 70% optioned Decar nickel project in central British Columbia to 47 holes approaching 15,000 metres. A second drill rig has been added to the project by Caracle Creek International Consulting and more will likely be added, judging by a decision to bring three different drilling companies into the project in order to secure competent drill crews. I participated in a field trip to the project on August 16 during which it became apparent that Cliffs has shifted from exploration to discovery delineation in a big way. A 22 man camp is already in place, and will soon double as can be seen from the prepared footprint in the camp photo below. Drilling without a winterized camp can take place until mid October, which means that Cliffs will need to run a very aggressive drilling campaign unless it is prepared to winterize the camp. Cliffs has plotted 47 drill holes on 200 m spacing within an area of 2,500 m by 700 m on the Baptiste Zone where 7 holes were drilled in 2010. Of these 15 will represent infill holes along the southern flank of the deposit which are expected to be done by mid September and which will form the basis of a initial inferred 43-101 resource estimate. The holes will be drilled 300 m at a 50 degree angle representing a vertical depth of 230 metres. The infill holes consist of pairs tracing an arc with a 2,000 m strike. If we allow the holes a 100 m buffer for resource estimation purposes, the footprint being tested for the inferred resource is 2,000 m by 400 m by 230 m, which at a specific gravity of 2.67 for the ultramafic host rock, represents a tonnage footprint approaching 500 million tonnes. Cliffs plans 32 stepout holes, starting with the higher elevation holes within the overall 2,500 m by 700 m Baptiste zone whose tonnage footprint to a 230 m depth exceeds 1 billion tonnes. Awaruite mineralization has been observed to a depth of 300 metres; Cliffs plans one, possibly two, deep 600 m holes into the Baptiste zone to see how the grain size and awaruite grade behaves at depth. These 47 holes averaging 300 m each exceed 14,000 metres. Cliffs also plans 4 holes on the Sydney Zone which sits at a higher elevation at Decar but is attracting Cliffs' interest because grain size appears to be coarser at Sydney. Two holes are planned for the Van target and one has already been completed on Target B. Based on last year's budget of $1.8 million for its 4,000 m program, Cliffs appears set to spend $7 million at Decar during the summer-fall 2011 season.

Although the news of the expanded drill program is a major milestone signalling that Cliffs has put Decar onto a mine development track following the July release of results from its metallurgical study (see Spec Value Hunter Comment - July 4, 2011), the stock closed down despite August 22 being a generally up day in the market. While this is not a welcome trend for bottom-fishers and spec value hunters who already own the stock, it is a welcome opportunity for the rest because a major level of risk has been removed, which is the possibility that while Cliffs might have been happy with the concept, it was still looking for a better manifestation of the concept. The resource estimate can be expected in Q1 of 2012 followed by a preliminary economic assessment (PEA) in Q2 of 2012. Cliffs is currently working on optimizing the magnetic-gravity separation flow-sheet which yielded a concentrate consisting of 52% iron, 2.6% nickel and 2.2% chromite with about 23% consisting of fairly inert magnesium silicate (20% consists of the oxygen in the magnetite molecule, the main oxide form of iron present in the concentrate, which vanishes when the concentrate is melted in a blast furnace). During the field trip Peter Bradshaw mentioned that concentrates as high as 20% nickel have been achieved through grinding and magnetic-gravity separation steps, but not under formal conditions which allow calculation of the recovery. Recovery is the key issue with the awaruite mineralization at Decar, which grades 0.1% to 0.15% nickel out of a total grade rangiing 0.2% to 0.25% nickel. Only the awaruite is deemed recoverable; metallurgical work indicates that grains below 50 microns are not recoverable. The goal thus is to find blocks of mineralization where the awaruite grains tend to be bigger than 50 microns, with 100-200 microns the ideal range and anything higher a bonus. When average grain size is 100 microns or better the recovery is 80%.

While the awaruite and total nickel grades and their relative proportions at the Baptiste Zone tend to be uniforn vertically and horizontally within the blackish-green ultramafic host rock, spatial variations of grain size distribution does occur, as was evident in the strip log from hole 1 shown above. It is reasonable based on the nature of the Decar geology to project that Cliffs will generate an inferred resource of 400 million tonnes grading 0.14% awaruite based nickel for the area that is the focus of infill drilling, which at an 80% recovery and $10/lb nickel price represents a recoverable rock value of about $24 per tonne which does not include any credit for the iron and chromite which are expected to be payables. It would seem that Decar is a low cost bulk tonnage mine begging to be made by Cliffs, with the main hurdle being a social license from First Nations groups. But it is not quite so simple. Cliffs must also document the grain size variation within the Baptiste Zone because there is a risk that although awaruite mineralization is consistent, large "holes" of finer grained awaruite may be present within the deposit. Mining and processing these blocks could result in a drastic drop in recovered nickel. If these are large and infrequent they can simply be mined and discarded as waste rock. If they are small and randomly distributed their impact will simply be reflected in average projected recoveries. It would be a problem if fine grained "holes" are large and frequent enough to require a complicated mining and waste removal plan. The geologists have not found any evidence of local structural controls for grain size variation, and for now believe it to be due to micro-fracturing related to larger scale forces.

To establish the degree of this risk and necessary mitigation measures Cliffs plans to conduct bench scale magnetic separation tests on 5 metre sample intervals, which would yield recoverable nickel grades along with fire assayed total nickel grades and awaruite nickel grades as measured through First Point's geochemical method it got certified last year. The latter was a huge breakthrough which remains proprietary to First Point, and which it is using in its hunt for similar Decar style projects elsewhere in the world. The market is not likely aware of this spatial grain size distribution risk at Decar, and is still stuck getting its head around the concept of mining rock with a 0.1%-0.15% nickel grade. We, however, already understand why Decar could become a mine despite the low grade, and should book mark this "recoverable grade" dimension as another derisking milestone to await when the resource estimate is completed. Based on the news that Cliffs is stepping up exploration at Decar to a scale which suggests a high degree of confidence that it can turn Decar into a profitable nickel mine, I am confirming my open Good Relative Spec Value Buy at the current price of $0.70.

Mountain Province Diamonds Inc (MPV-T: $4.95)

Spec Value Hunter Comment - August 24, 2011: Mountain Province gearing up for scale changing exploration

Spec Value Hunters should be looking at the recent weakness in Mountain Province Diamonds Inc as a buying opportunity in anticipation of exploration results by Q1 of 2012 that could boost the price target well beyond the $6-$8 per share range based on the current mining plan and the modeled carat value (see Spec Value Hunter Comment - October 8, 2010). On August 24, 2011 Mountain Province announced that it had received "unsolicited expressions of interest from third parties" but has now decided to cease further discussions. My assumption was that diamond dealers and wholesalers were bugging the junior about offtake agreements for future production from the Gahcho Kue diamond project in the NWT which is currently at the permitting stage of the development cycle. But CEO Patrick Evans has indicated that these parties were major diamond producers, which excludes the small AIM listed diamond producers, and by definition of not being a "third party", De Beers itself. That leaves a small group consisting of BHP Billiton, operator of the Ekati mine, Rio Tinto and Harry Winston, operators of the Diavik mine, and possibly Alrosa, operator of the Russian diamond mines. This is the first indication I have received from management that major diamond producers apart from De Beers have expressed a serious interest in taking out Mountain Province, which is a 49% participating partner with diamond marketing rights in the Gahcho Kue joint venture with De Beers.

On August 2 Mountain Province reported that the Mackenzie Valley environmental review panel has ruled that the 11,000 page Environmental Impact Statement filed by De Beers in December 2010 conforms with its terms of reference, and that formal review hearings will begin on November 20, 2011. This stage of the permitting process allows stakeholders to make public comment on the Gahcho Kue project, which proposes to open pit mine 3 million tonnes annually to produce about 50 million carats over an 11 year mine life. This process can drag on indefinitely, but Evans is hopeful that formal approval for the diamond mine will be in hand by the end of 2012, preferably by late summer to allow deployment of materials over the 2012-2013 winter road. Key to the speed of the review process will be the successful negotiation of an impact benefits agreement with the three First Nations groups affected by Gahcho Kue, which happen to be the same ones with whom De Beers negotiated agreements for the Snap Lake project. Evans is optimistic that agreements with all three groups will be secured by the end of 2011, a milestone that would accelerate the urgency of mine approval. Mountain Province has also been approached by a major Canadian commercial bank with regard to providing construction debt financing, another positive sign that Mountain Province will not be caught in a financing squeeze as happened to Aber, the junior partner in Diavik. Mountain Province decided to suspend discussions with suitors because it is about to embark on a couple exploration programs that could have a high impact on the stock's valuation.

De Beers plans to drill five holes starting in September to test the projected extension of the Tuzo pipe beneath the 350 m level to which an indicated plus inferred resource of 15,700,000 tonnes at 134 cpht representing 21 million carats has been estimated. Tuzo is an unusual kimberlite in that it looks like an upside down carrot, with the diameter of the pipe flaring at depth similar to what Stornoway has observed at its Renard project in Quebec. The grade of Tuzo's open pittable resource has been diluted by large blocks of country rock in the upper portion, though at the 300-350 m level the grade is at 175 cpht compared to 121 cpht in the upper portion. Past drilling has indicated that Tuzo continues to flare at a depth of 400 m. The diagram above from Mountain Province's 2011 AGM Presentation shows both the junior's wishful extrapolation of the pipe's flaring and a more conservative vertical pipe wall projection from the 350 m level by De Beers. The De Beers scenario has a tonnage footprint of 30 million tonnes between 350-750 m, which at a grade of 175 cpht would represent an extra 50 million carats. If the 5 hole drill program confirms this tonnage geometry, and micro diamond analysis confirms the macro grade potential, this would double the overall Gahcho Kue 49 million carat probable reserve scheduled for the current mining plan.

The Gahcho Kue production profile above shows that during the eighth year carat production will drop from 5 million carats annually to just below 3 million carats as Tuzo open pit mining gets underway. If De Beers can confirm the existence of a substantial high grade resource beneath the 350 m level at Tuzo, it will consider driving an adit from the pit bottom of the 5034 pipe, which will be depleted by the sixth year, to access Tuzo for underground mining at the same time that the upper portion is open pit mined. We should know by the end of 2011 how the geometry of Tuzo behaves at depth, and by Q2 of 2012 we should see what the micro diamond results indicate about the macro grade potential. Good news on this front will not require modification of the mining plan currently before the review board, but it will allow investors and potential takeover bidders to adjust their discounted cash flow model based valuations of the project.

In addition to waiting to see what the "Tuzo Deep" potential might add to the value of its 49% stake in the Gahcho Kue project, Mountain Province is also very eager to see what its 100% owned Kennady North claims might hold. These claims were part of the 200,000 plus hectare land package Mountain Province held during the Lac de Gras area play of the nineties when juniors and majors staked an area the size of Switzerland in the wake of Dia Met's Ekati discovery. After De Beers optioned the project on March 7, 1997 it conducted till sampling and airborne geophysical surveys within the overall land package, and did discover three dyke like kimberlites called Hobbes, Kelvin and Faraday along a linear trend 7-12 km northeast of the main Gahcho Kue cluster. During those days De Beers still reported micro diamond results according to its own sieve system, which is slightly different than the one used today for reporting micro diamond results. The size distribution chart below plots the De Beers sieve based results for the 5034 and Hearne pipes, which have probable reserve grades of 177 cpht and 210 cpht respectively, as well as the results for Kelvin and Faraday which despite small sample sizes yielded curves very similar to those of 5034 and Hearne. The composite curve for the Knife pipe which bulk sampled at about 30 cpht is provided for contrast. The conclusion is that the Faraday and Kelvin kimberlites sampled the same diamond source rock as the main cluster. The obvious question is why does Mountain Province own these claims 100%?

There is no obvious answer, even within De Beers today, but in 2006 De Beers decided to take only four claims to mining lease as part of the joint venture, and Mountain Province decided to keep the rest. The best one can guess is that De Beers was satisfied that on the basis of geophysical surveys and till sampling there were no other kimberlites of meaningful size left to be found, and the Faraday and Kelvin bodies were too small to ever be of economic interest. What De Beers seems to have overlooked are gravity surveys, which measure relative density. De Beers has done ground gravity surveys on the Gahcho Kue pipes and established that they do stand out as distinct gravity anomalies. It has now occurred to De Beers that it should have done gravity surveys on its mining leases as a form of condemnation work just in case there are high value kimberlites lacking magnetic and indicator mineral signatures. No doubt the "fat-bottomed" nature of Tuzo has raised suspicions that there may be more than meets the eye at surface. Starting in September Mountain Province will conduct a gravity survey with 50 metre spacing on the joint venture leases as well as its 100% owned ground. De Beers will process and interpret the results. This could yield positive surprises within the joint venture ground in close proximity to the main pipes which benefits De Beers, as well as surprises on Kennady North which would be of enormous benefit to Mountain Province and a serious headache for De Beers, especially given that Mountain Province is contemplating a spin-off of the 100% owned ground as a separate entity to its shareholders. Mountain Province expects to know if it has any drill targets by the end of October, and would drill them in Q1 of 2012 as soon as freezeup has made them accessible.

Kennady North is admittedly a longshot, but if it delivers, the suitors that Mountain Province just put on hold may very well go hostile, in which case De Beers will have to act quickly and aggressively to lock up 100% ownership of Gahcho Kue. Having another party messing around with exploration right next door to a major diamond mining operation is unlikely to be a pleasing prospect for De Beers management, especially if overlooked economic kimberlites were to emerge. After a year of ignoring Mountain Province while it pushed Gahcho Kue into the permitting queue, spec value hunters now have good reason to pay attention again. I recommend that bottom-fishers who bought on the basis of the initial top priority buy in the $0.50-$0.75 range on December 20, 2001 continue to hold 100% for the end game. With regard to the Good Absolute Spec Value Buy recommendation made at $1.59 on June 2, 2009 and repeated several times since then, the stock remains a Good Absolute Spec Value Buy with a target in the $8-$10 range once mine approval is secured, with trading action in the $10-$15 range developing if the 100% owned Kennady North project yields a discovery during Q2 of 2012 that justifies pre-emptive action by De Beers' competitors. It is not often that we get a 100% owned brownfields exploration play within a junior whose valuation reflects the traditional trough between the prefeasibility and production stages of the development cycle.

Empire Mining Corp (EPC-V: $0.25)

Spec Value Hunter Comment - August 26, 2011: Empire negotiates timely deal to acquire 100% of Bursa

The timing of my Good Absolute Spec Value Buy of Empire Mining Corp at $0.52 on February 28, 2011 appears to have been premature, but several developments are on the horizon which justify confirmation that Empire is a Good Absolute Spec Value Buy at the current price of $0.25. Empire was initially recommended as a medium priority bottom-fish buy in the $0.10-$0.19 range based on its Albanian chromium "security of supply" story, but the Spec Value Buy Tracker - Feb 28, 2011 was based on speculation that the Bursa copper-gold project in Turkey was on the threshold of delivering a major discovery at the Demirtepe target. I had to scale back expectations when followup drilling of the high grade copper-gold skarn discovery hole revealed that the skarn mineralization was confined to a 75 m wide by 250 m long by 200 m deep structural corridor underlain by barren granodiorite which suggested the zone had been displaced from its origin by a low angle fault. CEO David Cliff tested targets to the east he hoped might be the roots, but results were disappointing. Cliff raised the possibility that this zone could be developed as a small scale mine producing copper-gold as well as the industrial mineral wollastonite due to its high purity nature which apparently has recently been confirmed by an independent expert. In Spec Value Hunter Comment - May 18, 2011 I confirmed the Spec Value Buy but shifted its linkage back to the chromium project with any upside related to the Bursa project dependent on the delivery of an initial 43-101 resource estimate by the end of 2011, which I expected at best to justify a $100 million dream target for the wollastonite zone.

Further analysis by David Cliff led him to conclude that the Bursa Demirtepe skarn zone's displacement had been eastward rather than southward or westward, which gave new meaning to the ancient workings within the marble rock 1 km west of the skarn zone. Empire is conducting detailed mapping and geochemical sampling in this area as well as an IP survey, but the urgency to establish and test a major target of the sort that initially attracted me became subordinated to the status of the option agreement with Alacer which required Empire to deliver a prefeasibility study by late 2013 to vest for a 65% interest. On July 26, 2011 Empire finally put this nagging concern to rest with a deal that will allow it to acquire 100% by paying US $1.5 million and issuing sufficient stock to give Alacer Gold Corp a 19.9% equity stake in Empire.

Assuming 51,271,116 issued shares and an existing 800,000 share position held by Alacer, Empire would have to issue 11,379,016 shares, bringing the fully diluted capitalization to 69,360,132 shares of which Alacer would be the biggest shareholder at about 12.2 million shares. As long as Alacer owns at least 10% it will have the right to appoint one board member, and it will have the right to maintain its 19.9% interest by participating in any future equity financings. Cliff believes the deal will close in late September. This deal would lock up control of Bursa and give Empire free reign to explore and exploit Bursa's potential without worrying about deadlines whose fulfillment would be problematic if Empire made a huge copper gold discovery at Bursa. However, the deal is missing an important element which reflects a certain degree of management naivete.

The deal does not come with a standstill agreement which would require Alacer to vote its shares with existing management, and prohibit it from making a hostile bid for Empire, for a number of years. An example of such a deal is the 4 year standstill First Point secured from Cliffs Natural Resources Inc when it farmed out its Decar nickel project in late 2009. Empire management has a good relationship with Alacer management based on David Cliff's past history as Rio Tinto's European exploration manager, and Robert Giustra has good reason to believe Alacer would not go hostile on Empire management, especially given that Empire's Bulqiza chromium and Bursa copper-gold projects at this stage represent small potatoes for Alacer which has a market capitalization of $3 billion.

However, two things could change that relationship. One is that Empire does indeed make a major copper-gold discovery at Bursa, and the other is that Alacer may disappear through a takeover bid by a larger company whose relationship to Empire is not constrained by personal history. Empire is not in a position to demand a standstill-voting agreement from Alacer, since it is Alacer which is accommodating Empire's desire to own 100% of Bursa. But it would be a sign of goodwill and confidence in Empire management if Alacer would agree to such a request, and it would certainly subdue minority shareholder concerns that their exposure to maximum upside might be undermined by a large, predatory shareholder.

The timeliness of the Bursa acquisition deal has been enhanced by the August 23, 2011 announcement of initial results for a six hole 1,282 m drill program conducted on the Karapinar target on the Bursa project. Karapinar was explored by Rio Tinto and Alacer (then called Anatolia Minerals) in 2001-2007, and again by Empire in 2008 after it acquired the Bursa option as its capital pool qualifying transaction. The Karapinar area hosts a 2,500 m by 500 m zone of potassic alteration within a granodiorite porphyry (the pink area in the diagram above) whose stockwork density is most pronounced in the 500 m by 500 m area at the southeastern end where all but one of the holes have been drilled. The 11 earlier holes yielded secondary copper mineralization up to 1% over thicknesses to 100 metres, but the overall footprint was too small to interest Rio Tinto, and Empire was mainly interested in developing Karapinar as a medium sized SX-EW leaching operation.

The problem with Karapinar was that there did not appear room to develop additional tonnage. To the northwest the stockworking density is insufficient to support decent grade copper mineralization. To the south the zone has been displaced by a normal fault, which hole 17, not yet reported, has apparently confirmed. And the northern side is covered by a thick marble roof pendant as confirmed by hole #5. The area to the southeast was never drilled because it was mapped as a schist, the older barren country rock. David Cliff now has reason to suspect that this area has been mismapped, and that the historic exploration focus at Karapinar may have touched the edge of a major chalcocite enrichment blanket, a deposit style not seen in Turkey because of its tectonic history which inhibited the preservation of significant secondary enrichment zones. Hole 18, among the easternmost ones yet drilled, yielded 179.6 m of 0.48% copper, 0.014% molybdenum, and 0.1 g/t gold from a depth of 31.6 metres. This included 60 m of chalcocite mineralization from 79.6-139.6 m grading 0.93% copper.

One could dismiss this result, as the market seems to have done, as merely extending modestly eastwards a zone that is cut off by the schist, but there was something unusual about hole 18 which caught Cliff's eye. The upper 48 m from 39.6 m consists of oxide mineralization grading only 0.25% copper; beneath that is a higher grade chalcocite blanket which appears to have been formed by leaching of the upper portion. The initial holes in the western part drilled by Rio Tinto contained no chalcocite, while the later holes revealed an oxide to sulphide transition zone which contained a mixture of secondary copper minerals such as bornite, native copper and chalcocite. The thickness of the depleted oxide horizon, followed by an even thicker horizon of supergene enrichment, has David Cliff wondering if the untested schist to the east may in fact not be schist at all. The Google map above depicts a 500 ppm plus copper contour which surrounds the main Karapinar zone and occupies the northeastern and eastern flanks of the area to the southeast mapped as a schist. The area mapped as schist is uphill and densely wooded; past mapping by the Turkish Geological Survey and Rio Tinto was likely based on boulders rather than bedrock, and inhibited by difficult access. The discovery of a clearly developed chalcocite enrichment blanket in hole #18 has David Cliff thinking that perhaps the hill to the southeast was mismapped as schist, and the absence of copper geochemistry may be due to copper depletion arising from an extended leaching period. So rather than fizzling out as one moves toward the "schist", is it perhaps the case that the Karapinar zone blossoms into a thick and laterally extensive high grade chalcocite enrichment blanket under what is supposed to be barren schist that is in fact a debris and tree covered porphyry leach cap?

If so, this would be very unusual for Turkey which has a geological history of rapid uplift and erosion not conducive to the development and preservation of chalcocite enrichment blankets such as found in the Chilean Andes of which Escondida (from the Spanish "hidden", hint, hint) is the most famous example. Supergene enrichment requires rainwater to percolate through near surface primary copper mineralization, generating sulphuric acid which dissolves the primary sulphides, and then precipitate the copper in the form of secondary sulphides such as chalcocite when the solutions enter the water table. The more extended this leaching and enrichment cycle, the thicker both the leach cap and the enrichment blanket. This needs to take place for a long time at a surface with a stable elevation. The trouble with Turkey's tectonic history is that rapid uplift disrupts the leaching cycle, unleashes erosion which wipes out any enrichment zones that might have developed, and buries adjacent mineralization not uplifted. It is thus a waste of time to look for such deposits in Turkey, which may be why Rio Tinto did not look beyond the small potatoes secondary copper mineralization it found at Karapinar within a small footprint of favorable geology surrounded by supposedly unfavorable rocks.

The untested area has a footprint of 600 m by 400 m, which only has room for a 100-200 million tonne deposit, so we are not looking at a world class target. But for tiny Empire such a discovery with a high copper grade would offer substantial upside from the $18 million value implied by the current $0.25 price at 70 million fully diluted shares for a 100% net interest, with a dream target approaching $500 million, if the target area was indeed mismapped as schist. For bottom-fishers and spec value hunters the good news is that the game is on again for the Bursa project, and the title vesting risk is being eliminated. Empire's next stage will be to conduct detailed prospecting and mapping of the "schist" and conduct IP surveys over it to firm up the target, and, if justified, drill it after the Alacer deal has closed. Meanwhile Empire continues to advance the Bulqiza chromium project for which it hopes to have an initial 43-101 resource estimate by the end of 2011 which will kick off negotiations with a third party to fund development of a direct shipping underground chromite mine. Given these positive developments and the cheap stock price relative to my late February recommendation, I am confirming that the bottom-fish recommendation remains a Spec Cycle Hold 100%, and the Good Absolute Spec Value Buy remains valid at $0.25.

New Bottom-Fish Highs
Volume High Low Close Chg Status
Tawsho Mining Inc (TAW-V) 1,885,600 $0.500 $0.145 $0.490 $0.355 New BF LP Buy $0.10-$0.19

Top 10 Bottom-Fish Volume Traders
Volume High Low Close Chg Status
B2Gold Corp (BTO-T) 23,700,500 $4.030 $2.860 $3.740 $0.790 BF TP Buy $0.30-$0.49
IBC Advanced Alloys Corp (IB-V) 15,072,900 $0.230 $0.140 $0.210 $0.040 New BF LP Buy $0.10-$0.19
Champion Minerals Inc (CHM-T) 10,727,300 $1.270 $1.050 $1.200 ($0.070) BF MP Buy $0.30-$0.49
Avalon Rare Metals Inc (AVL-T)
10,625,600 $4.830 $3.610 $4.060 ($0.190) Good Absolute Spec Value Buy
Ucore Rare Metals Inc (UCU-V)
10,102,300 $0.850 $0.560 $0.710 $0.080 BF Spec Cycle Sell 25% Hold 75%
Realm Energy Intl Corp (RLM-V) 9,195,700 $1.020 $0.700 $0.890 $0.000 BF MP Buy $0.30-$0.49
Nevsun Resources Ltd (NSU-T) 7,957,300 $6.990 $4.840 $6.390 $1.240 BF Spec Cycle Hold 100%
Torex Gold Resources Inc (TXG-T) 7,483,300 $2.020 $1.650 $1.710 ($0.050) BF Spec Cycle Hold 100%
Mega Precious Metals Inc (MGP-V) 6,338,700 $0.930 $0.650 $0.770 $0.090 BF LP Buy $0.10-$0.19
Benton Resources Corp (BTC-V) 5,957,600 $0.590 $0.290 $0.300 ($0.290) BF MP Buy $0.10-$0.19

Top 10 Bottom-Fish Value Traders
Value High Low Close Chg Status
B2Gold Corp (BTO-T) $84,572,560 $4.030 $2.860 $3.740 $0.790 BF TP Buy $0.30-$0.49
Nevsun Resources Ltd (NSU-T) $49,018,934 $6.990 $4.840 $6.390 $1.240 BF Spec Cycle Hold 100%
Avalon Rare Metals Inc (AVL-T)
$44,584,212 $4.830 $3.610 $4.060 ($0.190) Good Absolute Spec Value Buy
Sabina Gold & Silver Corp (SBB-T) $26,361,286 $5.100 $4.070 $4.870 ($0.070) BF TP Buy $0.30-$0.49
Rare Element Resources Ltd (RES-T)
$14,718,005 $9.950 $7.280 $8.170 ($0.650) Good Relative Spec Value Buy
Torex Gold Resources Inc (TXG-T) $13,612,012 $2.020 $1.650 $1.710 ($0.050) BF Spec Cycle Hold 100%
Orko Silver Corp (OK-V) $13,540,727 $2.810 $2.210 $2.470 ($0.060) BF TP Buy $0.30-$0.49
Champion Minerals Inc (CHM-T) $12,461,282 $1.270 $1.050 $1.200 ($0.070) BF MP Buy $0.30-$0.49
Quest Rare Minerals Ltd (QRM-V)
$11,778,503 $4.890 $3.720 $4.170 ($0.080) Good Relative Spec Value Buy
Lydian International Ltd (LYD-T) $10,366,427 $2.550 $1.780 $2.350 $0.190 BF MP Buy $0.20-$0.29

Top 10 Bottom-Fish Price Gainers
Volume High Low Close Chg Status
Nevsun Resources Ltd (NSU-T) 7,957,300 $6.990 $4.840 $6.390 $1.240 BF Spec Cycle Hold 100%
B2Gold Corp (BTO-T) 23,700,500 $4.030 $2.860 $3.740 $0.790 BF TP Buy $0.30-$0.49
Tawsho Mining Inc (TAW-V) 1,885,600 $0.500 $0.145 $0.490 $0.355 New BF LP Buy $0.10-$0.19
Golden Queen Mining Co Ltd (GQM-T) 1,586,400 $3.100 $2.570 $2.920 $0.270 BF MP Buy $0.30-$0.49
Karmin Exploration Inc (KAR-V) 347,500 $0.500 $0.270 $0.500 $0.200 New BF LP Buy $0.30-$0.49
Impact Silver Corp (IPT-V) 1,759,000 $2.260 $1.790 $2.100 $0.190 BF MP Buy $0.30-$0.49
Zazu Metals Corp (ZAZ-T) 1,418,200 $1.300 $0.850 $1.250 $0.190 BF XP Buy below $0.10
Lydian International Ltd (LYD-T) 4,667,600 $2.550 $1.780 $2.350 $0.190 BF MP Buy $0.20-$0.29
Inca Pacific Resources Inc (IPR-V) 5,684,600 $0.350 $0.150 $0.340 $0.180 New BF LP Buy $0.10-$0.19
Avnel Gold Mining Ltd (AVK-T) 819,400 $0.590 $0.395 $0.550 $0.125 New BF MP Buy $0.10-$0.19

Top 10 Bottom-Fish Price Percentage Gainers
Volume High Low Close Chg Status
Tawsho Mining Inc (TAW-V) 1,885,600 $0.500 $0.145 $0.490 263% New BF LP Buy $0.10-$0.19
Inca Pacific Resources Inc (IPR-V) 5,684,600 $0.350 $0.150 $0.340 113% New BF LP Buy $0.10-$0.19
Karmin Exploration Inc (KAR-V) 347,500 $0.500 $0.270 $0.500 67% New BF LP Buy $0.30-$0.49
Geodex Minerals Ltd (GXM-V) 2,565,500 $0.200 $0.115 $0.200 38% BF MP Buy $0.10-$0.19
White Tiger Mining Corp (WTC-V) 362,700 $0.260 $0.190 $0.250 35% New BF MP Buy $0.20-$0.29
Avnel Gold Mining Ltd (AVK-T) 819,400 $0.590 $0.395 $0.550 29% New BF MP Buy $0.10-$0.19
B2Gold Corp (BTO-T) 23,700,500 $4.030 $2.860 $3.740 27% BF TP Buy $0.30-$0.49
Cariboo Rose Resources Ltd (CRB-V) 62,500 $0.430 $0.310 $0.390 26% New BF LP Buy $0.10-$0.19
Nevsun Resources Ltd (NSU-T) 7,957,300 $6.990 $4.840 $6.390 24% BF Spec Cycle Hold 100%
IBC Advanced Alloys Corp (IB-V) 15,072,900 $0.230 $0.140 $0.210 24% New BF LP Buy $0.10-$0.19

Top 10 Bottom-Fish Price Losers
Volume High Low Close Chg Status
Rare Element Resources Ltd (RES-T)
1,744,600 $9.950 $7.280 $8.170 ($0.650) Good Relative Spec Value Buy
Strategic Metals Ltd (SMD-V) 2,661,800 $3.080 $2.360 $2.510 ($0.490) BF MP Buy $0.10-$0.19
Peregrine Diamonds Ltd (PGD-T)
1,665,000 $1.740 $1.480 $1.550 ($0.300) Good Absolute Spec Value Buy
Benton Resources Corp (BTC-V) 5,957,600 $0.590 $0.290 $0.300 ($0.290) BF MP Buy $0.10-$0.19
Uranerz Energy Corp (URZ-T) 721,900 $2.560 $1.990 $2.150 ($0.230) BF MP Buy $0.50-$0.75
Verde Potash PLC (NPK-V)
657,200 $7.240 $5.870 $6.500 ($0.200) Good Absolute Spec Value Buy
Avalon Rare Metals Inc (AVL-T)
10,625,600 $4.830 $3.610 $4.060 ($0.190) Good Absolute Spec Value Buy
South American Silver Corp (SAC-T) 2,244,900 $1.920 $1.580 $1.710 ($0.160) BF TP Buy $0.10-$0.19
Corona Gold Corp (CRG-T) 359,200 $0.980 $0.800 $0.810 ($0.160) BF TP Buy $0.30-$0.49
Lion One Metals Ltd (LIO-V) 599,500 $1.250 $1.060 $1.090 ($0.160) New BF LP Buy $0.30-$0.49

Top 10 Bottom-Fish Price Percentage Losers
Volume High Low Close Chg Status
Benton Resources Corp (BTC-V) 5,957,600 $0.590 $0.290 $0.300 -49% BF MP Buy $0.10-$0.19
Laurentian Goldfields Ltd (LGF-V) 1,346,700 $0.220 $0.125 $0.125 -31% New BF MP Buy $0.10-$0.19
EMC Metals Corp (EMC-T) 1,925,900 $0.170 $0.125 $0.125 -24% New BF TP Buy $0.10-$0.19
INV Metals Inc (INV-T) 519,600 $0.400 $0.300 $0.305 -24% BF MP Buy $0.10-$0.19
Wolverine Minerals Corp (WLV-V) 1,280,400 $0.580 $0.380 $0.415 -23% New BF LP Buy $0.10-$0.19
Planet Exploration Inc (PXI-V) 231,500 $0.225 $0.180 $0.190 -21% BF MP Buy $0.10-$0.19
Northern Superior Resources Inc (SUP-V) 3,021,300 $0.390 $0.230 $0.250 -19% BF XP Buy below $0.10
NMC Resource Corp (NRC-V) 83,000 $0.600 $0.450 $0.450 -18% New BF MP Buy $1.01-$1.25
Amanta Resources Ltd (AMH-V) 2,175,900 $0.080 $0.040 $0.045 -18% BF XP Buy below $0.10
Harvest Gold Corp (HVG-V) 2,070,000 $0.055 $0.040 $0.045 -18% BF XP Buy below $0.10

New Bottom-Fish Lows
Volume High Low Close Chg Status
Prima Colombia Hardwood Inc (PCT-V) 2,593,900 $0.090 $0.075 $0.080 ($0.010) BF XP Buy below $0.10
Virginia Energy Resources Inc (VAE-V) 1,335,700 $0.175 $0.140 $0.155 ($0.010) New BF LP Buy $0.30-$0.49


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