Brent Cook: Industrial Revolution Redux

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May 18, 2011 1:38pm NYSE:AGQ NYSE:GDX

Mike Norman (Norman): Hi everybody, and welcome to I’m Mike Norman, your host. Well, what’s up with silver? Or should I say, what’s down with silver? In any

 case, lots of volatility recently. Here to talk about silver and other metals markets is my guest Brent Cook, who is the editor of Exploration Insights. Brent, thank you very much for coming on the program.

Brent Cook, editor, Exploration Insights (Cook): Glad to be here in New York.

Norman: So, crazy volatility in the silver market recently, going up to an all time high above–just marginally above–$50. Big, big price drop, about 35 percent. We know a lot of small investors got involved in silver. It’s often called “the poor man’s gold.” What’s your outlook

Cook: I tend to look at silver in the longer term, and value it in a relationship to gold. And generally there’s about a 60-to-1 ratio between gold and silver. And if you use a 60-to-1 ratio at a gold price of $1,500, we’re looking at silver price of $25-$30. And that’s sort of the number I use in my economic evaluations of mineral properties and such. It’s a great price right now.

Norman: But that’s a price based on sort of a scientific analysis of where the price should be. But do you think we’re dealing with an aspect of the market, or an element of the marketplace which is maybe not so scientific? And I’m talking about just investors having access to a very easy way to buy silver through ETFs. Does that distort it?

Cook: I think that’s what we saw when it jumped up to $50. It was a bubble for sure, a parabolic rise like that … rarely does something stay up like that. Again, I think you track it, the price where it’s been going and where it’s headed, and we’re looking $25-$30 over the next few years.

Norman: Could it stabilize in that price range, you think?

Cook: I think it will. And if gold jumps to $5,000—I’m not saying it will—then we’ve got to revalue silver as well.

Norman: You mentioned gold. Gold is also influenced by many of the same factors. You have the gold ETFs that allow people … and now these ETFs hold a lot of gold.

Cook: Well, I view gold as true money. As opposed to silver, which, as you say, is the poor man’s gold. And everything I see in the macroeconomic picture for the U.S., Europe and the world, inflation, the whole line on gold, I think it’s much more likely to go up than down. I’m not going to say how much. But I think by the end of 2011 we could be looking at $1,600, $1,700.

Norman: But if you look, for example, at gold production, and if you look at gold consumption by the traditional users, let’s say, the jewelry industry—which still to this day is the largest consumer of gold, of physical gold—that is a huge divergence in that picture. I mean, production is going up, physical demand from the jewelry industry is going down. Investors have been replacing that demand. They’re just buying it and hoping that somebody else is going to buy it at a higher price.

Cook: And betting on the U.S. dollar continuing to go down. And that’s an interesting point, production is going up. It’s not going up that much. Since 2000, the gold production has actually come down except in the past years, it started to rise a bit. But the problem we face—and this is what’s really important in what I do in my newsletter—is we’re producing on the order of 80 million ounces a year globally. That means we’ve got to find, develop, permit an 80 million ounce gold deposit every year just to stay even.

So it’s getting harder and harder to find those deposits. And for the very few junior companies that can find those deposits, we’re going to see 10-hundredfold increases in their share price.

Norman: That’s a fantastic return. But it’s based on, again, this sustained rising trend in gold. You said that the dollar’s continuing to go down, but yet, if you look at the dollar index, the one that’s the most widely followed index—which is a narrow index put out by the Fed—you know that dollar index is still above the low that we saw in 2008. So it hasn’t made a new low. I think it got down to 70. I think now it’s around 74 or 73, something like that. Yet gold has jumped above the highs that we saw in 2008.

Is there a little irrational exuberance in there? And by the way, if you look at a broader index of the dollar—which the Fed also publishes, which happens to include some minor countries that we trade with such as China and Taiwan and Korea and Singapore and Brazil and Saudi Arabia—that dollar index is not down very much. So I mean, the argument that the dollar is collapsing, it’s specious, I think, if you really look at the facts.

Cook: I would agree with you. But to me, the gold price is the ultimate value of the dollar. Since gold is priced in dollars, with increasing gold prices, they’re reciprocal; that is, the U.S. dollar price is actually decreasing our purchasing power, globally.

Norman: So you’re viewing this that it will be a sustained trend even—let’s say, what if the U.S. now looks for our new direction in policy to impose austerity on ourselves. Wouldn’t that be something that a) could be bullish for the dollar, and b) could be potentially deflationary? What about an environment where you have deflation?

Cook: That’s probably not good for gold. You’re definitely right. And likewise, if we start raising the fund rate, the Fed Fund Rate, that’s not a positive sign for gold. And you make a good point. Come June, July, when QE2 ends, something’s got to change. And it may be dollar-positive. And the U.S. economy slowly is improving.

Norman: It is improving. And especially vis-à-vis other economies, especially in Europe. I mean, we’re not looking all that bad. But it seems like investors really see a different picture. I think they’re seeing the picture that you see as well.

Let’s talk a little bit about some of the other metals. What about some of the base metals; for example, copper? So a big run-up in copper. Some hesitation now. Maybe some concerns like cooling of economic growth in China, a cooling of economic growth really worldwide, like you see in Europe. And then again the argument here, that we saw first- quarter GDP come down significantly from the fourth quarter of 2010.

Cook: Well, global copper demand has generally been increasing historically at about 3 or 4 percent per year. That represents 18 million tons of new copper coming into the market. So I also think that we’re going to see a cool-down in the global economy, and a slowdown in metal consumption.

But that doesn’t alleviate the problem we face in that we are not finding enough deposits to replace what we’re mining. So that to me says that the metal price … I don’t know if it’s going to stay at $4.50 or $4; we’re at a high level and it’s going to say high regardless of the global economy, looking out two, three, four, five years.

Norman: There’s also a push towards alternatives, greater efficiencies, and the demand destruction that occurs when prices reach a certain level. Is that coming into the picture now in any way?

Cook: Where possible, people are certainly replacing or substituting some metal or plastic of something for copper. And we’re seeing that with fiber optics, instead of copper wire and that sort of thing. And that’s happening. But it’s still looking at China, Asia, etc., India; their demand is taking off the slack that substitution would have caused.

Norman: And this is going to be a factor that will continue.

Cook: I think so.

Norman: These are growing economies.

Cook: We’re looking at the Industrial Revolution again.

Norman: That’s right. But also in the Industrial Revolution, we were running out of … I mean, up until the beginning of the 20th century, for example, whale oil was a very widespread utilized heating fuel. It was an industrial fuel. We were running out of that too, but we found substitutes as well.

Now, in your newsletter you mention small micro-cap mining companies. Are they mostly in Canada? Are they spread around the world?

Cook: Most of the companies are based in Canada on the Canadian Stock Exchange. But their projects are global in nature. Just last month I was in Colombia, Ethiopia, Nevada and Canada looking at projects. And I look at projects, evaluate them, and report back in my newsletter what looks good and what doesn’t. We buy or sell based on that.

Norman: And I imagine that the whole mining thing is exploding—I mean, you see it on reality TV now. They have gold mining shows. There’s a new one that just came on called “Coal.” It reminds me a little bit of the whole dot-com phenomenon that we saw at the end of the 1990s. And we all know how that ended. You don’t see any parallels here?

Cook: No, I don’t, because I think we’re looking at a fundamental shift in how much metal we can actually produce and supply for the demand. It’s a fundamental shift. And it’s time sensitive in that you can’t tomorrow go out and say, “OK, we’re going to find and develop this deposit right here.” It takes five years to find and you prove it up. Another five years to permit it. And then another five years to get it built. And if you’re sitting in a country called Ecuador, Angola or something like that, you might not even get it built. It’s a real structural issue.

Norman: So for an investor, just to wrap it up, your advice would be to put some of your money into these assets in a diversified portfolio, and just hold them for the long term. Not think about really trading it, right?

Cook: No. It’s very high-risk money. These things are very volatile. Up or down, 50 percent in a week. I think for that high-risk money you want to invest though, you need to follow these things very closely, because data changes. Drill-holes change what a property looks like. Or the metallurgy comes in and it’s either better or worse than the anticipated. So you’ve really got to watch these things.

And in my portfolio in the newsletter—which is what I’m doing with my money—there’s only 16 stocks right now; there have never been more than 20. I think the key is to focus on the companies and projects that you know. And for me, if I know more than anybody else on those projects, I’m ahead of the game.

Norman: It’s like keep your eggs in one basket, but watch the basket very, very closely.

Cook: Precisely.

Norman: All right, Brent Cook; thank you very much. That’s it for now, folks. This is Mike Norman. I’ll see you next time.

Related Tickers:  SPDR Gold ETF (NYSE:GLD), Market Vectors Gold Miners ETF (NYSE:GDX), iShares COMEX Gold Trust (NYSE:IAU), Sprott Physical Silver Trust (NYSE:PSLV), ProShares Ultra Silver (NYSE:AGQ), ProShares UltraShort Silver (NYSE:ZSL), iShares Silver Trust (NYSE:SLV).

Written By Hard Assets Investor (HAI) is a research-oriented Web site devoted to sharing ideas about hard assets investing. The site has been developed as an educational resource for both individual and institutional investors interested in learning more about commodity equities, commodity futures and gold (the three major components of the hard assets marketplace). The site will focus on hard assets investing without endorsing or recommending any particular investment product.

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