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Peerless Gold Mining Stocks

Introducing Tom Szabo's Peerless system for picking gold mining stocks...
TOM SZABO is co-chief analyst of Metal Augmentor, an investment research service focused on metals and mining. Szabo has co-founded several precious metal related businesses and investment funds.
Tom Szabo does not believe that you can judge all gold mining companies the same. In this interview with The Gold Report, Szabo uses the Peerless concept to rank companies qualitatively, but dynamically as their circumstances change.
The Gold Report: In a July gold mining research report, you wrote that the ongoing decline from the all-time high in the gold price may represent a correction of the last large up leg, which some say began in 2009 or mid-2008. Or it may represent a correction of the entire 1999-2011 advance in the gold price. Which is it? And has that correction run its course?
Tom Szabo: We are in a correction of the 2008-2011 rally and it is ongoing. Big picture, the gold price needs to drop below $1155 per ounce and then subsequently below $1067 per ounce before this would represent a correction of the entire gold cycle that goes back to 1999. We haven't seen such a decline at this point so we can't conclude that it's a larger correction.
TGR: We've seen modest upward momentum in the gold price since the lows of April. Is there enough momentum to invest in gold mining equities?
Tom Szabo: There are smaller cycles within a correction. So long as investors select the right gold equities they can do well. A lot of projects are viable at this gold price. A lot of discoveries are going to become mines at this gold price.
TGR: What's your near- and mid-term forecast for silver and gold prices?
Tom Szabo: I suspect we will see a secondary low for gold, perhaps near the low that we reached this past summer, before this entire corrective wave is over. Potential lows are $1155 per ounce and $1067 per ounce. Longer term, about three years or less, I suspect that gold will again challenge its 2011 high.
TGR: Is silver going to follow suit?
Tom Szabo: Silver will follow gold, especially during the initial phase of a rally. As a rally progresses, silver has the distinct ability to overshoot expectations. I easily see it exceeding $50 per ounce and spiking to a $70-80 per ounce level before settling to a low in the $30-40 per ounce range.
TGR: What is the sweet spot right now: explorers, developers or producers?
Tom Szabo: In this market, it has to be about growth, which is a concept that can be applied to all of those categories. Explorers make discoveries and grow the resource. Developers grow by taking a project into operation. Producers grow by adding capacity, upgrading or bringing additional projects into development.
TGR: uses the Peerless system to rank the quality of companies. How does that system work?
Tom Szabo: The Peerless system is a subjective determination that is based on quality. We consider the factors that point to the success of a silver or gold mining enterprise. Success can be measured in different ways and means different things depending on the development stage of a company and its projects. We use different criteria for an explorer versus a producer versus a developer.
It is also a binary rating where a company is either peerless or not. We don't rank a level of peerlessness, although we do keep track of potential peerless candidates that don't quite have all of the pieces together yet.
We keep our eyes on prospective peerless companies as they develop because we think they could have it in them to be successful. These are generally more risky, have some blemish or perhaps a past history that doesn't scream quality or the highest level of investor confidence. Nonetheless, we think they could be on a path to becoming peerless.
TGR: Some companies begin prospecting with a program of community engagement to let the locals know their intentions and potential outcomes. Other companies prefer to avoid this and just get down to business. Is there any evidence that suggests investors are better served by one approach versus the other?
Tom Szabo: We've looked at why companies fail to develop or continue on to development and one of the things that comes up is local stakeholder resistance. There are some cases where a company simply will not be able to mine in a particular area. There's so much resistance to mining that it's not going to happen. But in most areas, if a company faces a lot of resistance or has really strong opponents, it's often because the company has not properly addressed the opposition.
TGR: What do you make of companies that are "high-grading", which is mining the highest grade zones early on to pay back debt or get early profits?
Tom Szabo: High-grading is just a way to pick the low-hanging fruit. Historically, where mining was very labor intensive, it was usually the only way to mine profitably. In modern mining, to attempt to recover the initial cost of the mine or pay off the project loan quickly, it's almost necessary. I don't find it very controversial.
What's controversial is high-grading based on the metal price, which I actually think has some merit. Companies should high-grade when prices are near historic lows and highs. When prices are stable, they should mine the design grade.
The reasoning is pretty obvious and simple. When prices are high, deliver as much metal through the plant as possible in order to build up your cash position. When prices are really low there's usually no other option. If a company doesn't go after the highest grades or the most prospective portion of the mine, it may have to shut down.
An extension to that, for example, would also be locking in a price spike via short-term hedging. When silver prices momentarily reached $50 per ounce, it would have served the silver producers very well to lock in the price on a quarter or two of production yet none of them did that. They could have generated millions in additional cash flow with minimal risk.
TGR: Could you leave our readers with a tidbit of insight that could serve them well this autumn?
Tom Szabo: I would caution your readers to be aware of where we are in the market cycle and what type of companies they want to own and why. In a situation where not all boats are rising, only a select few are going to succeed. In this environment, investors need to have some growth stories. I don't think investors are going to be well served for the time being by simply investing in companies that are sitting on huge low-grade deposits but aren't doing anything to expand their potential, increase production or acquire projects to grow. There may be times when the companies with the biggest resource are the ones to own, but not now. Investors have to match strategy with the market reality.
Investors should also be aware of what stage the company is in. Unless investors are going to own an explorer from the first drill hole to production, there are factors investors probably don't need to worry much about early on. An investor should care about the factors that the market cares about while the investor owns the stock. This is pretty controversial and I suspect many investment professionals would have a problem with such a cynical approach.
Conversely, I think most retail investors will probably say, "No, this is too hard to do. You should really just look at the big picture." From my perspective, that shuts investors off from a lot of great opportunities (and exposes them to a few lousy ones). If investors are able to segment the holding period of their portfolios and match positions to a specific investment thesis, they can increase their odds of success.
TGR: Thanks for your time today, Tom.

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