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Why "Optionality" is Key to Gold Mining Success

How companies stay sustainable...

A COMPANY'S "optionality"—the condition of having choices—signals its chances of success according to Dr. Michael Berry. In this interview with The Gold Report, Berry, the editor of Morning Notes and discoveryinvesting.com, talks about optionality and sustainability in a market stuck in the mire.

The Gold Report: Dr. Berry, the market for junior mining stories is confusing and unpredictable. You have a Ph.D. in investment theory and decades of experience. Can you explain to our readers why precious metals equities are underperforming the benchmark indexes?

Michael Berry: As you know, market cycles are sometimes long. Right now, the junior market is in a risk-off mode. There probably is no other class of stock as risky as junior mining stocks.

In addition, most juniors do a poor job of managing their sustainability, of getting enough money in the treasury and making it work for them. Consequently, they run out of capital. This situation is likely to last for another year or two.

TGR: Despite being in a risk-off market, is money coming back into the market as a whole?

Michael Berry: There is a lot of money on the sidelines, but significant problems remain in the market. What cash is returning to the market is not finding its way into the juniors.

Advisers suggest buying large caps and dividend payers and so forth. Gold is still cheap at over $1,600/ounce ($1,600/oz). The Dollar got a little bit stronger recently and gold, in Dollars, took another tumble. But I cannot believe the Dollar will continue to strengthen. When the Dollar falls, gold will go up.

TGR: Over the course of 2012, the gold price increased by 6.2%. Should we expect similar performance in 2013?

Michael Berry: I would think so. I expect both gold and silver to appreciate this year. However, there is a disconnect between commodity prices and share prices, especially in the exploration space.

TGR: Do you see any meaningful rebound in the mining sector in 2013?

Michael Berry: That is a tough question to answer. Last month at the Vancouver Cambridge House Symposium, I sensed that we may be at a bottom, but we may stay there for quite a while.

You have to buy into these market bottoms. Look for companies that can sustain themselves. If you can put together a few good companies now, good defined by our 10 discovery factors, and hold them, one or two years is a likely timeframe for a rebound.

TGR: So, the rebound may lift select stories?

Michael Berry: Yes, and that relates to the discovery hypothesis.

Some junior mining stocks are trading for pennies. I have a friend, a fund manager, who buys these stocks. He says that the stock prices in his mining portfolio do not add up to a Dollar because the prices are so low. That is true across the market.

We use the Discovery Investing Scoreboard. Through the end of January, the top decile of junior miners, as selected independently by the Crowd, was down 16% over the past four months. The worst stocks, those in decile 10, were down 30%. Almost all of the juniors have been taken out to the woodshed.

TGR: At the Cambridge House Conference your presentation was entitled, "The Leavening of the American Quality of Life." Among other things, you discussed the impact on global investors of raising America's debt ceiling. What do investors need to know from that presentation?

Michael Berry: Bottom line, increased taxes in the US will affect business. There will be very low growth in gross domestic product, maybe even negative growth. We might even have another recession. There will be a wealth transfer from one segment of the economy, the president's top 1%, to another. There will be more government intervention in the marketplace.

TGR: Will we see a double-dip recession?

Michael Berry: I think that is likely. The Federal Reserve Bank is spending $85 billion ($85B) a month buying up paper. That is not working. Officially, we have 7.9% unemployment, but it is actually much higher, and underemployment is higher still. We have headwinds in student loan default possibility. Housing seems to be turning up a bit.

TGR: Do you pay much attention to the Dollar Index?

Michael Berry: Absolutely. Every country is devaluing its currency and trying to inflate its way out. The US will do it too.

It is very appropriate to follow the Dollar, because as the Dollar weakens, a lot of commodities—which are priced in Dollars—will have to go up in value. You can see it in copper already due to increased demand. Analysts are talking about $4/pound copper now.

TGR: The Dollar Index is roughly at 80 right now. In 2011, it dipped below 75. Could we return to that by the end of 2013?

Michael Berry: Yes, I think we could. Keep in mind that we are in the beginning of a mercantilist war being fought in the currency markets. The US is not going to promote a strong Dollar. Currency strength is always relative in a dirty float world. Washington wants to see the Dollar fall relative to the basket of other currencies. You cannot print this much money without having an impact on the value of the currency. I think we could see 75 again.

TGR: Despite a string of dismal responses to my questions so far, generally speaking you are an upbeat guy. Can you give us a few positive thoughts or themes?

Michael Berry: Overall, I am positive. I am not happy with what is happening in the US, but that is a political issue and I only have one vote.

Globally speaking, there is a convergence of lifestyles. I, and many others, have written about this concept of lifestyle convergence at length. I have called it a quality of life secular trend. I think this convergence is very positive.

However, the US might not lead that convergence. In Vancouver, I talked about the leavening or the regression of the quality of life in the US. In the emerging countries—with a combined population of 6B people—the quality of life will improve. As the quality of life improves, infrastructure is built out. You need more and better food, potable water, fertilizer, metals and energy.

The US and the Western countries will not lead us out of this mess; it will be the tremendous growth in quality of life in the rest of the world. Hand in hand within the next decade the Dollar must lose its reserve currency status.

TGR: In a recent edition of Morning Notes, you wrote, "After studying the junior markets and brainstorming strategies to generate returns, we have come to believe in the theme of optionality." What is optionality?

Michael Berry: Basically, optionality is about a company having choices, or options. Most companies do have choices. Options should always convey value to shareholders. The trick is to pick the companies that have multiple, good choices and know how and when to exercise their options.

TGR: Many of the companies you write about operate in Nevada, some in Mexico. 

Michael Berry:  There are a lot of discoveries in the goldfields of Nevada and many more junior gold explorers are setting up operations. Nevada has a great mining culture and geology. I prefer a good property in Nevada as opposed to Mali or South Africa.

These are the companies that will pop back first. If we get any move in gold, exploration plays in Nevada will revert in price first. They are very cheap right now. I could probably name 20 of them. 

TGR: Will stories get a bump now that copper demand is ticking up?

Michael Berry:  No company gets a bump unless it has good investor relations. One of our 10 factors for the Discovery Scoreboard is how a company presents itself to the market. Does the company explain its optionality? I think a lot depends upon on how active a company is and how good it is at dealing with the market.

TGR: Do you have any parting thoughts?

Michael Berry:  There is a lot more action now in Mexico, Nevada, even British Columbia. The money has to start to flow; when that happens, these companies will really take off in the capital markets.

It is important to analyze companies to understand their degree of sustainability. It is difficult to be a contrarian, but this is the time and this is the market where a good contrarian strategy will generate tremendous wealth over the next couple of years. In other words, buy and hold.

TGR: Dr. Berry, thanks for your time and your insights.

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