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Should investors lower their expectations...?

THINGS ARE upside down in the gold market. Valuations are irrationally low, while global consumerism fuels demand and supply comes up short. Lawrence Roulston, editor and publisher of Resource Opportunities, advises people to trust their guts as well as the numbers when weeding through prospective investments. In this interview with The Gold Report, he skirts around conspiracy theories regarding the recent gold sell-off and keeps his advice simple: lower expectations, get rid of poorly performing investments and load up on the companies going cheap. If you push against the trend, you might come out with your feet on the ground.

The Gold Report: In a recent edition of Resource Opportunities, you wrote, "This time is different from every previous bust." How so?

Lawrence Roulston: Some people described the late 1990s as a nuclear winter of the mining industry. Demand for metals was low, and a lot of new production had come onstream. Copper was trading at the lowest price ever in real terms. Today, we don't have that surplus. We have serious constraints on supply at a time when demand for metals is increasing. Half the planet's population is undergoing a process of modernization and industrialization. Billions of people are becoming consumers, buying cellphones and looking at refrigerators, cars and every other consumer product.

TGR: Does that include gold? It doesn't have an industrial purpose per se, and we saw a massive sell-off in gold mid-April.

Lawrence Roulston: Yes. The selling came largely from the exchange-traded funds (ETFs) and was triggered by the short signals from a couple of the big New York brokerage firms. The ETFs were being sold on a panic level, but buyers around the world were literally lining up to buy physical gold. The price has already stabilized.

TGR: Are you saying you don't expect further weakness in the gold price between now and fall 2013?

Lawrence Roulston: There will be a lot of short-term volatility. But people's desire to own gold on the physical level is not going away, whether people are buying gold jewelry in China or India or Europe or buying bars and coins—gold will act as a safe haven, as a currency hedge.

There will probably be further events such as what recently happened. I don't want to get into the whole conspiracy theory, but it seems clear that the brokerage firms involved in this had a phenomenal short position before making the calls to short gold. It was extremely profitable for them. If they've done it once, they're likely to do it again.

TGR: Anybody who's still in this space has lost money. Investors in the junior mining space want to know what the path is to making money again.

Lawrence Roulston: The shortest path is to own a company just before it announces a big new discovery.  My approach is to look at companies that have a real asset and are advancing it toward production. They'll either take it into production or will be taken over by a company that will. Maybe you won't get 10, 20 or 30 times returns, but there is a much higher probability of achieving a double, a triple or even a tenfold return than if you bet on an exploration discovery. I admit my approach hasn't worked so well over the past year, but I'm still totally committed to it.

TGR: Should investors lower their expectations?

Lawrence Roulston: You always have to ask: Is it just a greater fool theory? Who's going to buy these off you at two or three times? You can seek out a 30 to 50 times return, and if you're successful, it's pretty exciting. But lots of opportunities exist in this market if you're OK with two, three, four or ten times return over two, three or four years. There's a huge level of interest from the sophisticated money managers. Sovereign wealth funds, mining companies in every part of the world and private equity are all looking at the prices in the market right now and salivating.

TGR: Many people reading this might think, "Lawrence Roulston has been in this space for a long time and knows it better than most people do. Jeepers, if he's losing money, then there's no point." What would you say to them?

Lawrence Roulston: Let me put the current valuations into perspective: I've never seen anything like this in the over 30 years I've been in the business. The valuations are irrational. Companies are trading at discounts to cash, some at one-third of the value of cash in the bank. There are companies with multimillion ounce gold deposits trading at just slightly over the value of cash in the bank and, in some cases, even less than the value of cash in the bank. You could buy cash at a discount and get a gold deposit or a copper deposit thrown in for free. The profit potential is enormous for anybody who has cash and is coming into the market now.

TGR: How can investors figure out which companies have high investment potential and which are more likely to fail?

Lawrence Roulston: One simple test is whether the company has any cash. If it doesn't, the company is forced to raise cash in this market to survive. Many companies with no cash and mediocre projects effectively have no value, in my opinion. For some, fundraising will be so dilutive, it's hard to imagine a path back.

TGR: Cash is a vague term. What does it mean to you?

Lawrence Roulston: A number of companies have a few hundred thousand Dollars in the bank and are conserving cash—paying rent and salaries and not doing much else. But if that's all they're doing, they're going to burn through that money. If a company is going to add shareholder value, it needs to do something on the ground, physical work that will build value. It's hard to imagine a meaningful exploration program unless it has more than $1 million in the bank.

TGR: In the past few weeks, several majors have been publicizing the purchasing of significant stakes in other companies. These types of transactions used to be done more quietly. What are they trying to achieve with this strategy?

Lawrence Roulston: It's great that the majors are bringing attention to these alliances. More and more, the majors are relying on the juniors as their exploration departments. When the juniors convince the majors to put in hard cash like that, they pass a number of due diligence steps to display competence to spend the money wisely.

TGR: Have the majors done the due diligence for the average investor by investing in these companies? Would investors be wise to follow?

Lawrence Roulston: It implies that the major believes that the exploration team in the junior will spend its money wisely, but it's not to say that it is more likely to come up with success.

TGR: In a recent edition of Resource Opportunities, you wrote, "The good companies have been sold off along with the lesser quality companies, creating unprecedented opportunities for investors who can differentiate the worthwhile companies from the rest of the pack." What sets these companies apart in this market environment?

Lawrence Roulston: The most important differentiator is the management team. A lot of people focus on management or exploration teams that have been successful in the past, and that's valid. But I focus on finding the young people who are just coming up and who will be seen next year as the great success stories.

TGR: That's tougher, isn't it? That's similar to betting on the junior companies without any information.

Lawrence Roulston: In my position, I'm living and breathing this stuff. I spend a lot of time interacting with many of these management groups, and I can get a sense of which are likely to be the next successful ones.

TGR: Any up-and-comers?

Lawrence Roulston: Revolution has strong geological talent and has had some successes in the past.

TGR: On an entry point, is it best to invest just before a resource estimate, a preliminary economic assessment, a prefeasibility study or a feasibility study comes out? Which one offers the most potential?

Lawrence Roulston: In a normal market, all of them would have an impact. Over the past year and perhaps going forward, I'm not sure any would have a big effect. It depends on when the report comes out and if it exceeds or falls short of the expectations. Over the past few years, they have generally fallen short on the size of resource and capital expenditures have been far higher than expectations.

TGR: Which analysts covering this sector do you follow?

Lawrence Roulston: The Haywood Securities team is really good. Many analysts tend to be numbers focused, and their work largely involves computer modeling and pricing projections. Few get really involved in the more subjective side of the evaluations. That's an area where I'm different from a lot of the analysts. The early stages of my career were doing detailed financial modeling, and I've since developed a more subjective approach.

TGR: You need objective numbers but also some room to factor in subjective criteria, like management and jurisdiction, right?

Lawrence Roulston: That's exactly the path to success. You want a number set as a starting point that you can layer on. A lot of analysts miss out in that they're not willing to stick out their necks on more subjective appraisals.

TGR: About 70% of the junior mining space is gold mining, but which commodities do you remain bullish on?

Lawrence Roulston: I'm almost agnostic with respect to the commodity. When I do analysis, I don't factor in higher prices on anything. It has to make sense at or below the current levels with a rise representing a windfall gain. Investor sentiment is important. A lot of times I look at a project, like a tin project, and see something interesting from a technical perspective. Then I think, who the hell is ever going to pay attention to a tin project?

Another example is zinc. Looking out two to four years into the future, the fundamentals for the zinc market are very strong, yet investors won't touch zinc with a 10-foot pole. Many of the silver deposits are really zinc deposits with a silver byproduct.  

TGR: What will be your fundamental message to people at the upcoming conferences where you're speaking?

Lawrence Roulston: My fundamental message will be that there are some extraordinary bargains to be had in this market when share prices have been beaten up as badly as they have been, but it's more important than ever before to be selective. A large number of companies are still grossly overvalued, but other companies are trading at irrationally low levels. So take the time; do the due diligence. Find the companies that are trading at very low prices relative to the asset values and load up on them.

TGR: Why else should investors stay positive?

Lawrence Roulston: Some companies are going to double, triple or more in value over the next 12 months. If you can go counter to the popular thinking and come into the market at the bottom and ride it up, then your potential gains are enormous.

TGR: But what should people do if they have a portfolio of underperformers?

Lawrence Roulston: They need to bite the bullet and sell many of the companies they hold. They need to take a good, hard look at everything they own and make a decision on whether that company has near-term growth potential. I know it's painful to sell something at a loss. But if the price is down, you have lost money. You need to get whatever cash back you can and deploy it into things that have better, near-term growth prospects.

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