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Seeking Value in Gold Mining Juniors

Why silver mining stocks could offer greater upside than gold miners...

FORMERLY at Sprott Resource Corp., Gold Mining analyst Matthew Zylstra is focused primarily on junior precious metals producers, says The Gold Report.

Working in the finance sector since 1999, Zylstra joined Northern Securities in 2010. Here he shares some strategies that can move portfolio values significantly upward.

The Gold Report: What lies ahead for Gold Prices?

Matthew Zylstra: We don't officially put out a Gold Price forecast, but I believe that the bullish environment, basically a perfect environment, will persist because of continued geopolitical friction, inflation and currency debasement concerns. I expect the spring and summer to be relatively choppy, but conservatively I believe the price of gold will rise above $1500 per ounce. by the end of 2011.

TGR: Is this fear of catastrophe, fear of inflation, a hedge against a weak US Dollar?

Matthew Zylstra: I think it's a number of factors. On the demand side China is emerging as a large Gold Mining producer, but it is also a consumer of gold. It's trailing India, but demand is exploding and China looks poised to become the largest consumer nation. From the demand side, things look very positive.

Driving this demand I believe is a growing mistrust of fiat currencies, which are subject to the whims of politicians, the threat of monetization and the possibility of a sovereign debt crisis. I think it's the worth of a Dollar that should be on trial, versus the value of gold. If you cut the value of a currency in half, you know everything gets adjusted in price. Right now in North America, people are generally content in trusting paper money in its various forms, but I think this could change, especially with rapid increases in things like food and energy prices – these are hard to ignore.

When might that change occur?

Matthew Zylstra: I don't expect it would be something immediate or sudden – but I think it is happening now. As investors become more concerned with monetization and rising inflation, and as yields on debt securities remain at record lows, I simply expect people will become more concerned with the erosion of purchasing power and will move away from paper assets to tangible assets as a store of value.

TGR: We have had a fairly peaceful revolution in Egypt and now one not so peaceful revolution in Libya. There's turmoil in Tunisia, and it looks like a domino effect in northern Africa. Now we're thinking of the Middle East, particularly Saudi Arabia, Kuwait and Jordan. With all that's been going on, we have seen gold move up only about 5% since the beginning of February. That's not a spike. Is that because gold is fully valued at this point, and that might be why it did not react to this unrest?

Matthew Zylstra: Market reaction to political events is not always immediate or what we may expect. There are a number of factors to consider that influence the Gold Price. People in countries with high political risk may decide to slowly move their investments to gold because it is perceived to be a safe investment, but it takes some time for people to decide what, in fact, a safe asset is. For example, is the US Dollar a safe asset? Are bonds a safe asset? I think people perceive fiat money as safe currently, but as they see their purchasing power erode while holding these "safe assets," some will change their view and put it into a tangible asset like gold or silver.

TGR: Could it be a bullish signal that people have not had the knee-jerk reflex to Buy Gold in reaction to the unrest in the Middle East and northern Africa?

Matthew Zylstra: Yes. If all investors felt that political unrest automatically leads to higher gold values, then gold would likely be much higher already and hence there would be less opportunity for appreciation. I feel there is considerable long-term upside to the Gold Price, and part of that upside is because of healthy skepticism about gold and silver as safe haven currencies. This skepticism provides opportunity for bullish investors – it's sort of a contrarian idea. What I mean is that if everyone was invested in an asset, there wouldn't be any upside left.

TGR: Do you have a forecast for silver?

Matthew Zylstra: Silver has really surprised me. I don't have a price target, but I think the same factors that are influencing gold are factors for the move in silver. In the silver market there is also a lot of talk of a very large short position on the Comex, so short covering could be a big factor. I have also read a lot about the difficulties in obtaining physical silver.

TGR: Do silver producers have more upside than Gold Mining producers?

Matthew Zylstra: Yes, I believe that silver producers do have more upside. With the current spot price of silver in the $33-36 per ounce. range – which we have not seen since the 1980s – and with typical silver cash costs for producers in the range of $5-10 per ounce., margins will be significantly higher for silver producers even if silver prices stay where they are, and certainly if they go higher. I also don't think the recent and very significant rise in silver has been factored into silver equities prices. But I don't focus so much on the silver producers. I do look at some of the silver exploration companies, and that's primarily due to valuation.

TGR: What about the valuation of silver exploration companies?

Matthew Zylstra: Silver exploration companies trade at much cheaper valuations based on ounces in the ground, about one-fifth on average. I just think that on an enterprise value to resource in the ground valuation, they are significantly cheaper than the producers, but of course there are number of factors that must be looked at, including management, characteristics of the deposit and infrastructure.

TGR: If commodity prices remain the same, can producers increase margins enough to satisfy investors?

Matthew Zylstra: Certainly. Gold and silver mining producers could increase margins in two areas. They could reduce cash costs by increasing the number of ounces they produce so that they are able to spread fixed costs over a greater amount of production. They could also improve efficiencies, for example, by increasing recoveries.

TGR: Matt, we've enjoyed talking with you very much.

Matthew Zylstra: Thank you very much, George.

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