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How to Be a Cautious Gold Mining Investor

Business goes on – as does investment...

BUSINESS goes on – even with all the turmoil around right now – says Louis James, chief metals and mining investment strategist at Casey Research and senior editor of Casey's International Speculator. Louis James regularly travels the world evaluating highly prospective geological targets and visiting explorers and producers getting to know their management teams.

In this interview with The Gold Report, Louis James discusses what he expects for the rest of 2011 and 2012. 

The Gold Report: You said that there were "warning signs" of a forthcoming correction in the Gold Price in the July issue of International Speculator. Given the last-minute compromise from the Democrats and the GOP to raise the debt ceiling in the US; incredible amounts of poor economic data coming into focus that could possibly point to a double-dip recession; and the Gold Price dramatically topped $1,800/ounce (oz.) this week, what should we expect next?

Louis James: We remain very bullish on precious metals. For years to come that's likely to be the case. There will be ups and downs along the way, though. When I said that, it seemed that the powers that be were making noises about ending quantitative easing. The figures seemed to suggest that the recovery was underway and that the government wouldn't need to be quite so destructive with its monetary policy to prop up the economy. 

With these things in mind, it seemed prudent, for the short term, to deploy your investments with a possibility of a correction in mind, because without more quantitative easing, commodities could take it on the chin. 

At the same time, we were saying that the long-term trend is very solid. If you see something that's a good value, play anyway. Don't stay out of the market because it could go lower. We are glad we did because the market did go the other way. In July, we saw gold appreciate quite a bit. 

The whole thing with this debt ceiling was really silly in many ways. We've seen so-called government shut-downs before. But, really, business goes on. If you pull back and look at the bigger patterns, the fundamentals for precious metals remain very strong in the face of truly economically suicidal behavior on the part of the world's governments. 

TGR: What happens for the rest of 2011?

Louis James: We didn't see the great shopping season correction that you typically get over the summer. That doesn't mean it can't happen now. If broader market concerns affect the resource sector too, we could well see that. If not, then remember the longer-term trend. And remember that gold typically does really well in the fall [autumn]. Be cautious and don't be out of the market. 

TGR: You suggest that investors should expect a crash in the broad stock market sometime in 2012. With recent events, do you think this timeline has sped up at all?

Louis James: There is fear in the marketplace. This could be a tipping edge that leads into a 2008-style slide. I suspect that if that's the case, we'll probably see a longer and deeper slide than we saw in 2008, but not as acute. This is why we use a tranche strategy to mitigate the risk of different possible outcomes. 

TGR: Before we discuss tranche strategy, what would be some telltale signs in the market that would prompt you to tell people to cash out before the crash?

Louis James: We wouldn't try to time the market. If we see our market drop, we'll just buy more. We have been very cautious about how we deploy our cash. We are not all in. And we have been taking profits quite aggressively along the way, which doesn't always enamor us in the eyes of companies (they see taking profits as a sell, even if we are not exiting a position). We have been hoping to see a more dramatic correction than any of these little dips so far this year. 

Our portfolio right now is pretty lean and focused on emerging production stories. Almost all of our picks have a resource in hand or they have drilled into something. These are stories that should pull through any corrections ahead. In general, we're not looking to sell at all. We are looking to deploy the cash we've been building in case we get such an opportunity. 

TGR: How long did you wait in 2008 before you started buying again?

Louis James: Things started coming apart in August. We were buying gingerly at first; by October we were definitely buying more heavily. November was when we really backed up the truck for great companies that went on sale. In the December 2008 issue of the International Speculator, there were some pretty bold capital letter buy signals, best buy signals, that sort of thing. 

TGR: Eight weeks after the crash, I guess.

Louis James: It started in August and slid all the way down to late November. Then, 2009 turned into a good year starting from a low base. Gold started back immediately. The quality juniors that either had the gold, or you could see were going to have it, and had money, started back up again immediately. You could tell they were going to weather the storm without diluting the heck out of shareholders. The rest of the sector took a few months longer to head decisively north again.

TGR: Let's get back to tranche strategy, which is really Dollar-cost averaging, but in a very specific sense. Tell us how it allows investors to boost gains. Let's start with the hypothetical ideal position of 10,000 shares in company X at an initial price of $1 a piece, which is the same example you used in the June edition of International Speculator. 

Louis James: The idea is if you like something and see it at a good entry point, you don't buy the whole 10,000 shares at once because no one can predict the future. Instead, you buy a first tranche, a first slice of the whole pie you want. We suggest 20% — 2,000 of those 10,000 shares. Then, if the thing really takes off, you don't get left behind. 

More likely is that the shares will fluctuate. You wait for that and buy your second tranche—another 2,000 shares—at some significant percentage lower than the first tranche. Now you have 4,000 shares or 40% of your ideal position at a lower price than you started with. If the thing then takes off, you've got a lot more exposure to the upside. 

But, again, "things happen." 2008 happens or there is alarming news that hits the commodity sector specifically—like Fukushima hitting uranium stocks. Any number of things can happen and that can give you an opportunity to come in with a stink bid, an aggressive low-priced offer on a large block of shares. If the basic premise remains intact, and you can buy larger chunks of shares at a much lower price, now your cost basis is much lower. 

If you are proven right, your profits will be much higher. And if you don't get the chance to back up the truck on a cheaper large block of shares, you still have a substantial amount of exposure to the upside. It's win/win either way. 

TGR: Here is a quote from 321 Gold's Bob Moriarty: "People buying gold at $252 in 1999 were paying the lowest real price for gold in a century. They were investors. People buying silver in late 2001 were buying at the lowest real price in 5,000 years. They were investors. You can almost never get hurt buying at record lows when the price of a commodity is below the cost of production. 

Speculators, on the other hand, get smacked on a real regular basis. They depend on more people coming into the market and are speculating on future prices. Regardless of what you think about the future of the US Dollar, $1,637 gold isn't a record low and you are not an investor by buying at that price. You are a speculator only." How do you respond? 

Louis James: Bob is talking about stock gamblers. Never mind the specific price information. The formula for making money — whatever kind of investment strategy you have — is to buy low and sell high. To buy high and sell higher — to rely on the "greater fool" theory — is what Bob is alluding to here. If you buy high, because things are on a tear, you're chasing momentum. Since we can't see the future, this is really just gambling. 

A speculator is not a gambler. An investment speculator looks at any distortion in the economy and particularly government-induced distortions because these have highly predictable outcomes. The speculator sees the distortions and stands where the money will flow as a result. If the governments artificially lower interest rates, this has predictable outcomes. If the governments start printing up scads of new currency units, this has predictable outcomes. And so forth. 

TGR: It was a pleasure speaking with you.

Louis James: Thank you.

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