Don't Retreat, Reload Your Gold

Gold Price corrections are an opportunity to buy, says this analyst...

WE'VE SEEN WORSE when it comes to Gold Price corrections, says Wellington West senior analyst Paolo Lostritto to The Gold Report.

A graduate in geological and mineral engineering, Paolo Lostritto has formerly worked with Scotia Capital and MGI Securities. Now he counsels investors to "use this opportunity" to build gold positions, because he foresees upside by the second half of 2011. In this exclusive interview with The Gold Report, Paolo shares his insights.

The Gold Report: Reuters reported that for the fourth time in two months, China has boosted the reserve requirement ratio (RRR) for their largest banks in an effort to curb inflation. Thailand and South Korea have made similar moves in recent weeks, and the first RRR move in China was made after inflation reached above 5% in November. Do you expect this to have an impact on the Gold Price?

Paolo Lostritto: We've seen a reaction in the Gold Price over the course of the last several weeks in response to these tightening measures. Historically, North American players have experienced inflation pressure in the form of labor inflation, like during the 1970s. This time around, we're seeing inflation problems in the developing economies such as Asia and Brazil. However, these inflation pressures are starting to get exported around the globe. An example would be the recent focus on food price inflation. The reserve requirement adjustments are in response to these types of issues. Should the velocity of money accelerate to more traditional levels, this problem is only going to get worse.

TGR: We're continuing to see some significant downward movement in the Gold Price this week. What's Wellington West's position on the ongoing volatility in the gold market?

Paolo Lostritto: In the last 10 years, there's been a slow and steady progression of the Gold Price in response to the amount of fiat currency that has been issued; this is an attempt to stimulate economies around the globe. During that progression, there have been many examples of much more volatile corrections than the recent one. Wellington West still believes this is just a short-term blip in a long-term secular trend, and that weakness should be looked at as a buying opportunity.

The one advantage of having eyes and ears on the ground in terms of the physical market is that you're able to see the ebb and flow of true physical demand. We have contacts in the industry that we tap every once in awhile, and this is pretty fresh data on a large scale. That's hard to ignore.

TGR: How much does gold have to fall before you and the Street become worried about high cash-cost gold producers and their margins?

Paolo Lostritto: We look at it on a case-by-case basis. At Wellington, we are using $1400 per ounce gold for 2011 and 2012, and use a long-term Gold Price thereafter of $1000 per ounce. Gold Mining equities have been in a sweet spot since 2008 whereby costs have been somewhat contained while commodity prices have improved. The time to make serious money in the equity markets is during phases when you have margin expansion, similar to the 2001 to 2004 period. However, during the 2004 to 2007 period, margin compression despite higher commodity prices was a bit of an issue, which was reflected in the lack of equity performance. We are starting to see signs that costs are creeping up again. Consequently, one is more inclined to lean toward producers that have the majority of their capital expenditures behind them, or alternatively, royalty companies that give you exposure to the commodity but not to potential cost inflation.

TGR: What factors are behind those rising costs?

Paolo Lostritto: We're starting to see a little bit of cost inflation in steel and oil prices, but the majority of cost inflation is coming from the shift in labor and currencies. This is effectively the same problem that we had in the 1930s, when every nation was trying to entice economic growth through competitive currency devaluation. But if everybody is doing it, it's a race to the bottom, and who really wins? That economic backdrop presents some difficulties to investors trying to preserve wealth, and that's why some are turning to gold as a means of protecting themselves.

TGR: Before we part ways, what's your outlook for the gold market in 2011?

Paolo Lostritto: We exited 2010 with a lot of fervor. There were a few generalists who would not normally participate in the space who entered it, and it was a bit frothy there for a time. We are currently experiencing a little bit of retracement, which is shaking out some fast money. But we've seen this before, over the course of the last 10 years. I still have faith in the investment thesis, especially given that some Central Banks have gone from net sellers to net buyers of gold. There continues to be examples of large pension funds looking for a means to protect their wealth. And there are numerous examples of oil-producing nations quickly converting their oil-cash into gold as a means to protect that wealth.

I look at what's going on now as a short-term correction; I am not quite sure how long it will last, but I would use this opportunity, if you haven't already, to rebuild your gold position, because I believe the second half of 2011 is going to be a lot of fun.

TGR: Paolo, thank you for your time.

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