Not necessarily, but cheap money seems to be all the Fed knows...
EQUITIES ANALYST Mike Niehuser, founder of Beacon Rock Research, is bullish on gold and well-managed Gold Mining producers.
Beacon Rock produces research for an institutional audience and focuses in part on precious, base and industrial metals, oil and gas and alternative energy.
In this interview with The Gold Report, Mike Niehuser explains why he is bullish on Gold Prices.
The Gold Report: What is your perspective on the price of gold and your forecast for 2011?
Mike Niehuser: Based on gold's recent price history, it looks like we were a little conservative. Our forecast for 2011 included the price of gold ranging from $1,300/oz. to $1,500/oz. with the potential in the wake of a catalyst to go over $1,600/oz. by year-end.
TGR: With Gold Prices at record levels, do you attribute weakness in mining stocks to seasonal weakness or is the market forecasting lower Gold Prices in the near to midterm?
Mike Niehuser: The accuracy of the forecast is not as important as providing a more or less arbitrary gauge for assessing the buoyancy of mining stock prices against the primary metal underlying these companies' assets.
Considering sustained Gold Prices and softening mining stock prices, we can draw a number of conclusions: One, that Gold Prices are ahead of themselves and ready for a seasonal correction, or two, markets are signaling lower prices, implying that higher metal prices may not materialize in later years when projects accelerate production.
On the contrary, we remain confident in our earlier forecast and see few forces mobilizing to take Gold Prices lower in the mid to long term.
TGR: Why are you bullish on Gold Prices?
Mike Niehuser: In normal times, if there is such a thing, we might see a seasonal correction in the spring or following a period of excitement, much like we recently saw with silver approaching record levels a couple months ago.
I find it interesting that gold has long since moved through record levels of the late 1970s but has yet to produce a price chart like silver peaking just a couple months ago. Gold Prices have been remarkably resilient and appear to be setting a new normal.
Considering the excitement for gold at half the price just a couple years ago, and gold stabilizing at record levels, it is somewhat amazing that investors seem almost indifferent.
TGR: What do you credit for breaking seasonal patterns?
Mike Niehuser: We are living in historically uncertain times. A populist uprising against the banks has not taken place in Europe, as banks appear more willing to restructure debts and kick the can down the road, rather than discipline member countries' loose financial behavior.
China appears to be facing both inflation and limits to growth, a new concept for them in recent history, and it's unclear how they will deal with a population unhappy with increased interest rates.
It would appear that the strategy here in the US is to manage interest rates and inflation, at least as they are measured globally, but high commodity prices, high rates of long-term unemployed and anemic growth expose the limits of monetary policy and increasing regulations. In all three instances, government intervention is likely to increase misallocation of resources that will lead to a more extreme correction.
TGR: Are higher Gold Prices inevitable?
Mike Niehuser: Not necessarily, despite loose monetary policy. With weak demand for credit and investment, and QE2 ending, in the near term we see interest rates declining and unemployment increasing.
An uncertain regulatory and tax environment may reduce the velocity of money leading to lower gold and commodity prices in the near term. But the only tool at the Federal Reserve's disposal, the only one that they appear to understand, is loose monetary policy. It is hard to see how they can back away from a QE3 with indifference toward deficit reduction and the willingness of the Chinese to continue to buy Treasury bonds.
TGR: So you see modest increases in Gold Prices until inflation becomes a concern?
Mike Niehuser: Yes, as long as low-cost imports from China, financed by Treasury purchases, continue to roll in, deflation rather than inflation remains a concern. Lower growth or production in the United States is eventually inflationary without free trade or allowing wages to fall.
"Money illusion" temporarily placates the masses, but only temporarily. In the meantime, should legislators cap the debt or foreign investors require higher rates on Treasuries, the blindfolds will drop from their eyes.
Systematic risk and moral hazard have gone global and we are all now "Too Big To Fail." Gold prices measure the progress of political and market economies. Sustained higher Gold Prices suggest global failure to maintain confidence or to protect the essential element of currency to be a store of value. The direction of Gold Prices appears inevitable so it is only a matter of time and severity.
TGR: If Gold Prices are, on average, ahead of your forecast and in your opinion moving higher, what accounts for the recent softness in demand or prices of Gold Mining stocks?
Mike Niehuser: Good question, the easy answer is uncertainty. Not only do we have excessive government intervention, but the world almost daily appears more unstable. Pollsters used to ask people if they felt less secure after 9-11. Now the question is do people feel more secure after Bin Laden's death?
Democracies are inherently unstable. In the nuclear age, lessons may be final. Whether in the Middle East or in the United States, it is not the outcome, but an uncertain journey that increases the risk premium component of interest rates.
This clearly decreases the present value of future cash flows. While this may push stock prices down, at some point they bottom and reach equilibrium, and investors may expect abnormally high returns for risk taking. Investors buying in early 2009—deep value investors and true contrarians that held through the spring of 2011—have been richly rewarded. It is starting to feel a lot like the fall of 2008.
TGR: What do you mean?
Mike Niehuser: In the second half of 2008, it seemed like fundamentals didn't matter. Management teams that executed on guidance for developing projects or production seemed to be punished for any news. Following silver peaking in April, most mining companies have taken a significant haircut.
This appears to be from a lack of demand or buying, rather than fundamentals or investors liquidating positions. This has created a similar buying opportunity, not as extreme as 2008, but possibly quite significant.
Should Gold Prices strengthen through the end of the year, lower stock prices should increase the demand for industry consolidation, acquisitions, stock repurchases or value investors. Major mining companies or the Chinese wanting to secure pipelines of production may set off a rally in 2011.
TGR: What are you recommending investors consider when analyzing a company's prospects?
Mike Niehuser: We believe markets should eventually recognize value and investors should focus on companies with potential to build value that may be recognized. This would include competent management and a balance sheet sufficient to execute on its strategy.
Should metal prices provide for positive margins—and $1,500/oz. gold is arguably sufficient for projects to be economic—advancing projects up the value curve should lead to higher stock prices. Because the market may favor production or exploration, we look for companies with near-, mid-, and long-term upside.
We believe this may provide the greatest opportunity for companies to gain recognition and secure and retain a shareholder base—in other words, build market capitalization. This characterization of near- to long-term upside fits the full range of producers, advanced development and exploration companies.
TGR: Thanks for sharing your insights with us, Mike.