Gold News

Mexico Mike: Investing in Silver

The gold/silver ratio looks set to turn lower as silver catches up with gold's gains...

JUNIOR MINING-STOCK and exploration consultant Mike Kachanovsky works on a freelance basis for a variety of publications including the Mexico Mike column in Investor's Digest of Canada.

A founder of Smartinvestment.ca, which serves as an online community for the discussion of all topics relating to junior Gold Mining and silver stocks, Mike Kachanovsky here talks to the Gold Report about the silver/gold ratio and the relative scarcity of precious metals...

The Gold Report: Mike, you're pretty optimistic on gold and silver. Can you provide us an overview of why?

Mike Kachanovsky: Right now in response to the crises that are occurring around the world, many governments have chosen to keep interest rates artificially low and issue large amounts of printed currency in the hopes of supporting their domestic economies.

When you have that much additional currency being injected into economies, it creates inflation pressures and people seek security outside of paper money and in precious metals stocks. So that's why I think you're going to see more upside in the spot market price for gold and also for silver, which has, historically, been a monetary metal.

TGR: You're focused a lot on silver. Can you give our investors a perspective on investing in silver vs. gold?

Mike Kachanovsky: In terms of the distribution of silver and gold in the earth's crust, there's about 15 times more silver than gold. If you look at the market price for the last 100 years, the ratio has trended a lot higher than that. You usually have about a 50-to-1 ratio of gold price to silver price. And so I think you're going to find that there's going to be a narrowing of that gap.

Part of the reason that silver has been at such a discount to gold is the impression that it's plentiful, which is just not the case. In fact, we know in the United States, for example, there was a 5-billion ounce inventory of above-ground silver, and that's been almost entirely depleted in the last 30 or 40 years. Now there's perhaps about 300 or 400 million ounces of documented silver inventories and I do not think new mine production will be able to keep up with demand in the years ahead. There is going to be a shortage.

Most of the gold that has been mined since the beginning of history is still sitting in bullion form some place in the world. Whereas, most of the silver that has been mined has been consumed in various industrial applications and is effectively gone forever. It's in such small quantities that it's not easily recycled and restored back to the market.

So, I think as you see silver decline in availability, you're going to see it close that gap in pricing compared to gold. I think gold is going to be rising rapidly, as I mentioned earlier, from monetary pressures – inflation – and the economy. Silver should rise more rapidly just on the scarcity premium as less and less silver is available to meet worldwide demand.

These are the kind of things that will be driving factors to make silver outperform gold, and both are going to be excellent investments in the future. But I really believe that silver is going to be a much stronger performer.

TGR: What's your view on investing in precious metals mining companies vs. the commodity itself?

Mike Kachanovsky: Well, if history is any indication, the mining companies tend to deliver stronger gains in a bull market than do the metals themselves. So, for example, if you'd expect that silver is going to double in price in the next couple of years, you'd probably expect that the mining companies that are leveraged to silver would go up 5 or 10 times in value from where they are at today, just because they have that greater leverage than the metal.

I also think that a lot of the Gold Mining and silver companies have defined resource deposits and you're going to see a lot more interest from investors to buy up these companies because they're going to be perceived as that much more valuable.

TGR: Mike, you're quite bullish on Mexico. What is it about Mexico that is intriguing to you?

Mike Kachanovsky: I think Mexico is an ideal place to look for junior mining stocks, and the reason is we almost lost a generation of development. Back in the '90s a lot of the mines in production in Mexico were basically shut down because of the lower metal prices that kicked in, and also because the domestic mining laws did not permit foreign mining companies to own more than half of any project or deposit. Those laws were changed late in the '90s to allow foreign companies to come in and own 100% of mining projects again.

You basically had a lot of great projects that were stalled that had an excellent upside. And so as soon those rules changed these projects have been vended into junior mining companies with access to funding and modern exploration technology. I believe there are more than 250 companies just from Canada that are currently active in Mexico, and many of them own 100% of their projects.

It's really been a renaissance for the whole mining industry in Mexico – and not just in silver – there's molybdenum, there are base metals, there's gold. And another big attraction is the mining and operating costs, which are so much lower than most other places of the world. Lastly, Mexico is attractive because it's very supportive in terms of mining law. Mine development is an economic priority in Mexico.

Compare Mexico to British Columbia, a jurisdiction that is similar in terms of resource potential. Part of the problem with B.C. is that it takes about seven years from the date of the discovery to actually get into operation because the process is so layered with hurdles a company has to jump to get to the point where they can dig the shovel in the ground and start moving the first ton of ore. In Mexico, they don't tolerate obstructionism. There's preferential granting of water rights and road access and infrastructure in order to accelerate the development of a mine.

So, those three factors – the strong resources, low mining costs, and favorable mining laws are what make Mexico attractive to me as an investor.

TGR: When you say junior mining stocks, are you looking at producers or explorers? And how do you differentiate between the two in terms of investment strategies?

Mike Kachanovsky: A lot of companies are having a difficult time accessing funding. There's been a lending freeze worldwide, and that's really hit the mining industry hard. Right now there are very few junior mining companies that actually have production, recurring cash flow or earnings. These companies are probably the better performers because they don't have to rely on outside sources of funding in order to advance their business model.

So if I were to rank the most desirable companies today, I would say right now you need to look at companies that are self-financing. That would be my primary target because there's less risk with those companies – they'll be able to continue their operations because they can still find the money they need to keep moving forward.

As far as the explorers, they're less attractive right now. Unless they've done a good job raising money, they are going to find themselves unable to go to the market for an equity offering without severely diluting the float. Their share prices are lower, so, as an investor, you've got an opportunity to buy these stocks very cheaply, but you have to be patient. You also have to very aware of the risks – if these companies cannot eventually get financing, they could default on the terms of their projects, and may even face the risk of getting delisted or go out of business. And mining is a risky game, that's something people should always be aware of.

From my point of view in today's market, it's very important to seek companies that are cash-flow positive, have growth in the pipeline, strong balance sheets and strong management that's demonstrated they can continue to operate under difficult market circumstances. And we don't know how long this will go on for; we could be seeing a trend reversal going on right now. Or it could go on for another couple of years before things improve and the financing becomes easier to attain. Investors have to be aware of these things.

TGR: You mentioned some other areas you were interested in outside of Mexico – British Columbia and Quebec.

Mike Kachanovsky: I like British Columbia because it has such endowment of mineral resources and a long history of mining activity in Canada; but currently, I am a little bearish on B.C. because I believe the pendulum for regulation and environmental oversight has swung a bit too far to the extreme end. It's very difficult, time-consuming and costly for companies to get approval to move forward with development plans in British Columbia. So, it's on a wait-and-see list for me now.

I would say the second-most attractive jurisdiction in the entire world for mining, after Mexico, is Quebec in Canada. Again, one of the reasons I like Quebec is that it is a very strong center for mining. The province recognizes and understands how big a contribution the mining sector makes to their overall economy. And hence, they've created legislation and tax structure that is very favorable for mining companies to attract that investment and keep their people employed.

Quebec has reimbursed companies for up to half of their exploration expenses for projects within Quebec. That's almost like getting a private placement completed every year without having to issue any new stock. So, companies that spend $3 to $4 million drilling and defining the deposit within the province will get half of that money back from the Quebec government. That's extremely attractive; it means the money goes further, and the support for the mining industry is there to nurture and assist with development rather than putting hurdles in front of these companies.

TGR: Are there any last ideas you would like to share with our readers?

Mike Kachanovsky:
I think the most important thing for investors to do is put together an investment plan and stick to that plan. One thing about trading in the precious metals stocks is that there is a great emotional undercurrent wherein people sometimes get seduced and carried away by excitement and greed. Historically, there have been so many episodes where these stocks went into these great bull markets and people got in over their heads. Conditions can change very quickly as we learned in late 2007 and all through 2008.

So, it's very important to develop a plan that makes sense for you. Be mindful of how much of your allocation is going towards these stocks, whether you want to focus on explorers or producers or a mix of the two, and which jurisdictions you want to focus on and pay close attention to.

For me, my plan is to focus on companies with proven management and a strong balance sheet where there's very limited risk that they may not be able to keep their doors open, pay their bills and remain current on their projects. I look for companies that are active in places that are friendly to mining, where there's less chance that their project will be halted or taken away from them even if they are successful in defining a resource.

I also look for companies that have growth in the pipeline because, at the end of the day, if you're right about the sector you choose to leverage in, it's still the growth stocks that tend to gain the highest multiples and perform the best. So when I look for growth, I look for either an increase in the resources – if a company has 100,000 ounces of gold defined and is able to advance exploration and improve that up to a million ounces – that's very significant growth and that generally will lead to gains in share price. Or, if you have a company that is producing a million ounces of silver a year and has a plan in place with reasonable objectives to perhaps increase that to two million ounces a year, that's a company that I'm going to want to look at. So, my own personal philosophy is to put as much money as I can into the handful of companies that reach all of my objectives for investment.

I'd also look at silver stocks right now because I believe they're going to outperform all the other companies. And I'd look at producers that I believe will be able to be self-sustaining even if this market cash crunch persists for a long time to come.

Finally, I think the potential for acquisitions is worth considering. At this time, I believe we're more likely to see a lot of acquisition activity going forward because so many great projects are basically dead in the water due to lack of funding. A lot of large companies are still successful and producing, and they are sitting on strong balance sheets, which compel them to go shopping for other assets. Mining management is aware of these dwindling resources and is always looking for the next resource. So, I wouldn't be at all surprised to see a round of very aggressive consolidation in the months ahead.

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