'Silver and gold, silver and gold'. . . what to invest in—silver or gold? Investors on either side of this long-running debate are passionate about their precious metal of choice. But are they looking—or listening—to the right indicators? In this exclusive interview with The Gold Report, Mike Kachanovsky, aka 'Mexico Mike' from his Investor's Digest of Canada column, discusses historical changes in the gold-to-silver price ratio, shrinking supply. . .and what to buy.

The Gold Report: Mike, you're pretty optimistic on precious metals. 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?

MK: 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 five-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?

MK: 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 five 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 these mining 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?

MK: 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?

MK: 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: Do you have some companies that you are following that have nice balance sheets and good management?

MK: I certainly do. For my portfolio, I track many different companies on the daily trading behavior. But I also do extensive research into anything that looks attractive, before I buy. That means digging through financial statements and all sorts of other information in order to narrow the field. There are probably 2,500, perhaps as many as 3,000, active junior mining stocks in the world; and, if you're able to narrow that down to perhaps a 100 or 150 of the very best companies out there and you know a lot about them, then you just do your buying at the most appropriate timeframes when you have the best value.

I have a number of companies I have bought and own as a core part of my portfolio, and I actively continue to add to my holdings. I think if I could narrow my choices down, the number-one junior mining stock in the world, in my opinion, would be IMPACT Silver (TSX: V.IPT).

TGR: What makes them number one?

MK: Well, they're active near Mexico City in an historic mining district that has been in production for 400 or 500 years—all the way back to the original Spanish Colonialism in Mexico. In this project, they control the entire district—more than 350 square kilometers of land holdings. From their main mill, you can look to the horizon in every direction and Impact controls 100% ownership of all of it. Impact has outlined over 1,000 historic mine workings and mines from previous operators going back several hundred years, and they have enough targets to keep them busy for 100 more.

Secondly, the development curve for Impact has been very short. In just the two years since they've taken over this project area, they've been able to put four mines into production. In fact, they're actively developing a fifth as we speak.

The third thing I like about Impact is it's one of the few junior mining stocks anywhere in the world that's been able to report recurring earnings—not just positive cash flow—but actual net earnings after taxes, administration, non-cash items like depletion and expense for management, options and that sort of thing. So, Impact is actually able to fund their operations internally; they haven't had to go to market to raise money for two years.

I also like their financial strength—especially in this market. Their working capital position is about $7 million, which is very strong and they have a clean balance sheet with no debt. They have a fantastic inventory of targets to advance for development. They have extensive exploration, they stay ahead of their operations by outlining new discovery zones, are able to make money as they go, and they own their entire district without having to depend on another partner to maintain its share of development in order to move forward on their objectives.

So, to me, Impact is one of those stocks that if you're looking for access to mining exploration and silver production—they're a primary silver producer—I think they're a must-have for a portfolio. It's trading around 55 cents to 60 cents today; so it's actually undervalued compared to many of its peers. When you have an above-average stock that is priced below average, I think it's a no-brainer. That's what I think is the best stock in the world to own if you're looking for access to junior mining sector.

TGR: What's the number-two stock?

MK: Well, the number-two stock could be one that is a little more appropriate for people who are less risk tolerant, and that would be Alamos Gold Inc. (TSX: T.AGI), which is also a Mexican mining company. It's obviously leveraged to gold; there's no silver. It's active in the northern part of Mexico, in Sonora. And Alamos is an intriguing company because it has about a four-million ounce deposit, which has so far been defined in all resource categories. Their mine right now has a fairly robust operating size, about 10,000-12,000 tons per day, which is a very large mining operation. And they're producing around 150,000-170,000 ounces of gold a year, which puts them solidly in the mid-tier size.

The problem with Alamos is it's a one-mine company. They only own that one project. The learning curve took them a couple of years to get it where it's operating at their specified design capacity, and they're at that right now. Their efficiency is very high. They have tremendous exploration upside still untested on their property, so it's likely they're going to continue staying ahead of their production and adding ounces of deposits quicker than they actually develop it and take it out of the ground. So, that's a plus, but they're still a one-mine company.

Alamos is also debt free, with a large working capital position. So, I think what we're going to see with Alamos in the next 12 months is they're going to make an acquisition themselves and get some diversification in their operations either in Mexico or elsewhere so they have another working mine. Or, they're going to become an acquisition target and another mid-size or senior producer is going to take a run at them with a hostile acquisition bid.

Either way it's going to be good for shareholders; and right now, Alamos is trading around $9 a share. Alamos is another stock that I think that investors can buy regardless of what the market does. It's a low-cost producer, so if gold prices decline slightly or significantly in the months ahead, Alamos will still be able to generate a profit. Because it has so much leverage to gold, Alamos shares should rise in tandem with rising gold prices. I also think it's attractive as a hostile acquisition target; so, as an investor, there's always the chance of getting that payoff when some other company makes a move to take them out.

Please stay tune tomorrow for Part 2 of this interview

DISCLOSURE - Mike Kachanovsky:

I personally own shares in all of the companies mentioned in this interview. In addition, I am a founder of www.smartinvestment.ca and an advertising fee has been paid by Avino Silver Mines and Eastmain Resources Inc. in sponsorship of this website.

Mike Kachanovsky is a consultant providing analysis of junior mining and exploration stocks. His work is published on a freelance basis in a variety of publications, including the Mexico Mike column in Investor's Digest of Canada. Mike is a founder of the website www.smartinvestment.ca , which serves as an online community for the discussion of all topics relating to junior mining stocks. 

For additional comments on IMPACT Silver (TSX.V:IPT), Alamos Gold Inc. (TSX:AGI), First Majestic Silver Corp. (TSX:FR) (PK SHEET:FRMSF), Pan American Silver Corp. (TSX:PAA) (Nasdaq:PAAS), Coeur d'Alene Mines Corp. (NYSE:CDE) (TSX: CDM), Avino Silver & Gold Mines Ltd. (TSX.V:ASM) (OTCBB:ASGMF), Eastmain Resources Inc. (TSX:ER), and Goldcorp (TSX:G) (NYSE:GG) from newsletter writers, money managers, and analysts, click on the respective links or visit The Gold Report.

Streetwise - is Copyright © 2009 by Streetwise Inc. All rights are reserved. Streetwise Inc. hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part. 

The GOLD Report does not render general or specific investment advice and does not endorse or recommend the business, products, services or securities of any industry or company mentioned in this report.  

From time to time, Streetwise Inc. and its  directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.  

Streetwise Inc. does not guarantee the accuracy or thoroughness of the information reported.  

Streetwise Inc. receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.  

Participating companies provide the logos used in The Gold Report. These logos are trademarks and are the property of the individual companies.