The Gold Report: Leonard, what are the most pressing issues facing investors today?
Leonard Melman: Let's start with the fiscal cliff. If America falls into this abyss, the combination of tax increases and spending reductions will slow down economic growth. Interestingly, political leaders in Europe are calling for increasing taxes and decreasing spending in order to solve their problems. I find it amusing that the solution to economic problems being proposed by leaders on the European side of the Atlantic is thought to be the problem on the American side of the Atlantic.
TGR: How do you account for the disconnect?
LM: It is due to a philosophical inconsistency and a lack of economic understanding on the part of the world's political leaders, most of whom are not well qualified as economic thinkers, nor as philosophers for that matter.
TGR: How important is a philosophical stance to making a cogent economic analysis?
LM: Adhering to a strong underlying philosophy can guide leaders through difficult times. Unfortunately, demands by the public for more and more government services are making politicians even more reluctant to come down on the side of austerity, particularly in America. The results are uncontrollable deficits and a massive national debt. The statutory debt limit of the U.S. government is $16.394 trillion. The national debt of the U.S. as of mid-December was $16.337 trillion. Therefore, a mere $52 billion remained before the ever-rising debt reaches the statutory limit.
TGR: What will happen if no measures are taken to change the debt limit?
LM: According to law, portions of the government must cease operations once the limit is reached. Nobody wants to see that happen, least of all politicians. So I believe they will likely agree to increase the debt limit by another couple trillion dollars.
TGR: What will happen if the two-party system fails to agree on tax and spending cuts? How will the market respond?
LM: The market operates in two different directions. The precious metals market historically has regarded instability as a plus. The financial markets have historically regarded instability or uncertainty as a minus. If the parties fail to resolve either the fiscal cliff or the debt limit problem, I believe the financial markets will react negatively, but the precious metals markets will most probably react positively.
TGR: Then why has the price of gold bullion during the last year been so out of sync with the deflated price of junior gold mining stocks?
LM: In late 2007 and early 2008, the price of gold hovered near $800/ounce (oz). It's over $1,700/oz now—more than double the earlier price—and yet the three most popular mining share indexes, the Philadelphia Gold and Silver Index (XAU), the NYSE Arca Gold BUGS Index (HUI) and the Market Vectors Gold Miners ETF (GDX), are all below their late 2007 and early 2008 levels. That is rather astonishing. The reason is that the nature of mining—especially for the juniors—has undergone dramatic changes in recent years, none of which are positive. Increasing energy, transportation, geological and licensing costs make it now more expensive to mine for metals, but the most pressing problem is that the time that it takes to put a newly discovered mine into operation has increased at a rapid rate.
I've been in this business for four decades. In the late 1970s, a mine could anticipate rapid progress from the time of discovery. A junior simply raised money, put the money into the ground, proved up the asset, got construction financing and went into production. Now a series of lengthy bureaucratic processes are making it difficult for mining companies to raise new funds in the financial markets because that causes share dilution.
Share dilution tends to knock down share price, which makes it difficult to arrange the next round of financing, which then makes it even more difficult to advance exploration and development and a most difficult spiral ensues that makes it very difficult for miners to generate revenue from production.
TGR: Are environmental regulations the only cause of slowing timelines for new mine development?
LM: There are other obstacles. In Canada, we have an aboriginal problem. The courts have literally given many aboriginal tribes the ability to interfere in the progress of a mining venture. Companies are required to "consult" with them at various stages of progress. Consultation is expensive, it's time consuming, and it can be interrupted by legal procedures at almost any time.
TGR: Do you see any changes in the near term?
LM: The near term remains very difficult. In the long term, I'm fairly optimistic, because the world needs metals to survive, plain and simple. You can't cook food, you can't drive anywhere, you can't process energy, you can't run computers, you can't have medical instruments and you can't do almost anything that we do in modern life without metals. When genuine metal shortages begin to develop, we will see pressure build for a revision in these policies.
TGR: Are there any North American gold juniors that can weather these difficulties?
LM: There are some. I've developed an interest in Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX). A while back, I got to know Darin Wagner, and he struck me as a very competent individual. He successfully sold a company called West Timmins Mining Inc. (WTM:TSX), and now he's the president of Balmoral. He understands the value of obtaining properties with a high likelihood of success. The old adage is that if you want to develop a new mine, acquire property in the vicinity of an old mine. Balmoral is working in the Detour Gold Trend along the Québec-Ontario border, which has four different multimillion-ounce projects. Wagner has a great chance of success there.
"Share dilution tends to knock down share price, which makes it difficult to arrange the next round of financing."