Policy Note 2011/6 | November 2011Although it didn't originate with an economist, the malaprop “It’s déjà vu all over again” is invariably what springs to mind in the aftermath of virtually any euro summit of the past few years, all of which seem to end with the requisite promise of a so-called “final solution” to the problems posed by the increasingly problematic currency union. But it’s hard to get excited about any of the “solutions” on offer, since they steadfastly refuse to acknowledge that the eurozone’s problem is fundamentally one of flawed financial architecture. Today’s crisis has arisen because the creation of the euro has robbed nations of their sovereign ability to engage in a fiscal counterresponse against sudden external demand shocks of the kind we experienced in 2008. And it is being exacerbated by the ongoing reluctance of the European Union, European Central Bank, and International Monetary Fund—the “troika”—to abandon fiscal austerity as a quid pro quo for backstopping these nations’ bonds.
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In the Media | October 2011
The Gold Report
Business Insider, October 19, 2011. Copyright © 2011 Business Insider, Inc. All rights reserved.
The Gold Report: Many of the resource companies in Pinetree Capital’s investment portfolio are gold companies. Gold went from above $1,900/ounce (oz.) in early September to around $1,600/oz. currently. Now, European central banks have sold 1.1 million metric tons of gold into the market to drive the price lower. Pinetree’s share price has followed gold lower and your exposure to gold remains high. What’s Pinetree’s pitch to investors right now?
Marshall Auerback: We had a very significant run up in the gold price, so some correction is understandable. But the conditions that created the run-up to $1,900/oz. have not dissipated. If anything, they’ve become more pronounced, notably in the Eurozone, where investors must begin to seriously consider the possibility of a break-up of the European monetary union and the implications that has for gold. And if you look at the monetary overhangs in places like China and Japan, it’s hard to find stores of value there either. So we have had some significant spec liquidation, some central bank sales—a plus, as central bankers are usually a great contrary indicator—and yet the price appears to have stabilized around $1,600/oz. Gold stocks, in contrast, still reflect valuations that are substantially lower than the current gold price. It is also important to note that the capital markets, in contrast to late 2008, have not shut down. Good quality mining projects can still obtain funding, especially for projects with robust economics, which a number of our holdings possess.
Pinetree has a unique structure. We raise money from the markets, which means that our longer-term funding requirements are, to some degree, shaped by market perceptions and market enthusiasm for resource stocks. But it also means we are not subject to monthly, daily or quarterly redemption pressures, so we can hold on to some smaller names that now offer the most compelling value they have offered in years.
TGR: A few years ago, Pinetree went from being focused on technology and biotechnology stocks to resource-based equities.
MA: Yes, the fundamental thesis has not changed. The developing world is likely to remain the dominant social, political and economic theme for at least the next few generations. Commodity prices have soared because the depletion of readily available resources is now finally outstripping the ingenuity of mankind to extract these resources. That is not just our view. Jeremy Grantham of GMO believes that this has changed the fundamental trend in real commodity prices, though the explosive nature of these prices in recent years has no doubt been amplified by speculation and historically unprecedented and ultimately unsustainable fixed investment in China. So you will get periodic corrections, especially during periods of global economic slowdown, but we don’t think this changes the long-term thesis. The portfolio composition has changed somewhat to reflect a changed economic environment of less base metals, more precious metals, but that is a tactical, as opposed to strategic, decision.
TGR: Did that one-month, $300-dollar drop in the gold price ruin gold’s reputation as a safe-haven investment?
MA: Not really. The price rise was, like other commodities, undoubtedly amplified by the actions of trend-following speculators. These are generally weak holders, and they tend to get shaken out when there are market gyrations of the sort that we have experienced over the past few months. But the fundamental reasons for holding gold have, if anything, grown stronger over the past few months.
TGR: Is the fear-trade gone? Is gold now trading strictly on supply and demand fundamentals?
MA: Given the way that markets have traded toward the end of the quarter, where you get maximum incentive to “paint the tape” in an upward direction, we think it is way too premature to suggest that the fear trade is over. Ultimately, though, gold is a supply/demand story. The market has been in fundamental deficit for decades and only the sales and leasing of gold by the central banks have prevented an even more acute price explosion.
TGR: The market is always about timing, but timing is even more important now given the rampant volatility in the markets. Fearing an economic collapse, many investors exited the junior sector once the volatility started in August. Many of those same investors remain on the sidelines today and some probably want to get back in. Is there something they should wait for—like a bottoming of the gold price—or is now the time to return?
MA: We think the time when you get maximum valuation is during these periods of turbulence and fear, when the baby gets thrown out with the bathwater. The good stuff is thrown out along with the bad as redemption pressures mount. Since we are in a comfortable position vis-à-vis our cash positions, we are in a good position to capitalize. Especially as Pinetree, for reasons explained before, doesn’t face comparable redemption pressures.
TGR: Our readers are primarily retail investors who like the high-risk, high-reward nature of the precious metals juniors. Pinetree is essentially a retail investor with lots of cash and a crack research team. How is Pinetree playing the current market? Have you been adding to your positions on the market dips? Have you sold off? Have you held tight? Give us the scoop.
MA: We try to “feed the ducks while they’re quacking,” in the sense that we recognize that many of these holdings are small and illiquid, and we tend to take large, strategic stakes. When our assessments are largely validated by market action, then we find that it is a good time to reduce, particularly because with these smaller, less liquid names, we are almost always going to be a bit early because we have to trim when there is good demand. This is especially the case when the company’s development has largely tracked what our analysts forecasted and with that comes the growing popularity of the shares with the broader market. Selling in those kinds of situations gives us the flexibility to take on new deals or, as is the case today, to buy from distressed sellers.
TGR: What are your favorite five gold plays in the Pinetree Capital portfolio?
MA: Gold Canyon Resources Inc. (GCU:TSX.V) is one. We are big believers in this deposit. The initial resource should be out by the end of this year and is promising to be several million ounces with grades exceeding most other bulk tonnage deposits in Canada. Looking at the dimensions of the deposit, specifically the new extension to the southeast, the potential here continues to grow far beyond what the company’s initial resource will give it credit for.
Queenston Mining Inc. (QMI:TSX) is the consolidation of key past producing mines in the prolific Kirkland Lake mining camp. There is an Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) take-out potential. Extensive drilling on the Upper Beaver and the South Mine complex joint venture with Kirkland Lake Gold Inc. (KGI:TSX) continues to add ounces.
RoxGold Inc. (ROG: TSX.V) is operating in Burkina Faso and has just raised the money needed to acquire 100% of its flagship asset. High-grade deposits are very hard to come by and the results it has consistently seen show potential for just that. With mid-major companies operating in the region, as RoxGold continues to add size, it becomes more and more likely to be an attractive candidate for a take-out.
Continental Gold Ltd. (CNL:TSX) recently reported a very large high-grade resource on its Buritica gold/silver/base metals deposit in Colombia. If you look around right now there aren’t too many deposits that hold size and grade like this one and, with 250 kilometers of assays to come since the resource was calculated, there is still a lot of upside from here.
Mawson Resources Ltd. (MAW:TSX; MWSNF:OTCPK; MRY:Fkft) is exploring at Rompas in Finland, a new discovery with bonanza gold where samples up to 22,723 grams per ton (g/t) gold and 43.6% uranium have been identified. The weighted average of all channel samples from the 2010 program is 0.59m at 203.66 g/t of gold and 0.73% uranium within a sampling footprint of 6.0 km. strike and 200–250m width. More than 300 discovery sites have now been identified within the mineralized footprint. At this very early stage of exploration, Rompas has to be considered as one of the most exciting global gold discoveries (with a uranium credit) to emerge into the marketplace, in terms of its high grades and hundreds of surface showing over a large area.
TGR: What are three gold plays Pinetree has positions in that few have ever heard of?
MA: Redstar Gold Corp. (RGC:TSX.V) is exploring in Alaska where properties have limited historical drilling. However, the company has seen very high grades. Currently, it is drilling up there and with the recent addition of the International Tower Hill Mines Ltd. CEO to their board, there is reason for interest. The company also has a joint venture with Confederation Minerals Ltd. (CFM:TSX.V) up in Red Lake. Thus far, Redstar has seen very high grades over 200 g/t over narrow widths stretching over a potentially several kilometer-long strike length. This kind of project requires lots of drilling; however, thus far, there has been some good continuity of success and with any sort of thicker intervals, this would be a project well worth the interest.
Prosperity Goldfields Corp.’s (PPG:TSX.V) exploration is headed up by Quinton Hennigh, who is also on the board of Gold Canyon and is heading up its exploration program. Stock had a large run-up prior to results, which the market clearly saw as disappointing. Despite this, we think these results show great promise given that Prosperity was the first in the area and the potential size of this deposit is very large. This project is in Nunavut; however, a winter camp has been set up and, relative to the region, the infrastructure is better than most.
Terreno Resources Corp. (TNO:TSX.V) is focused on a few different resources in South America. The company just raised $2.8 million and so it is cashed up to move forward on the initial exploration of both precious/base metal projects in Argentina as well as their phosphate/potash exploration in Brazil. It has had some solid trench results thus far down in Argentina, which is promising. The phosphate/potash market seems to be one of the few places where most analysts agree there will be a lift in pricing in the future so we are excited to see the exploration results.
TGR: Let’s switch gears to silver. Does Pinetree believe silver is a better near-term investment than gold?
MA: No, we think gold is likely to be the better performer if a global recession becomes the predominant concern, as opposed to systemic issues. That said, there have been some fairly violent moves to the downside over the last few weeks. The bear talk on China has really been overdone. Remember, China has over $2 trillion in foreign exchange reserves, so it has ample firepower to combat the forces of recession. In the very short term, we could get these massively oversold conditions worked off if it looked like the world was not coming to an end and silver could have a nice pop. Look at the U.S. data recently:
- Since late August, the U.S. economic data has surprised somewhat to the upside.
- Initial unemployment claims rose less than expected; September chain store sales look stronger than expected; Ford Motor Company’s sales for September were up 9%.
- It looks as though GDP growth may come in better than 2% annually in both the third and fourth quarters, surpassing recent pessimistic expectations.
As far as China itself goes, suddenly all the analysts, economists and portfolio managers that were all bulled up on China two years ago, a year ago and even six months ago have become all beared up on China. We are hearing about an imminent hard landing in China from everyone. So why the sudden bearishness about China?
It is claimed that China’s informal credit market is out of control. Property developers and businesses are starved for credit; business investment and real estate will fall. A hard landing is at hand. Let’s put this informal credit market into perspective.
This informal credit market is estimated at 3–4 trillion yuan RMB. The Chinese economy is now estimated at something north of 40 trillion yuan. According to Fitch, the formal credit market plus the shadow banking system totals about 70 trillion yuan.
When one looks at these numbers one can see that the growth of informal lending and the extremely high interest rates on informal lending represent a problem in China. But it does not impact a significant share of aggregate expenditures.
The real problem lies with the banking system and the shadow banking system.
TGR: Is this important credit market now poised to take Chinese aggregate demand down?
MA: We doubt it. Interest rates in the banking system are negative in real terms. The banking system is still expanding at a double-digit annual rate. Interest rates in the shadow banking system are much higher; they are no doubt positive in real terms, but it appears they are not usurious. In any case, this credit is still being allowed to expand at a very rapid rate. Will the authorities be able to deal with problems in the banking system or shadow banking systems, which are the credit markets that matter?
The answer is probably yes. The biggest credit excesses and the biggest white elephant fixed investments in this cycle lie with the local authorities. The Chinese government in one fell swoop removed half a trillion dollars of such loans off the backs of these local authorities. A half a trillion dollars! That is as large as the entire alleged informal credit market that everyone is getting so beared up about.
Longer term, the Chinese economy is an out-of-control Ponzi economy. Labor force growth will go negative. Surplus labor in agriculture is depleting. Fixed investment is impossibly high relative to a falling warranted rate of growth. Very bad things will eventually happen. However, the Chinese economy is also an extreme command economy. Extraordinary measures will be taken to avert these very negative outcomes.
The Chinese economy is highly indebted. The Chinese central government is not. Before the proverbial you-know-what hits the fan, the Chinese government will use its balance sheet to keep the white-elephant over-investment juggernaut going. Do not underestimate the fiscal capacity of the Chinese government and its willingness to use it. We do not think the excesses today in the Chinese informal credit market are a reason to get very beared up on China all of a sudden. The Chinese bear story will unfold progressively over a long time.
The real threat in China is inflation. China’s fixed investment has become increasingly credit dependent. To keep the fixed-investment juggernaut going and avert a hard landing, there must be sustained rapid money and credit expansion. There is already a large monetary overhang. The combination of these flow and stock dynamics threaten a very high inflation down the road. Which again makes the long-term case for gold very bullish.
TGR: Where is Pinetree getting its exposure to silver?
MA: Apogee Silver Ltd. (APE:TSX.V). The company’s primary focus is the Pulacayo-Paca Property located in southwestern Bolivia. The property includes the historic Pulacayo mine, which was the second largest silver mine in Bolivia’s history with historical production exceeding 600 million ounces of silver. Although there is obviously some risk with dealing in Bolivia, there are still many operating mines and we feel the deposit warrants the risk.
Southern Silver Exploration Corp. (SSV:TSX.V; SEG:Fkft) recently acquired the Cerro Las Minitas property in Durango, Mexico. There is a history of production right in the middle of the property and thus far, the company’s initial holes have been promising. This is a very early stage project and there is a lot more definition needed before a resource can be laid out; however, Southern Silver is in a good region and we feel the property certainly has potential.
TGR: What are some investment themes that you expect to play out in the coming months?
MA: We think that the markets could surprise again to the upside as we have apparently discounted a double dip recession, whereas a slowdown might be more accurate. This period might end up being closer to 1998 than 2008.
The trouble with the view that we are heading for another 2008 is that all crises are different. But they do share one common element: the inability of markets to perceive that when a market discontinuity is fresh in the minds of investors (e.g., 2008); it seldom repeats until that institutional memory is dissipated. Now, I believe that European banks are insolvent conditional upon the PIIGS collectively being insolvent. Clearly, this is the case for Greece (although the European Central Bank (ECB) could easily forestall this if it keeps buying Greek debt), but for the others, this is unclear—and, particularly in the case of Spain and Italy, a function of the rates at which they can borrow. So while the ECB provides a liquidity backstop, they have the room to adjust. Of course, the missing ingredient is growth. Europe already looks as though it has slid into recession. I would argue that recession, as opposed to systemic risk and bank runs, is already priced into European stock markets. But nothing is certain.
While the current crisis in Europe is worse than the 1998 crisis with LTCM and Russia, in 1998 it was thought that the entire system would collapse. Remember in 1998 Fed funds were 5%, not zero; 10-year notes, above 4%, not 2%+; 2-year notes were 5%; SPX was 30x earnings, not 15x. We had not gone through a 1974-style liquidation in reverse parabola terms except for the one day 1987 sell-off, as we did in 2008–2009. Real estate (houses) was not selling for prices yielding 10%–15% on lower-end real estate, but that is where the focus of foreclosures is felt. The story will be told in the next eight trading days.
TGR: Thank you for your insights.
As Pinetree Capital’s corporate spokesperson, Marshall Auerback is a member of Pinetree’s board of directors and has some 28 years of global experience in financial markets worldwide. He plays a key role in the formulation and articulation of Pinetree’s investment strategy. Auerback is a research associate for the Levy Institute and a fellow for the Economists for Peace and Security.
Policy Note 2011/1 | February 2011
Like marriage, membership in the eurozone is supposed to be a lifetime commitment, “for better or for worse.” But as we know, divorce does occur, even if the marriage was entered into with the best of intentions. And the recent turmoil in Europe has given rise to the idea that the euro itself might also be reversible, and that one or more countries might revert to a national currency. The prevailing thought has been that one of the weak periphery countries would be the first to call it a day. It may not, however, work out that way: suddenly, the biggest euro-skeptics in Europe are not the perfidious English but the Germans themselves.Download:Associated Program(s):Author(s):Related Topic(s):
Policy Note 2010/4 | November 2010
A common refrain heard from those trying to justify the results of the recent midterm elections is that the government’s fiscal stimulus to save the US economy from depression undermined growth, and that fiscal restraint is the key to economic expansion. Research Associate Marshall Auerback maintains that this refrain stems from a failure to understand a fundamental reality of bookkeeping—that when the government runs a surplus (deficit), the nongovernment sector runs a deficit (surplus). If the new GOP Congress led by Republicans and their Tea Party allies cuts government spending now, deficits will go higher, as growth slows, automatic stabilizers kick in, and tax revenues fall farther. And if extending the Bush tax cuts faces congressional gridlock, taxes will rise in 2011, further draining aggregate demand. Moreover, there are potential solvency issues for the United States if the debt ceiling is reached and Congress does not raise it. This chain of events potentially creates a new financial crisis and effectively forces the US government to default on its debt. The question is whether or not President Obama (and his economic advisers) will be enlightened enough to embrace this “teachable moment” about US main sector balances. Recent remarks to the press about deficit reduction suggest otherwise.Download:Associated Program(s):Author(s):
Public Policy Brief Highlights No. 110A | April 2010
More Care Less InsuranceThe United States has the most expensive health care system in the world, yet its system produces inferior outcomes relative to those in other countries. This brief examines the health care reform debate and argues that the basic structure of the health care system is unlikely to change, because “reform” measures actually promote the status quo. The authors believe that the fundamental problem facing the US health care system is the unhealthy lifestyle of many Americans. They prefer to see a reduced role for private insurers and an increased role for government funding, along with greater public discussion of environmental and lifestyle factors. A Medicare buy-in (“public option”) for people under 65 would provide more cost control (by competing with private insurance), help to solve the problem of treatment denial based on preexisting conditions, expand the risk pool of patients, and enhance the global competitiveness of US corporations—thus bringing the US health care system closer to the “ideal” low-cost, universal (single-payer) insurance plan.Download:Associated Program:Author(s):
Public Policy Brief No. 110 | March 2010
The United States has the most expensive health care system in the world, yet its system produces inferior outcomes relative to those in other countries. This brief examines the health care reform debate and argues that the basic structure of the health care system is unlikely to change, because “reform” measures actually promote the status quo. The authors believe that the fundamental problem facing the US health care system is the unhealthy lifestyle of many Americans. They prefer to see a reduced role for private insurers and an increased role for government funding, along with greater public discussion of environmental and lifestyle factors. A Medicare buy-in (“public option”) for people under 65 would provide more cost control (by competing with private insurance), help to solve the problem of treatment denial based on preexisting conditions, expand the risk pool of patients, and enhance the global competitiveness of US corporations—thus bringing the US health care system closer to the “ideal” low-cost, universal (single-payer) insurance plan.Download:Associated Program(s):Author(s):
Policy Note 2009/9 | October 2009View More View Less
Oblivious to any lessons that might have been learned from the global financial mess it has created, Wall Street is looking for the next asset bubble. Perhaps in the market for death it has found a replacement for the collapsed markets in subprime mortgage–backed securities and credit default swaps (CDSs). Instead of making bets on the “death” of securities, this new product will allow investors to gamble on the death of human beings by purchasing “life settlements”—life insurance policies that the ill and elderly sell for cash. These policies will then be packaged together as bonds—securitized—and resold to investors, who will receive payouts when the people with the insurance die. In effect, just as the sale of a CDS creates a vested interest in financial calamity, here the act of securitizing life insurance policies creates huge financial incentives in favor of personal calamity. The authors of this Policy Note argue that this is a subversion—or an inversion—of insurance, and it raises important public policy issues: Should we allow the marketing of an instrument in which holders have a financial stake in death? More generally, should we allow the “innovation” of products that condone speculation under the guise of providing insurance?Download:Associated Program:Author(s):
Working Paper No. 561 | May 2009
To save America—indeed, the global economy as a whole—the private/public sector balance has to shift, and the neoliberal economic model on which the country has been based for the past 25 years has to be modified. In this new working paper, Marshall Auerback details why the role of the state needs to be reemphasized.
The abandonment of a mixed economy and corresponding diminution of the role of government was hailed as the “rebirth of individualism,” yet it caused rising inequality and the decline of median wages, and led to the widespread neglect of public goods vital to its citizens’ welfare. Meanwhile, the country ran through the public investment it had made from the 1930s to the 1970s, with few serious challenges from policymakers or mainstream economists.
The neoliberal model was also aggressively exported: the “optimal” growth strategy for all emerging economies was supposedly one that emphasized limited government, corporate governance, rule of law, and higher levels of state-owned and -influenced enterprise—in spite of significant historical evidence to the contrary. Not even the economic wreckage in Mexico, Argentina, Thailand, Indonesia, and Russia seemed sufficient to challenge, let alone overturn, the prevailing paradigm.
That is, until now: in reaction to the financial crisis, many governments—led by the United States—are enacting massive economic stimulus packages and taking a central role in promoting economic growth strategies. This reemergence of state-driven capitalism constitutes a “back to the future” investment paradigm, one that is consistent with a long and successful pattern of economic development. But once we get beyond the pothole patching and school repairing, what industries can be pushed forward using public seed capital or through Sematech-like consortiums? What must be brought to the fore is the need for a new growth path for the United States, one in which the state has a significant role. There are already indications that the private sector is beginning to adapt to this new, collaborative paradigm.Download:Associated Program:Author(s):Related Topic(s):