Prepared for the Attack of the Short Sellers: Joe Reagor

The Gold Report  |

Despite the ongoing attack of the short-sellers, the fundamentals of gold and silver production are increasingly robust. ROTH Capital's Joe Reagor tells The Gold Report why he believes the price of gold is steaming toward $1,500/oz, with silver prices following in the wake. Reagor highlights several junior precious metals miners in a market that is out to prove the bears

The Gold Report: Let's talk about the growth and stability of gold and silver sales in Q2/14. What catalysts are on the horizon?

Joe Reagor: The biggest national markets for gold right now are India and China. U.S. investors are bearish on gold and silver. Europeans are more toward neutral. But there are more than 2 billion people living in China and India. They are the largest gold buying market, outweighing the larger financial markets of the U.S. and Europe.

Conversely, silver has underperformed gold during the last nine months. The average grade of a solid silver project is 100 grams per ton (100 g/t), while the average grade of a good gold project is less than 1 g/t for open pits. Advancements in recovery technologies mean that the silver-gold recovery ratio is moving toward 100:1. That is a much greater ratio than when I started on The Street, when gold traded at 53:1, and it presages well for silver.

TGR: What's the balance between industrial uses and retail uses for gold?

JR: Gold's only real use is as jewelry. Otherwise, it serves the ups and downs of investment demand and the requirements of banks buying it for reserve purposes. It is used a little bit in dentistry and a little bit in high-end technology, but those applications are not enough to be determining factors of the gold price. The jewelry usage is the largest use, but even that it is not enough to consume the total world gold supply. Normally, the recycling market alone is almost enough to support the jewelry market, especially in recent years with the get-cash-for-gold boom that occurred in the U.S. and in other countries. People were taking old jewelry items and getting $0.85 on the dollar for the gold content.

In reality, gold investment demand is going to continue to drive total demand, but it might not necessarily drive the price. If we look at most commodities that have an investment demand, when they are at peak, the pricing is determined by demand for investment. And that is what has happened with gold. The price rise toward $1,800/ounce ($1,800/oz) was solely driven by peaking investment demand. But in the current pullback, the valuation is not so much based on investment demand. There are large gold buyers who set a price floor. China creates a floor around $1,200/oz when it buys everything it can get its hands on through Shanghai. But above that, pricing is based on the cost of production. If every gold mine in the world shut down, the price of gold would go up tremendously, counteracting the low price regime essentially instantaneously. The better producers are performing at $1,250/oz all-in cash cost numbers. Most industries need a 20% economic profit margin to survive. That puts the real price of gold at $1,500/oz.

TGR: What about silver?

JR: The cost to produce silver is a bit lower than gold because silver comes with valuable byproducts, such as lead and zinc in some cases. But silver-only mining can still cost in the $20/oz range, so that suggests a rational silver price above $20/oz. It is important for silver miners to concentrate more on producing silver than on producing byproducts, however.

TGR: Can you take a wild guess at what the prices of gold and silver will be in a year?

JR: A year from now, I expect that the price of gold will be in the $1,500/oz range. My rationale for that is twofold. If we look historically at the last four gold cycles, the recovery the year after the bottom has been strong all four times. In fact, it has averaged 25% more than the average price the year following the bottom of each gold cycle. Our latest bottom was $1,192/oz on June 28, 2013. Applying 25% to that for this year, the price averages out to $1,492/oz. I do not believe that we will fully get there this year, though. For one thing, it is clear that there are forces invested in keeping the gold price down for the immediate future. But $1,500/oz is a doable number, if based solely on the cost of production methodology that I explained.

Silver tends to be more volatile, when it does move. Silver could be significantly higher than our $25/oz number for 2015, which is a bit less than the movement in gold on a percentage basis. That is based on the expectation of a 20% margin on the $20/oz cost producers, of course.

On the other hand, if enough mining companies manage to save 5% across the board on cash costs, that could move gold and silver prices down by 5% as well. And vice versa. If the cost of mining were to rally up again, that could result in even higher precious metal prices.

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The other thing that affects price concerns crisis situations around the world. Currently, the Ukraine issue is important, although it does not look as if the U.S. will become involved there militarily. Military engagement between the U.S. and Russia would be a bad thing for the global economy. But there are goldbugs out there who are betting on gold prices rising due to the possibility of war. The gold price could go up in a war scenario, but I do not advocate that as a rationale for buying gold. On the other side of that coin, when political situations diffuse there can be pullbacks in gold and silver pricing. But timing pullbacks tied to worldwide political issues is very tough to calculate, as are wars.

TGR: You mentioned that there are people with a vested interest in keeping the price of gold down.

JR: There are a number of other gold companies with large short positions on them. There are also some large-scale trading shorts on gold by the larger banks, which were put into place as gold declined from $1,600/oz to $1,200/oz. There is some concern that some of those might be in the red today, because they were still putting shorts into place when the gold price was around $1,200/oz. If that is the case, it is in the best interests of the short holders to encourage the bear argument against gold. The bearish swaying of the investor mentality causes an additional bear movement on gold that is not supported by the fundamentals of gold production. Avoid the bears.

TGR: Thanks a lot, Joe.

JR: Thank you, Peter.

Joe Reagor is a research analyst with ROTH Capital Partners, providing equity research coverage of the natural resources sector. Prior to ROTH, he worked in equity research at Global Hunter Securities and at Very Independent Research, covering a wide array of resources companies including metals (steel and aluminum), mining (gold, silver and base metals) and forest products (containerboard, OCC, UFS, and pulp). Reagor earned a Bachelor of Arts in economics and mathematics from Monmouth University.

Source: Peter Byrne of The Gold Report (4/23/14)

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