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The Recovery Is an Illusion: John Williams

Source: JT Long of The Gold Report (5/18/12)

http://www.theaureport.com/pub/na/13404

John Williams, author of the ShadowStats.com newsletter, shines light on his interpretations of the GDP, CPI, unemployment and other government statistics in this exclusive Gold Report interview from the recent Recovery Reality Check conference. Highlights include what the money supply measures tell him and why QE3 will be a hard sell.

The Gold Report: John, at the recent Casey Research Recovery Reality Check conference you described the economic recovery heralded by the Obama administration as an illusion based largely on skewed inflation data. Can you walk us through why, based on your calculations, a recovery is impossible?

John Williams: We can start with the gross domestic product (GDP), which like most economic reports is adjusted for inflation. If you take inflation out of it, what is left should be changes in economic activity, as opposed to changes from prices going up or down.

Reported GDP activity for Q3/11, Q4/11 and Q1/12 was above where it had been going into the recession. Formally, that is a recovery. The problem is that no other major economic series shows that same pattern, which is a physical impossibility if the GDP numbers are accurate.

I contend that the recovery is an illusion created by the government using inflation numbers that are too low when deflating economic series. The lower the inflation rate you use for adjustment, the stronger the resulting inflation-adjusted growth.

In addition, a number of reports such as payroll employment have no ties whatsoever to pricing or inflation. Payrolls have risen a little bit since the trough, but they just recently recovered the levels they hit before the 2001 recession, some 12 years ago. They have not come close to their pre-2007 highs.

TGR: Would you include the unemployment rate among those unreliable reports, given that it does not count people who have stopped looking for jobs or are underemployed?

JW: It is a matter of definition, but that is right as to the headline number at 8.1%. Looking at the number of people who consider themselves unemployed, there has been no real decline in the unemployment rate. It remains at a level not seen outside of the worst recessions.

If you include people who are out of work and have given up looking for work, but consider themselves unemployed because they would take a job if one were available, the unemployment rate is something over 22%. Again, this is not a number tied to inflation.

TGR: You compared that to the Great Depression in your presentation.

JW: During the Great Depression, the estimated unemployment rate peaked in 1933 at 25%. But that included 27% of the population living and working on farms. Today, less than 2% of the population works on farms. A more meaningful comparison perhaps would be the non-farm unemployment rate, which in the 1930s peaked at about 35%. We are still shy of that.

TGR: Which is a more accurate indicator, the payroll employment rate or the GDP?

JW: The indicator here, in terms of payroll employment or the number of jobs, is well off its peak. There has been no employment growth in 10 years, despite 10% growth in the population. There is no recovery based on the employment data, which is a coincident indicator. That is a more accurate picture of what is happening in the economy than the rosy scenario coming out of the GDP estimates.

Another series that has no ties to inflation is housing starts. This is perhaps the hardest hit area of the economy. It peaked in 2006, has dropped about 75% and is bottom-bouncing. It is stagnant at a historically low level.

Consumer confidence is the same. It plunged and is bottom-bouncing.

TGR: Consumer liquidity is related to consumer confidence. There is a lack of positive, inflation-adjusted income growth. Your statistics show the real average weekly earnings for production for non-supervisory employees was down 0.6% from the first quarter of 2011. It peaked in 1973 and has been going downhill ever since. How important are real earnings and associated retail spending to a recovery?

JW: They are quite important. We are not in recovery because consumers are in severe financial straits. There is a structural problem with income. We have lost a lot of jobs offshore-generally higher paying production jobs-due to our ever-expanding trade deficit.

Not only are average earnings down at an individual level, so is household income. In the 1970s, when earnings peaked, it was more common to have one person in the household working, usually the husband, with the wife at home raising the kids. As individuals saw their income drop off faster than inflation, many households needed to have two people working to make ends meet.

Adjusted for the government's inflation measure, household income continues to shrink month after month. Without real growth in income-growth that's faster than the pace of inflation-you can never have sustained, positive growth in consumption. You can buy short-term growth through debt expansion, but the key is sustainable growth.

TGR: Student loans, which are up 29.9% from 2011, have been in the news lately. Are student loan burdens and their interest rates having a real impact on the economy or are they just an isolated piece?

JW: I think of student loans as one part of outstanding consumer credit. A lot of people looking at the system's liquidity believe that consumer credit outstanding has almost reached its pre-recession high. That is due solely to the expansion of student loans.

Normal consumption lending-credit cards or fixed loans-has been dropping off and is bottom-bouncing. The extraordinary growth in student loans looks like a big problem going forward, a bubble like the mortgage market.

If you look at the overall bank lending, banks' balance sheets are so impaired that they cannot lend normally. Everything considered, bank lending is flat.

TGR: Is our GDP structured such that domestic consumer spending is needed for a recovery?

JW: Consumer spending accounts for 71% of the GDP and everything else is pretty much related to it in some form or another.

For example, look at retail sales. If you remove the artificially depressed inflation numbers imposed by the government, you see a pattern of plunging activity and bottom-bouncing. The same is true for industrial production.

The liquidity problems are at a point now that consumers, both in terms of income and credit, have not been in a position to fuel a recovery. There is no recovery coming. That has all sorts of implications for the markets.

We had a financial panic and a near collapse in 2008. The people in Washington, D.C. had to prevent a collapse. The primary function of the Federal Reserve is to keep the banking system healthy, to keep it afloat. Taking care of the economy and containing inflation are secondary goals.

The federal government and the Fed created, spent, guaranteed or loaned whatever money was needed to keep the banking system alive, and the government will do that again. The problem is, that creates inflation and is not very effective. Yes, we avoided a systemic collapse, but the banking system is still in trouble four years later. The solvency crisis continues. The economy has not recovered. All they have done is kick the proverbial can down the road.

TGR: What do your money-velocity statistics show relative to the existence or absence of a recovery?

JW: I still track what used to be the broadest measure of the money supply, M3. There are three M measures. The M1, the smallest measure, includes cash, checking deposits, traveler's checks and such. The M2 includes M1 plus savings accounts, small time deposits and retail money market funds. That is as far as the Fed goes today.

It used to have an M3 category, which included M2 plus substantial categories such as institutional money funds and large time deposits. The M3 is almost twice as big as the M2. The Fed stopped reporting M3, but I still track it.

A lot of people have noted the strong growth in M2 recently, but I believe that growth is out of context. That growth is due to funds flowing out of M3 accounts into M2 accounts. The broadest measure, M3, had some recent growth, but it is beginning to stagnate and turn down. That is a sign of stress in the system.

I put together a stress measure based on the ratio of M3 to M2. When the ratio is high, you generally have good confidence in the banking system. Big, uninsured funds are flowing into the banks.

At the crisis point in 2008, the ratio plunged. Immediately, the Fed introduced quantitative easing (QE). When that failed to bring the banks around, it introduced QE2. The ratio of M3 to M2 continues to worsen. I would expect we will see QE3 from the Fed in the not-too-distant future.

The Fed may call it something else, because QE3 will not play well politically to announce the infusion of a couple of trillion dollars into the banking system. The Fed will say it is necessary to stimulate a slowing economy.

This is a very dangerous situation, one that eventually will lead to a massive decline in the U.S. dollar. Global confidence has been lost in the dollar. I think the Fed's next action will trigger renewed dollar selling, leading to dollar inflation, which is already starting to accelerate. Weakness in the dollar tends to spike oil prices, a big factor behind domestic inflation.

We have been having inflation in a weak economy. Instead of being driven by strong demand-which is a relatively happy circumstance for having inflation-inflation today has been created by a weak dollar and unstable monetary policy by the Fed. That is not a happy circumstance. It is a circumstance that promises much higher inflation as people look at preserving their assets.

TGR: The federal government has been reporting inflation between 2% to 3%. You just updated your 2012 hyperinflation report. What is real inflation right now?

JW: The government's numbers are accurate by its definition, but they are not what people think they are. Over the years, the methodologies have changed.

The average person thinks that the Consumer Price Index (CPI) measures inflation, that it reflects the cost of maintaining a constant standard of living. They also believe that it reflects out-of-pocket inflation. It does not, nor does it reflect the cost of maintaining a constant standard of living.

After World War II, the CPI was used to measure the cost of inflation for a fixed basket of goods and services. For example the basket of goods might contain a gallon of gas, a pound of steak and a loaf of bread. The government would measure the same, year after year. However much the price had gone up, that was how much inflation had gone up.

In the 1990s, Fed Chairman Alan Greenspan and Michael Boskin, then chairman of the Council of Economic Advisors, started pushing the story that the CPI was overstating inflation. They figured that adjusting the CPI reporting would reduce the Social Security cost-of-living adjustments. That is why they did it. If they had not changed the CPI, Social Security checks would be about double what they are today.

But at the same time, they introduced a substitution that made the CPI worthless for anyone trying to use it as a target for calculating, for example, what their minimum return on investment should be in order to maintain their standard of living.

If you use an inflation rate that is too low, you get a too-strong inflation growth. You see recovery that is not there, which is what we've been seeing.

Other changes have been made beyond the CPI substitution. Usually, when the government changed its methodology, it published an estimate of the change's effect on inflation. If you add all of those changes together, you find that, since 1980, about five percentage points have been taken away from the annual inflation rate. Another two percentage points can be attributed to changes the government did not consider methodological and therefore did not estimate the effect, but they are very much a factor.

So, seven percentage points have been taken out of the CPI. If inflation is being reported at 2.5%, adding that 7% back in puts inflation up around 9.5 to 10% using the 1980 CPI methodology. Using the 1990 methodology, it would be 6% to 7%. That is what people need to be making to stay ahead of inflation.

TGR: What can individuals do to protect themselves if the hyperinflation you are predicting comes to pass?

JW: We keep moving down the road to hyperinflation. This is not the time to worry about short-term gains or losses in the marketplace. It is the time to make sure your basic wealth and assets are protected against inflation, and that you are in a position to ride out a bad financial storm ahead.

TGR: How do you do that?

JW: Your primary hedge is physical gold; precious metals, including silver; and some assets outside the dollar. I still like the Swiss franc-its ties to the euro will not last. I like the Australian dollar and the Canadian dollar. Having funds actually outside the U.S. is a plus. To get through the crisis, you need a hard asset that is liquid for the near term.

Over the longer haul, gold stocks are wonderful hedges, but if the system gets into real trouble, which I think it will, you may have liquidity issues in the market. I am talking about limitations on the physical ability to transact in the market. You may also have liquidity problems with real estate, although over time, real estate is a tremendous hedge against inflation.

TGR: What is the best investment advice you ever received?

JW: Well, I do not generally take investment advice, but the best investment advice I ever gave myself was to buy gold.

TGR: Advice our readers will appreciate. John, thank you for your time.

Walter J. "John" Williams has been a private consulting economist and a specialist in government economic reporting for 30 years. His economic consultancy is called Shadow Government Statistics. His early work in economic reporting led to front-page stories in The New York Times and Investor's Business Daily. He received a bachelor's degree in economics, cum laude, from Dartmouth College in 1971, and was awarded a Master of Business Administration from Dartmouth's Amos Tuck School of Business Administration in 1972, where he was named an Edward Tuck Scholar.

Williams went into much more detail about the economic troubles he foresees for America during his presentation at the recent Casey Research Recovery Reality Check Summit. You can hear it in its entirety, as well as every recorded summit presentation with the Summit Audio Collection. It contains over 20 hours of recordings and features contrarian investing legend Doug Casey, Porter Stansberry of "End of America" fame, former director of the US Office of Management and Budget David Stockman, and Thoughts from the Frontline Editor John Mauldin. All together, 31 of the greatest financial minds of our time were on hand to share their views of the economy and offer actionable investment advice, including specific stock picks, to protect you in these troubling times. For more information about how to add this invaluable collection to your resource library, click here.

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Source: Brian Sylvester of The Gold Report (5/18/12)

http://www.theaureport.com/pub/na/13396

Aaron Kennon, co-founder and CEO of Clear Harbor Asset Management, shares some of his company's trade secrets in this exclusive interview with The Gold Report. Educating yourself is critical before investing, and Kennon suggests questions to ask, what specialized knowledge your adviser should know and why small-cap and junior resource equities are offering surprisingly thrilling returns.

The Gold Report: Clear Harbor Asset Management actively invests in resource equities, and it's doing so during one of the most bearish periods ever for resource equities, particularly for small-cap resource equities. Some institutions are leaving the space altogether while others are reducing their exposure. What are your plans?

Aaron Kennon: While the resource benchmarks have all suffered significantly over the last several years, Clear Harbor's natural resources strategy has returned more than 58% since inception 27 months ago. This compares to an approximately 4% return by our benchmark, which is the Standard & Poor's Global Natural Resources Index. We're thrilled with this performance and believe that our team is well positioned to take advantage of investment opportunities in a more proactive fashion while the vast majority of investors remain either defensive or rattled. So our plan is to stick to our disciplined, value-oriented approach to the sector and continue to perform well for our clients.

We have also constructed a strategy where the majority of our securities are listed and operated outside the U.S., with approximately 50% of the positions representing small-cap companies. This contrasts with most of our competitors, who are forced into the mid-cap and large-cap segment of the market due to the size and scalability of their investment strategies. Clear Harbor has no intention of backing away from this sector, which has long been a specialty for us. There are too many attractive investments and too many compelling macro tailwinds. From the rise of the global middle class to the future population expectations to the undeniable fact that the world is embarking upon the most expansive monetary experiment of all time, resources are an essential component for any investor's portfolio.

TGR: You said most of the equities that you invest in are based outside the U.S. Do you have anything in China?

AK: Our position in Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) represents our only natural resources investment in China at the moment.

TGR: Are you employing new or different strategies to counteract or even take advantage of the risk-off sentiment in the resource space right now?

AK: Yes. Some companies in the sector possess more cyclical risk than others. The larger, more diversified resources companies capture the general cyclical trends in the market but do not have as much business-level risk imbedded in them, whereas many of the smaller-cap companies significantly outperform or underperform due to geological or operational success. We attempt to balance both of these risks in the portfolio and adjust our strategy based on shifts in company-level valuations and macro risks. Our strategy provides us with the flexibility to shift from resources equities into the actual commodity, which some other strategies do not have. In an environment where we believe that equities could experience significant stress, we have the ability to lighten up on our gold mining exposure and perhaps allocate that capital into bullion, or shift from the mining sector altogether to agriculture or oil and gas. Of course, we can also maintain cash when we deem appropriate.

TGR: Could you break down the asset allocation inside Clear Harbor's Natural Resources Strategy?

AK: One third of the portfolio is in the metals and materials sector, just under two thirds is in the energy sector and the remaining piece represents agriculture.

TGR: Has that changed over the last year?

AK: The allocation has remained relatively steady.

TGR: Many analysts will tell investors that they need to do their due diligence before investing in junior resource plays, but that's very easy to say and much harder to do.

AK: Due diligence is critical when analyzing the investment merits of a junior resource company. We always try to meet with management teams and determine their knowledge base and try to glean an understanding of their past successes and failures. We also seek to determine a company-level valuation based on existing and future resource potential. A drilling program at the junior exploration level can either kill a project or expand its resource potential and legitimize management's vision for the company. This speaks to the geologic risk and, therefore, the investment risk that is inherent in a junior company.

TGR: Are there some rules of thumb that you apply to your due diligence?

AK: There are several. A few that immediately come to mind are: quality and flexibility of management, appreciation of the capital markets and valuation of the stated and prospective resource assets. The ownership structure is also of interest to our due diligence. Does management own equity? If so, how much?

TGR: Do you have a geology background? Do you like to look at the core?

AK: I've looked at lots of core. I do not have a geology background in an academic sense, but I spend a good deal of time on the ground with geologists. For example, when I was in Argentina recently, we had an opportunity to travel with a geologist from one mining company to the other, and he was extraordinarily helpful in connecting geology to an investment thesis.

TGR: These days, geologists can put numbers into computer models to build preliminary economic assessments and NI 43-101 technical reports. But these models often don't take into account things like structural controls in terms of geology and other nuances of a deposit. As a result, are these mines not performing to the levels put out in prefeasibility and even feasibility studies?

AK: It varies. I make sure that there is a good deal of geology knowledge at the company level but also a respect for and an understanding that, at some point, an exploration program needs to go from being a science project to potentially a business model that can return value to shareholders. Part of my job as a portfolio manager is to find companies that have people at the top who can merge those critical components.

TGR: While you were in Argentina, the country's government nationalized Repsol YPF SA (REP:BMAD), a division of a Spanish oil company. What was your reaction to the news?

AK: While this was a significant event for the country and the capital markets, my initial reaction was not one of shock but of disappointment. The government's decision follows a pattern of contempt for foreign creditors. With that said, some of the largest companies in the world continue to wade into the country and accept the political risks. Apache Corp. (APA:NYSE) is increasing its capital expenditures in the country by 20% to $300 million (M). In my opinion, the Argentine government will find it challenging to seek out international partners to operate and expand the YPF resource in production. That will lead them to conclude that what occurred in this particular instance should not apply to other resources companies in the country in the future.

TGR: How does this compare to Venezuelan President Hugo Chávez seizing the assets of a number of oil contractors there as well as the Crystallex International Corp. (KRY:TSX) gold mine?

AK: Time will tell. YPF was once a publicly owned company, owned by the Argentine government before it was privatized and sold to Repsol in the 1990s, so the YPF nationalization was justified through several lenses: populism, colonial angst and national pride. The Argentine government recently aired a commercial that presented the history and identity of Argentina as firmly entwined with the history of YPF: former Argentine President Juan Perón, the Argentine flag, a crowd of children waving flags and a YPF gas station choreographed together in this television commercial. I'm not sure the government could pull off a similar ad displaying McEwen Mining Inc. (MUX:NYSE; MUX:TSX; MAQ:TSX) or Minera IRL Ltd. (IRL:TSX), for example.

TGR: While in Argentina, you spent time with Rob McEwen, the former CEO of Goldcorp Inc. (G:TSX; GG:NYSE). McEwen had remarkable success building Goldcorp into a top-tier gold producer, now the second largest gold company in the world. After he left Goldcorp, he started U.S. Gold Corp. (UXG:TSX; UXG:NYSE) and that performed remarkably well for shareholders as well. Then he took a large position in Minera Andes Inc. (MAI:TSX; MNEAF:OTCBB), and the two companies came together to form McEwen Mining. How did he react to the news of YPF being nationalized?

AK: He didn't panic. He is a seasoned mining executive who has had to assess political, geological and execution risk on many occasions in the past. I'm sure he was disappointed, but he continues to believe there is good reason to maintain a significant presence in the highly prospective Santa Cruz province of Argentina.

TGR: Apache is there, and it is going to up its investment by 20%. On the gold side, Goldcorp is there. McEwen is there. AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) is there as is Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ). For silver, Coeur d'Alene Mines Corp. (CDM:TSX; CDE:NYSE) is there. Does the presence of these companies provide you with a measure of security in some of your Argentine investments?

AK: Certainly. These global players see the rewards in this region while also recognizing the risks. A junior investor should welcome their activity in the region. Juniors may seek partnerships with the larger players that have significant cash reserves and a desire to grow production in the coming years. Approximately 10 companies are actively exploring, developing or producing in this province. It remains a largely untapped opportunity, and that always attracts me as an investor.

TGR: This is a growing theme in this space that countries, especially in South America, continue to nationalize resource-based assets. It seems like it's only going to get worse before it gets better. What makes it get better?

AK: We don't see the core natural-resources countries in the region moving in this direction. Chile, Peru and Colombia are the other South American countries that remain on our radar screen. These three governments and their respective jurisdictions all function in their own unique way, but we do not see a thesis that what has occurred with YPF, for example, applies to the entire mining sector.

TGR: But Peru withdrew a mining permit from Bear Creek Mining Corp. (BCM:TSX.V). And there's across-the-board resource nationalization via higher royalties and ownership stakes.

AK: Santa Cruz is a tundra, a desert-like environment with very few people and very little surface water. Peru has mountainous areas, ravines and the potential for mining activity to interfere in a negative way with the natural environment and local populations. We need to be careful not to confuse a removal of a permit for environmental purposes and local concerns with a true interference of government due to a desire to nationalize and retain capital within the country.

TGR: Apart from the Santa Cruz province being rather isolated and lightly populated, what else makes it a point of destination for mining companies seeking precious metals?

AK: Santa Cruz is vast but has significant infrastructure-roads, electricity-and also a meaningful level of collective mining knowledge on the ground there, both local and international. Most important, the geology appears exceptional by global standards. It was untouched by the mining industry until the mid-to-late 1990s. In other South American countries there are hundreds of years of artisanal mining. While San Juan has more history with mining and energy, Santa Cruz is in just the first years of what should be several decades of significant exploration and production success.

Larger producing mining companies with clean balance sheets and cash to put to work want to seek out mining companies in this capital markets environment that are on the verge of developing their mines, have already started to develop or are just in the process of producing. The geology is critical, but considering the stage of mine development may be an interesting strategy right now. A mid-stage or predevelopment-stage company is a multibillion-dollar company's acquisitions sweet spot right now. In this challenging capital markets environment for the junior space, there may exist very interesting opportunities for the majors.

TGR: Are you buying companies, with that thesis in mind?

AK: Yes. The geology is exceptional, similar to Nevada in the mid-1800s: outcroppings, very little activity. This is a geologist's and a gold miner's paradise. And we're not day traders in our strategy; we like to make investments, establish relationships with management and see a return on our capital over time.

TGR: You're saying buy-and-hold can still work in this space.

AK: Absolutely.

TGR: What is the typical hold time?

AK: It's significantly above the average holding period for a typical natural-resources strategy, particularly in the junior space. Greater than two years. Our strategy is only 27 months long, and many of the positions that were in the strategy on day one are still there today.

But we also look at every position objectively. We're not beholden to the notion that every position needs to be a long-term holding. If the facts change, if management changes and we do not like the direction of the investment, we will change course as well.

TGR: What are some of your positions in precious-metals equities in Argentina?

AK: The positions that we own at the firm level that have exposure to Argentina are Minera IRL and Argentex Mining Corporation (ATX:TSX.V; AGXMF:OTCBB), but we have several names on the radar screen that we're still doing work on: Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:FSE), Mariana Resources Ltd. (MRY:TSX; MARL:LSE) and McEwen Mining.

TGR: Why did you decide to take a position in Minera IRL, a small, precious metals-focused company?

AK: Minera IRL is an interesting company not only because it is a small cap that is under the radar screen of many investors, but it also represents the characteristics that an acquirer ought to look for in its business model: It has some existing production. It has a huge land resource. It has geographical diversification. It is active in Peru as well as in Argentina-it has production in Peru and is about to build an open-pit mine, Don Nicolas, in the Santa Cruz province. I am impressed with operational management, its geology knowledge base of the area and its willingness to be creative and nimble. The team is highly motivated and organized. It seems to communicate extraordinarily well and work well together across cultures, experiences and skill sets.

TGR: Argentex is developing its Pinguino silver-gold project in the Patagonia region of Santa Cruz province. What do you make of that deposit?

AK: The risk-reward profile of Argentex is different than that of Minera IRL, but I still think it's a compelling profile. It has a resource estimate coming out this quarter, which should prove up the highly prospective nature of its resource, which is a silver resource. This is an asset that is trading at $0.10-0.12/ounce. The company has a bit of cash. It is drawing down about $200,000/month. It has probably $9.5M cash on its balance sheet. I am particularly impressed with the chief geologist over there, Diego Guido. He is also a professor at University of Buenos Aires and has access to other interesting perspectives within the geology space.

TGR: That stock is down about 20% this year. Does that make you nervous, when you see a company sliding 20-25% in less than half a year?

AK: We bought it about 30% lower than current prices. So it's down on a year-to-date basis, but it's a recent acquisition for us. So we're actually quite pleased with where it is at this juncture. I think it speaks to who we are here at Clear Harbor Asset Management, which is a group of patient investors, and it also speaks to a little bit of luck.

TGR: Is that one of the things that you're doing right now, seeing a lot of value out there and cherry picking some of the low-hanging fruit?

AK: Yes. There is some exceptional low-hanging fruit in the mining space at the moment. If you look at any sort of multiple across the space, cash-flowing gold mining companies are trading at historically extraordinarily cheap multiples. There are lots of reasons for that. One is the general nature of capital markets at the moment. Another one is disbelief that we're going to see gold prices remain at current levels and perhaps go higher. Third is the historic transition of capital from the equity gold mining space to exchange-traded funds. There's a significant opportunity to take advantage of these prices and carefully allocate capital across companies that you've done your work on and companies that represent different risks: country risk, perhaps geology risk to some extent and the risk of some being development stage, others being exploration stage and others being operational stage. Having a diversified portfolio is also important at this juncture.

TGR: Eldorado Gold, with an asset in Brazil, tried very hard to buy Andean Resources Ltd. (AND:TSX; AND:ASX), but Goldcorp ultimately won that auction. Do you believe that Eldorado will attempt at some point to reenter Argentina?

AK: Perhaps. It now is integrating the European Goldfields Ltd. (EGU:TSX; EGU:AIM) acquisition. This is a very talented management team. This is a group of people that has outperformed expectations over the last several years. To the extent that it integrates and moves the Turkey plans in the right direction, it wouldn't surprise me if we see it dabbling in Argentina.

TGR: Are Argentex and Minera the only two in which you have positions in Argentina?

AK: Yes, but we are doing some additional work and believe that if someone is looking to allocate capital to the country based on the thesis that the YPF scare is overdone, you want to look not only at Minera IRL and Argentex but also look at Extorre, Mariana Resources, Mirasol Resources Ltd. (MRZ:TSX.V) and McEwen Mining.

TGR: Do you have some parting thoughts on the space at large?

AK: The capital markets are going to continue to challenge the juniors. This is an extraordinary time to be in the driver's seat with capital and to allocate selectively to compelling investments, not just in Argentina but around the world.

TGR: Thanks for your time.

Aaron Kennon serves as chief executive officer of Clear Harbor Asset Management and is a member of the firm's Investment Committee. Prior to co-founding Clear Harbor, he was a portfolio manager at Ingalls & Snyder LLC where he managed multi-asset class securities portfolios for institutions and high net worth individuals. Prior to joining Ingalls, Kennon worked at the Royal Bank of Canada and Citigroup Inc. Kennon is a graduate of Yale University.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.

DISCLOSURE:

1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.

2) The following companies mentioned in the interview are sponsors of The Gold Report: Goldcorp Inc., Argentex Mining Corp. and Extorre Gold Mines Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.

3) Aaron Kennon: I personally and/or my family own shares of the following companies mentioned in this interview: Eldorado Gold Corp., McEwen Mining Inc., Argentex Mining Corp. and Minera IRL Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story.

4) Note that the natural resource strategy was launched as a separate portfolio at Clear Harbor on Feb. 1, but it has been a subcategory within the firm's larger "go-anywhere" strategy since February 2010. Performance figures are unaudited. This is not a solicitation to buy or sell any security.

Streetwise - The Gold Report is Copyright © 2012 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC 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 Reports LLC 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 Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

Streetwise Reports LLC 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.

101 Second St., Suite 110

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Source: Brian Sylvester of The Gold Report (5/16/12)

http://www.theaureport.com/pub/na/13381

Silver has been called the most volatile of metals. But volatility produces opportunity, according to Chris Thompson, a top-ranked StarMine analyst with Haywood Securities. In this exclusive interview with The Gold Report, Thompson forecasts a strong year-end for the devil's metal, despite price weakness so far in Q2/12, and shares the names of a select group of companies that stand to profit.

The Gold Report: Chris, Haywood Securities' estimated silver price for 2012 is $36/ounce (oz), but the "devil's metal" has averaged less so far in 2012, closing above $36/oz only once. Are you expecting a significantly stronger second half for silver?

Chris Thompson: Silver performed relatively well in Q1/12. We hope that the silver price will find support at current levels of ~$28/oz through Q2/12 and Q3/12, with potential for a strong Q4/12.

Looking at the silver price right now, I see that it's struggling to hold its head above $28/oz. If we do see a significant breakdown from $28/oz, it may somewhat compromise our forecast for this year averaging $36/oz.

TGR: Do you think investors shy away from the silver space given its overall size and susceptibility to manipulation?

CT: Silver is often referred to as the most volatile of all precious metals. In that sense, it's not for the faint-hearted investor. However, with volatility comes opportunity as long as timing is right. The benefit that silver provides is that it finds value as a store of wealth, as well as an ingredient used in industrial applications, so it offers investors a dual benefit where silver fundamentals benefit from economic growth as well as economic uncertainty.

TGR: In an April 23, 2012, research report, you told investors to "look for quality over quantity" when it comes to silver equities. What makes quality?

CT: A lot of investors look at the size of an in-situ metal resource hosted by a project when looking for a value opportunity presented by exploration and development-stage companies. They tend to ratio that against the enterprise value (EV) of that company to derive a valuation.

Silver is often mined with other metals as by-products. Just recognizing a straight EV dollar/ounces in the ground valuation can be a little misleading. Also, silver is inherently more challenging to recover metallurgically than other precious metals, which influences operating costs and recoveries.

When you layer these peculiarities into the picture, it becomes a complicated story and one that really cannot be valued based on a straight EV dollar/ounce in the ground valuation. We also look at size potential. We look at operating margins on the tonne, as well as jurisdiction. It's a sector where participants should be evaluated on a number of factors rather than just how much silver they have in the ground.

TGR: What sort of opportunities is the volatility creating?

CT: Silver has broken down from its highs in Q1/12. The sector has sold off, which has been exaggerated in some instances. If you're a believer in silver holding its head above the $28/oz mark, opportunities exist where equities have been beaten up more than they should have been based on weakness in the silver price. When the silver price exhibits volatility, volatility in equities is exaggerated, and that creates opportunity.

TGR: The performance of equities has lagged their underlying commodities in the precious metals space for almost 18 months. Why don't the equities respond the same way when the commodity goes up?

CT: We've definitely seen a dislocation between equity valuations and metal price since late 2010. The Toronto Stock Exchange Venture Index is currently at about the same level it was in in the middle of 2010 when the silver price was $17/oz and gold was $1,200/oz. Equities, whether they're exploration, development or even cash-flowing equities, haven't reflected strength in metal prices for some time now.

TGR: They are, but only to the downside.

CT: In the last six months, we have seen a lot of worry and concern about operating costs; capital costs; and jurisdictional, geopolitical and permitting risk. It's not just a story of metal prices anymore. Performance now relates to a whole host of other factors that determine how quickly and easily development-stage projects can advance to production or exploration-stage projects can advance to development.

TGR: Do you expect more mergers and acquisitions (M&A) in the silver space, perhaps based on this garage sale effect that's going on right now in the equities space? What market factors prompted that conclusion? Is that conclusion unique to the silver space among precious metals?

CT: We have to look at the industry from two points of view. First, we have to look at it from an acquirer's perspective. What companies are positioned to purchase assets? What companies are looking to grow their production profiles through making acquisitions? Second, you have to look for prospective acquisition targets. What companies have good-quality assets that are suffering in today's market because of lack of funding and weak investment sentiment for development- and exploration-focused stories?

What we find in the silver sector is that despite the current soft silver price, operating margins that a lot of silver producers are enjoying are some of the best in the sector. The average industry cash costs for silver producers are less than $10/oz, which implies a healthy operating margin at a silver price of ~$30/oz. A lot of silver producers are generating significant cash flow in this environment.

Realizing that investor sentiment in the mining sector is weak, a lot of companies that are trying to advance exploration projects or development-stage projects are battling to finance the advancement of their development and exploration plans. You coined it-it is pretty much a garage sale out there for exploration and development stories. The acquirers have healthy treasuries and the ability to generate additional cash flow to support larger treasuries and the targets are being starved of funds to develop their project-it's a buyer's market.

TGR: Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE), recently paid AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) $200 million (M) for AuRico's El Cubo gold mine and a couple of other smaller exploration projects in Mexico. Do you believe AuRico will use that cash for M&A?

CT: I can't talk about AuRico, but I can talk about Endeavour. Endeavour is an emerging midtier silver producer. It is currently working toward delivering upward of 5 million ounces (Moz) silver production annually over the next two years. Endeavour and other emerging midtier companies are growing their production base through acquisition. What seems to be a more common acquisition target in the sector right now are not development-stage or exploration-stage projects, but companies with operations. Endeavour's purchase of the AuRico assets fits very well into this focus and is not a surprise. First Majestic Silver Corp. (AG:NYSE; FR:TSX; FMV:FSE) used the same sort of strategy by acquiring Silvermex Resources Inc. (SLX:TSX; GGCRF:OTC). There is, especially in the emerging midtier subsector, a consolidation of players.

TGR: El Cubo's total resource is 1.14 Moz gold and 53.5 Moz silver. At $1,600/oz gold, that's $1.8 billion (B). At $30/oz silver, that's another $1.6B. That's a total of $3.4B in all categories. Even just the proven and probable reserves of 322,000 oz (322 Koz) gold and 18.5 Moz silver amounts to more than $1B. It seems like quite a bargain. Why did AuRico do that deal?

CT: I would argue that this is not a core asset for AuRico. AuRico has a relatively aggressive production growth plan. It is guiding toward more than 500 Koz gold production by 2014. Obviously, this comes with significant capital cost commitments. As far as silver valuation is concerned, Endeavour will pay about $250M for the asset and some exploration projects. Layering that into a reserve base of about 38 Moz silver equivalent (Ag eq), it is paying about $6.75/oz Ag eq. This is a little expensive, but understand that it's a producing asset. The same calculation using the resource base arrives at about $1.70/oz Ag eq, which is fair value for an asset portfolio that includes an operating mine. The value opportunity for Endeavour will be its ability to turn the operation around economically.

TGR: What about the exploration potential of the other two projects that were part of this deal-Quadalupe and Calvo?

CT: They present blue-sky opportunity for Endeavour. More important, Endeavour can generate value for the company by improving the operating efficiency of El Cubo, bringing down cash costs, adding ounces at the operation and developing the exploration assets.

TGR: Did you raise your target on Endeavour after that deal was announced?

CT: No. We still have a target of $10.50/share for Endeavour. We're waiting for the company to finalize the transaction, as well as provide more details about how it's going to be financing the $250M acquisition.

TGR: You were recently awarded the 2011 StarMine No. 1 Stock Picker award for the Canadian metals and mining sector. Congratulations. What are some of your favorite picks among the primary silver stories?

CT: I define a primary silver story as one that's more valuable for its silver metal value than other metals using Haywood's long-term metal price assumptions. We regard Bear Creek Mining Corp. (BCM:TSX.V) as a company that's of interest primarily because of the development potential offered by its flagship asset, the Corani deposit in Peru. In time, Corani could offer +10 Moz silver production annually supported by byproduct credits. There are not too many projects at the feasibility stage of development that can offer that sort of annual silver production potential. Bear Creek is our preferred large-project developer.

TGR: It's a world-class deposit, but Bear Creek is having permitting problems that are preventing its low-cost Santa Ana silver project from moving to production. It can't bring Corani to production without the cash flow from Santa Ana. What's the likelihood of Bear Creek finding a joint venture (JV) partner?

CT: There's concern relating to Bear Creek's ability to finance Corani. The company is in the throes of applying for permits for Corani. We do regard this asset as being financeable. Also, we do regard Peru as a world-class jurisdiction for exploration and project development in the mining space.

TGR: What are the estimated costs to bring Corani to production?

CT: We're looking at just under $575M.

TGR: And it could do that without a JV partner?

CT: Preferably it would like to sell the project for the right price, but the company isn't waiting to be acquired. It is aggressively developing the project to production. The company has just under $100M in cash. Santa Ana was the company's second-tier project. The advantage of Santa Ana was it is a relatively cheap mine to build and bring into production.

TGR: Bear Creek recently hired Renmark Financial to do some investor relations. Will that be enough to change the perception of the company in the marketplace?

CT: We need to see a rebuilding of investor confidence in Peru as a favorable jurisdiction for mine development. The company can't do much more than what it's currently doing to develop Corani. The company needs to continue to promote the benefits of Corani, as one of the world's largest undeveloped and economically viable silver projects, and work with the local communities.

TGR: How about some other primary silver producers? Would you put Kimber Resources Inc. (KBR:TSX; KBX:NYSE.A) in that category?

CT: Kimber, with its Monterde project in Mexico, is a very interesting company. Monterde is a development-stage gold-silver deposit. Based on the company's current stock price, and what the project can offer, it is cheap. We know the company is in the throes of putting together another resource update for Monterde. We see Monterde as being a very attractive potential acquisition target for a midtier silver or gold producer. There's a large gold silver resource with a high-grade core, which has been the focus of the company's current deep drilling program. It's a neat little project from an acquisition perspective.

TGR: Who are the would-be suitors?

CT: There is a small group of companies: Endeavour Silver, Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE) or First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE), a company with operations in Mexico that knows the jurisdiction. It's an asset that would look good in the portfolio of a midtier producer-a company that is aiming to tag on 2 Moz silver production annually with a good gold credit. The challenge is that this group hasn't yet showed any interest in buying projects-just operating mines.

TGR: Kimber has had some good drilling results at depth at Monterde. Could those results change the picture for a potential suitor?

CT: They support the high-grade potential offered by Monterde at depth. Monterde has been mistakenly perceived by the marketplace as being a low-grade project. The drill results that the company has released over the last six to eight months suggest there is a high-grade core at depth. It's going to be very interesting to see what comes out when the company releases its revised resource estimate, which is anticipated in the next month or two.

TGR: We've seen some recent examples of nationalization, most notably in Argentina. The Argentinian government recently expropriated the assets of Yacimientos Petrolíferos Fiscales (YPF:NYSE), which is a Spanish oil company. Could there be ripple effects felt in the mining industry?

CT: It paints Argentina in a poor light as a prospective jurisdiction for mining and exploration. It's very unfortunate this has happened. It creates a lot of uncertainty, worry and fear over development of any resource-based asset in the country. We do like the exploration potential that the country offers. We follow a number of companies in Argentina, one of which has a very substantial land position in the Santa Cruz province.

TGR: Which one?

CT: Mirasol Resources Ltd. (MRZ:TSX.V). It's unfortunate. It's these issues that really are beginning to have an overriding influence on the sector and, in many senses, taking away some of perceived opportunity that higher metal prices offer.

TGR: Do you see that having a direct effect on the share price of companies like Mirasol?

CT: It creates uncertainty with regard to how easy it would be for Mirasol, or any company in a similar position, to advance the development of an asset in Argentina. I do see this development as being damaging to the share prices of companies active in Argentina based purely on the uncertainty that comes with this sort of geopolitical risk.

TGR: Tell us about Mirasol's flagship project and why the company merited coverage.

CT: When we look at an exploration-focused company, we have to be satisfied with the team and the property portfolio that the company offers. Mirasol has a very well qualified, experienced exploration-oriented team and a very attractive property portfolio.

In addition to that, the company has a JV with a major silver producer, Coeur d'Alene Mines Corp. (CDM:TSX; CDE:NYSE). Coeur d'Alene is earning a 61% interest in the Joaquin project, with Mirasol being the JV partner. The Joaquin project is arguably the most important development-stage asset that Coeur d'Alene Mines has, something that is needed to grow its production profile.

TGR: Do you believe that Mirasol is a potential acquisition target given the size and scope of Joaquin and Coeur d'Alene's majority interest?

CT: I think so. We've always looked at Mirasol as being a potential acquisition target. We know Coeur d'Alene's interest in Joaquin and see that as potentially being a trigger for an acquisition based on consolidation of ownership. We also recognize that the company has a very attractive land position, which ranks as one of the most prospective jurisdictions for precious metals exploration today.

TGR: There are a number of interesting silver explorers, even some developers, on Haywood Capital's Watch List. Which ones are you following most closely?

CT: Exploration company Soltoro Ltd. (SOL:TSX.V) could potentially deliver a significant resource base at its El Rayo project in Mexico.

International Northair Mines (INM:TSX.V) may deliver a maiden silver resource at its La Cigarra project in Mexico in mid-year.

Developers Kimber, Bear Creek, South American Silver Corp. (SAC:TSX; SOHAF:OTCBB), MAG Silver Corp. (MAG:TSX; MVG:NYSE), Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:FSE) and Tahoe Resources Inc. (THO:TSX; TAHO:NYSE) may offer development opportunities in the space, as well as producers Endeavour Silver, Fortuna Silver and Aurcana Corporation (AUN:TSX.V; AUNFF:OTCQX) may offer growing production growth profiles.

TGR: How far away is Aurcana from being an American silver producer?

CT: Aurcana is in production. It has two assets, the La Negra asset in Mexico and the development-stage Shafter project in Texas. Our understanding is that it's in the process of commissioning Shafter right now. We're also anticipating a revised resource estimate on La Negra. We're looking at a company that can deliver just over 4 Moz/year silver production at a little north of $8/oz cash costs.

TGR: Tahoe Resources is a very big resource at this stage.

CT: Tahoe is a very interesting company. It's a development-stage story at the moment, but it offers potential to be a near-term producer. The company recently announced a revised resource estimate that showed a 50% increase in Indicated silver resource to 367.5 Moz.

But it comes at a price. The market cap for Tahoe is ~$2.6B. That's what you pay right now for one asset that can deliver $20M silver/year and a potentially higher production rate with further development. Escobal also offers potential to achieve good operating margins.

It's a company we're watching very closely. We want to see the company get its permits. The permit is a very important milestone because it will remove a level of jurisdictional risk.

TGR: What approach to silver equities, especially those in the exploration and development phases, will best serve the average retail investor?

CT: Looking at silver equities is no different from looking at equities focused on developing, advancing and exploring for other metals. One of the most important attributes of any company is management. You need a good team that can deliver efficiencies in what is a relatively challenging time for mining based on a lot of cost creep and margin squeeze. It's all about the team. In silver we look for quality over quantity. Look at the ounces in the ground that will work from an operating perspective rather than just the size of the inventory.

TGR: High grade, too?

CT: Grade, good metallurgy, safe jurisdiction. As I've said before, people throw out silver projects in many senses as offering size potential, but there is no value in having hundreds of million ounces silver in situ in the ground if you can't mine them profitably. Also, be wary and recognize that silver is arguably the most volatile of all precious metals and equities, by extension, are also volatile.

TGR: Thanks for your time and insight.

Chris Thompson was trained in South Africa and has over 20 years of industry experience working as a geologist for major through to junior mining/exploration companies, in addition to a stint working as a mineral economist for the South African state. He has a bachelor's degree from the University of the Witwatersrand, a graduate degree in engineering, a master's in mineral economics and a PGeo designation. Thompson has been with Haywood Securities for over six years and specializes in junior exploration and the silver and PGM sectors. Thompson was recently awarded the 2011 StarMine No. 1 Stock Picker award for the Canadian metals and mining sector.

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DISCLOSURE:

1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.

2) The following companies mentioned in the interview are sponsors of The Gold Report: Fortuna Silver Mines Inc., Silvermex Resources Inc., South American Silver Corp., MAG Silver Corp., Extorre Gold Mines Ltd., Aurcana Corp., Kimber Resources Inc., and Tahoe Resources Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.

3) Chris Thompson: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this story.

4) Haywood Securities Inc. has reviewed lead projects of Endeavour Silver Corp. (EDR-T), Bear Creek Mining Corp. (BCM-V), Kimber Resources Inc. (KBR-T) and Mirasol Resources Ltd. (MRZ-V) and a portion of the expenses for this travel have been reimbursed by the issuer.

5) Haywood Securities, Inc. or one of its subsidiaries has received compensation for investment banking services from Endeavour Silver Corp. (EDR-T), Bear Creek Mining Corp (BCM-V), Kimber Resources Inc. (KBR-T) and Mirasol Resources Ltd. (MRZ-V) in the past 24 months.

6) As of the end of the month immediately preceding this publication either Haywood Securities Inc., one of its subsidiaries, its officers or directors beneficially owned 1% or more of Bear Creek Mining Corp. (BCM-V) and Mirasol Resources Ltd. (MRZ-V).

7) Haywood Securities Inc. or one of its subsidiaries has managed or co-managed or participated as selling group in a public offering of securities for Kimber Resources Inc. (KBR-T) and Mirasol Resources Ltd. (MRZ-V) in the past 12 months.

8) Haywood Securities Inc. pro group holdings exceed 10% of the issued and outstanding shares of Mirasol Resources Ltd. (MRZ-V).

9) An individual officer or director of Haywood Securities Inc. or one of its subsidiaries owns >10% of Mirasol Resources Ltd. (MRZ-V) outstanding shares.

Streetwise - The Gold Report is Copyright © 2012 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC 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 Reports LLC 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 Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

Streetwise Reports LLC 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.

101 Second St., Suite 110

Petaluma, CA 94952

Tel.: (707) 981-8999

Fax: (707) 981-8998

Email: jluther@streetwisereports.com