In the topsy-turvy gold equities market, it can be difficult to spot junior mining firms capable of delivering substantial pay-offs. In this exclusive interview with The Gold Report, top market analyst and Resource Opportunities newsletter editor Lawrence Roulston identifies undervalued firms from Africa to British Columbia that have high-quality assets, access to development cash, solid management teams and bright futures.

COMPANIES MENTIONED: EXTORRE GOLD MINES LTD. – GOLDQUEST MINING CORP. – KAMINAK GOLD CORP. – KEEGAN RESOURCES INC. – MILLROCK RESOURCES INC. – NEW GOLD INC. – NEWSTRIKE CAPITAL INC. – PAGET MINERALS CORP. –PRETIUM RESOURCES INC. – RIVERSIDE RESOURCES INC. – SANDSTORM GOLD LTD. – SUNRIDGE GOLD CORP.

Lawrence Roulston: Most of the gold in the world is held for the long term. Only a small portion of total gold holdings is actively traded. Short-term price fluctuations are largely the result of traders reacting to news. A long-term chart of the gold price tells the real story. Gold is trending higher and there are short-term fluctuations, but the long-term direction is obvious.

The important message is that the long-term outlook for gold remains extremely bullish. The gold producers have an ongoing need to replace reserves, and they want to grow their businesses. That’s the basis for viewing the exploration and development companies. You’re going to beat yourself up trying to figure out what the next short-term move is going to be in the gold price, but if you take this long-term uptrend seriously and look at the companies developing deposits that are likely to be taken over by the larger companies, that’s a much better way to play the gold market.

TGR: In February, you told The Gold Report that for gold shares, “the worst is over.” Do you still feel that way? Are there signs that a bottom for equities has been reached?

LR: That call was premature. There was a brief rally. It turned around when the gold price dropped. The U.S. dollar replaced gold as a safe haven as people fled from the uncertainty in Europe. At that time, I differentiated between the resource markets overall and the higher-quality junior companies. The message still applies. Better-quality companies with good assets, cash on hand and strong management are building strong bases in their share prices at this time. Some of these companies have come down to the bottom and are trading at cash value. There is not a lot of downside once they’re trading at cash value.

We are in the midst of the summer doldrums. People aren’t really paying attention to the junior markets. That’s going to change in September when people come back from holidays. Investors are going to recognize that companies with good assets are trading for cash value or near that level, and that there is more upside potential than there is downside risk.

“The long-term outlook for gold remains extremely bullish.”

The big factor that is really going to drive the markets is takeovers. We’re seeing it now. For instance, Avion Gold Corp. (AVR:TSX; AVGCF:OTCQX) just received a takeover offer that was a 70% premium to its 20-day trading price. There are going to be a lot more offers like that, and that’s going to make savvy investors pay attention.

TGR: In terms of companies trading at or near their current cash value, are there any firms that you think are a good deal for investors right now?

LR: Keegan Resources Inc. (KGN:TSX; KGN:NYSE.A) has $200 million (M) in the bank, and its market value is not a lot more than that. It has a 5 million ounce (Moz) good quality gold deposit in Ghana. That’s an example of how irrational the valuations are in this market now.

TGR: Speaking of rationality, what specific political and economic trends are affecting the price of bullion and the price of gold equities?

LR: Short-term prices are impacted by news headlines, but headlines are not all that accurate. We hear constantly about the slowdown in China. In reality, China is the largest consumer of metal and its economy is growing at better than 7% a year. That’s less than the 8–9% growth of recent periods, but it’s still a phenomenal pace of growth for the second largest economy in the world.

TGR: What about the so-called euro dilemma?

LR: The situation in Europe is the most significant element impacting investor sentiment. Markets have pretty much discounted a complete collapse of the euro. Personally, I don’t think we’re going to see a complete collapse of the euro. I think a more practical outlook is that the powers in Europe are moving ever closer toward a wide-open monetary easing in the same way that the Americans used monetary policy to overcome the 2008 global financial crisis. And it worked very effectively in the U.S. The American economy is not booming yet, but it has certainly rebounded from a recession to a period of slow growth.

TGR: What would be the effect of quantitative easing in Europe on gold investors?

LR: Over time, it will be very positive for hard assets in general, and especially for gold, but also positive for the whole range of commodities. Monetary easing depresses the value of currencies. It’s inflationary. Hard assets like gold and other metals are going to effectively hold their value in real terms as the value of currencies decline. In the long term, the easing could be very bullish for commodities in general.

TGR: Given that now is a good time to bargain hunt for junior mining stocks, what standards should investors use when evaluating whether a particular junior has a solid chance at making it through the next year or so and emerging as a contender?

LR: The biggest payoff for a junior exploration company comes with a new discovery. We saw that recently with GoldQuest Mining Corp. (GQC:TSX.V). In a period of three months, its stock price went from $0.05/share to $1.50/share. But, unfortunately, discoveries like that are not very common. Investors must balance risk and potential reward by buying companies that have a solid asset combined with a realistic prospect of a takeover. The value of a quality asset increases as the owner expands and upgrades the resource by conducting engineering studies and moving toward production. Companies with solid mining assets and good management teams that are advancing toward production provide the best balance.

It’s hard for companies to raise money. Financings can be dilutive to the point where a company may never recover. But enterprises with cash in hand are in strong positions. And companies with good assets and strong management can still raise money. Pretium Resources Inc. (PVG:TSX; PVG:NYSE), for instance, is presently raising $18M in a flow-through financing that’s priced at a 25% premium to market. To be a winner, a project has to have size and it has to have grade. It has to be well located with regard to infrastructure and jurisdiction. Now, having said that, the number of good jurisdictions is shrinking. The most recent downgrade came as Bolivia announced the takeover of a project from South American Silver Corp. (SAC:TSX; SOHAF:OTCBB). It’s getting harder and harder to find good-quality assets in favorable jurisdcitions.

TGR: Is that good or bad for the junior investor?

LR: Long term, it’s good. The value of the good-quality assets will appreciate. In decades gone by, there was a surplus of good-quality metal deposits available for development. When metal prices rose, a lot of new deposits came onstream and knocked back the metal prices. We saw that cycle repeated several times over the last few decades. But the situation has dramatically changed; there is no longer a surplus of good-quality assets. Finding large, high-grade deposits is getting harder. That means that when a company makes a discovery, the discovery is more likely to yield a high value for shareholders.

TGR: Looking at the relative share prices of junior companies over a two-year window, we see some that are still holding value, despite some downturn in share price. For example, Newstrike Capital Inc. (NES:TSX.V) was $0.40/share in August 2010 and now it’s $1.80/share despite having risen as high as $3.40/share in the interim. There are other firms with similar stories. Do you consider this type of comparison to be an indicator of company strength for the long term?

LR: Yes, those price ranges are good indicators of value in this market. There are several ways to explain undervaluation of high quality firms. Some individual investors are terrified and are selling across the board; they want out of all equities. Another huge component in the selling is investment funds, hedge funds and other institutional-type investors who came into the resource sector not really knowing what they were doing. Now they are looking to get whatever they can get for their positions. Consequently, sophisticated investors are picking up great bargains. That companies like Newstrike are still holding value indicates that they have tangible assets and solid management.

TGR: Are there other companies that you are looking at that are holding value comparable to Newstrike?

LR: GoldQuest is up from $0.05/share to $1.80/share in a period of months after a discovery. Where it will go from here, who knows? It will depend on the next drill results.

Pretium is up 2.5 times over the last couple of years.

Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:FSE) has doubled from two years ago; Sandstorm Gold Ltd. (SSL:TSX.V) has tripled.

These are all companies that have good management and solid assets, which are getting recognition from, in the case of Extorre, another mining company, and for the others, from investors who understand the sector.

TGR: Are some of these juniors with relatively low stock prices benefiting from joint ventures with seniors?

LR: Absolutely. I’ve always been a fan of the joint venture approach to exploration. It’s a very high-risk business, and it’s better to use other people’s money for the early-stage exploration. For example,Millrock Resources Inc. (MRO:TSX.V) has held up better than some other companies because it benefits from senior companies that are funding the work on its projects. Another example of that synergy isRiverside Resources Inc. (RRI:TSX), which has held up well in a really tough market.

TGR: Can you be a little more specific about Riverside and what’s going on there?

LR: Riverside is a prospect generator-type company that has initiated many exploration projects. A number of juniors and seniors are funding work on its projects. It’s focused on North America, so it’s in good political jurisdictions. It has two deals where it has entered into strategic alliances to conduct regional exploration programs, one in Mexico and another in British Columbia. That kind of business model is very effective, especially for a company like Riverside that is able to attract the big companies that can afford aggressive exploration programs.

TGR: You mentioned Millrock. Can you tell us a little bit about what’s going on with that firm?

LR: Millrock has quite a number of exploration projects in Alaska and also in Arizona. It has joint ventures with senior companies. Quite a lot of work is going on at the moment. Any of those projects could turn into a major discovery.

TGR: Tell us more about Newstrike. What makes it attractive?

LR: Newstrike is working on a project in Mexico in a very prolific gold belt. It has a big property position and has made a discovery. It is systematically drilling off the discovery and has potential for additional discoveries on its property.

TGR: I wonder about Africa, which has a host of political and infrastructure obstacles. Are there any undervalued juniors operating in eastern Africa that have drawn your attention?

LR: I like Sunridge Gold Corp. (SGC:TSX.V) a lot. It has a very good project at the feasibility stage. It is gold and base metals. In this kind of a market, investors don’t want anything to do with a country like Eritrea, but Nevsun Resources Ltd. (NSU:TSX; NSU:NYSE.A) has been very successful in that country, has developed an operating mine and was able to raise debt financing in the international markets. Sunridge is on the same path to mine development. At its current share price, it’s way undervalued. “I like to focus on firms that have a tangible asset in hand.”

In the face of growing fears of a renewed global plunge into economic depression and a climate of low apparent price inflation, investors might expect commodities and precious metals to be falling in price. Instead, gold continues to hover around a relatively high $1,640 an ounce and silver at $29. At the same time, central banks – including those of the ever more important China, Russia and India – continue aggressively to buy gold.

At a time when very complex financial instruments allow for the seemingly effective hedging of all manner of risks, why should precious metals, which ostensibly involve considerable downside risk, continue to be attractive? Simply, investors in precious metals see traditional risk management instruments as too dependent upon the challenged financial markets that they fail to represent true and ultimate insurance.

The 2008 financial crisis was rooted in a property bubble, but was magnified when reckless risks were often passed on to unknowing, conservative third-parties. This was accomplished by means of increasingly sophisticated and deceptive financial instruments. When the unthinkable happened and property prices turned down, the highly interconnected Western financial world was awash with toxic assets and so-called hedge instruments, including derivatives. At one stage, total financial collapse threatened, so governments stepped in to absorb these toxic assets or pass them off to more solvent banks.

To most observers, the threat was averted. To others, it was merely hidden in banks, central banks, and national treasuries. The result is that massive, latent deleveraging continues to threaten Western economics and cast doubt on all categories of paper assets. Among other consequences, this has raised the prospect of a dismantling of the euro, the world’s second currency. And yet another round of political and central bank interventions have been taken to avert this outcome.

Despite its posturing, Germany wants the EU to survive as the domestic market for its exports. As long as Germany sees the euro as vital to EU survival, she will support the continuation of the status quo, even if it is necessary to support prostrate economies like Greece. But even Germany’s treasury could become overwhelmed attempting to finance and support all the PIIGS (Portugal, Ireland, Italy, Greece and Spain) in its pasture.

At each stage of the operation to paper over the growing threat of national insolvency, the actions taken by regulators, financial companies, central banks, and governments become not only increasingly desperate, but also expose the systemically vulnerable global financial system to unforeseen shocks.  Sensing this, more players turn to precious metals as an escape.

Looking at the current international financial shoring up operations is like looking at an old, massive dam which has suffered structural damage from earthquakes. Unwilling or unable to rebuild the dam, politicians have been content to pour cement over the cracks. Not only is this unsound engineering, but it also hides the real cracks from plain sight. As such, no one knows from where or when the next potentially fatal fissure will come.

Right now, all eyes remain trained on Europe. If Germany were to overplay its hand within the eurozone, the common currency could collapse. That would throw the $600 trillion derivative market into panic, threatening the viability of most of the Western world’s prime banks, commercial enterprises, and even governments.

Judged by recent experience, it would likely lead initially to a surge in the US dollar as investors sought perceived ‘safety.’ Indeed, foreigners now own some $6 trillion, or almost 40 percent of the US Treasury’s debt. However, with Treasury debt now at 102 percent of GDP, the United States has joined Portugal, Italy, Ireland, Iceland, Greece, and Japan in the ignominious club of nations with debts larger than their annual production. Should this fact start to worry overseas holders (let alone domestic owners) of Treasury debt, a collapse of the US dollar could follow. The undertow of a sinking dollar could drag down a massive web of closely interrelated and sophisticated hedging securities and vehicles. Indeed, a mass of financial assets previously perceived as ‘uncorrelated’ would appear suddenly to be correlated all too closely in collapse. A sudden absence of bid prices, even for prime securities, would devastate paper fortunes across the West.

However, those who hold precious metals as a hedge should escape the worst of the fray. If the last decade is any indication, keeping in mind that past performance is no guarantee of future results, gold is still regarded as a true safe haven – its appeal growing as other paper reserve options are exhausted. In the event of a Western collapse, not only gold and silver, but all commodities will still be in demand across the developing world – itself insulated from Western foibles by its high domestic savings and tremendous productive capacity.

The current high prices of precious metals, in the face of possibly deep economic recession, indicate that the prospect of a sudden and catastrophic financial collapse is very real. Indeed, as long as politicians continue to ignore the real implications of the uncertainty they are creating, gold and silver should continue to set new nominal highs.

John Browne is a Senior Economic Consultant to Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.

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