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Outlook on gold and mining stocks By Kenneth J. Gerbino                      April 16, 2004

Kenneth J. Gerbino & Co. is a money management firm based in Beverly Hills, California and has been investing in precious metal mining stocks for 30 years. Their managed accounts in precious metals investments were up over 100% in 2003. Additionally, the Gerbino Gold Group LLC. is a private fund investing in precious metal stocks.

Some will remember Ken as the Founder and Chairman of the American Economic Council, the lobbying group established in 1979 and credited for the passage of the Gold Coin Act of 1984, which brought the American Gold Eagle Coin into being.

The GoldEditor.com interviews opinion leaders in the metals market, surveying the landscape for new trends – and new companies – which our subscribers might find intriguing. After meeting fund manager Ken Gerbino at a recent mining investment conference, we arranged an interview to explore his views on the metals market.

Ken shared his views on the mining market in general with us, along with some of his top picks in the sector. His exhaustive research methodology, developed over the last 30 years, allowed us to peek at how he values one of his favorite holdings - Northern Orion Resources (NTO-AMEX, NNO-TSX). His industry experience and his detailed number crunching gave us a fresh new look at the company.

GE: 2003 was a very good year for the mining sector, what’s your outlook for 2004?

KG: Most commodities with gold and silver and the base metals will go up in price in 2004. Long term global monetary increases are now affecting commodity prices coupled with strong demand, led by very robust demand from Asia. I think gold will trade between $375 and $450 this year, which would be bullish for the mining companies especially those that have a good growth profile. After 2004 gold will trade higher.

A major upswing commodity price pendulum is starting that could last for a decade. Past bull markets in metals were always cyclical and short term. China and India have changed all this. We are witnessing the beginning of a multi-decade demand driven bull market in resources….and at the same time we are at the tail-end of 10 years of one of the greatest money printing binges the world has ever seen by almost all countries, especially the U.S.

These two mega-trends are now coinciding and the result will be higher prices for natural resources. I would be very happy with a gold price of $400 for the next 10 years, as there are always opportunities in the mining sector. But the fundamentals favor a higher price.

GE: How will this play out in regards to gold?

KG: This is an historic change in mankind’s progress. People are just starting to grasp this. China is now the number one consumer in the world of copper, steel, platinum, zinc, and iron. They produce more steel than Japan and the United States combined. There are more cell phone users in China than in the U.S. Over 200 million users now. I was just in Beijing. China is booming. I saw 3 cops in 7 days in a city of 18 million people. Communism is a joke. The army, unions, in fact almost every organization owns businesses and has investment pools. Capitalism is everywhere.

The U.S. and Europe consume 11 grams of gold per capita annually…about a third of an ounce...and most of that is jewelry. When China catches up on a per capita basis it will be equal to 5 times the global mine production of gold annually! Even a 10 % demand increase over annual mine supply is huge in terms of the gold market…this will be 50 times that…and these numbers are mostly just for jewelry. This is what is coming. The Chinese currency was wiped out in the late 40’s…so they know the value of gold as a currency also. The investment demand from China coupled with jewelry demand will change the gold equation for decades to come. Now lets be very logical here. The mining companies have to replace 84 million ounces of production from reserves each year. That’s the equivalent of finding 17, five million ounce deposits a year. This is impossible. I’ve seen maybe one five million oz discovery in the last two years. So from a longer-term supply viewpoint a squeeze is developing as well.

GE: Interesting. Tell us what specific criteria you use to evaluate mining stocks?

KG: If it’s a developing story I always look at the grade (richness) of the deposits and try to get a handle on the dimensions of the mineralization before anything else. If it’s a producer, I’m looking at two distinct parts to the equation…the usual suspects…net asset values, net present values, cash flow, mining costs per oz, but I am also looking at the most important projects in their pipeline that have yet to come on stream. Here is where the value proposition can change.

We do our own in-house version of a stripped down scoping study (preliminary engineering report) on properties. We pencil out 30 or so factors that we believe are crucial to the project’s viability. Years ago we use to have 80 factors extrapolated out 15 years for all these companies and it was overwhelming and too complex. I have now narrowed it down to the nuts and bolts. This allows us a rough but very important advanced look ahead of Wall Street by sometimes 12 months on the value of a deposit or discovery. It allows us a jump on analysts that are waiting for resource calculations and engineering reports from management. After 30 years of analyzing mining stocks and making every mistake in the book, I feel this is the best method.

The grade of the resource to me is the key variable that must be there. Managements can look pretty good with higher-grade deposits whether open pit or underground. Grade allows you to make up for a lot of problems that usually occur in most mining operations. Of course, good people are essential …a good mining operation usually means the management are good problem solvers. Ideally, we like companies already with production and with very large precious and base metal resource projects (for gold a 3 million oz minimum resource potential) in development. Here is where you get value and growth.

GE: You are known for not speculating on grass roots exploration plays... why?

KG: Grassroots (early) exploration plays are probably the highest risk investments around and should be avoided. Years ago the ratio was something like only one out every three thousand exploration companies ever produced an ounce of gold or silver. Advanced exploration and development plays with at least some defined resource are sometimes okay for high-risk takers, but one has to be very careful here. The advanced projects at least have enough drill results and preliminary engineering questions somewhat answered to allow you to make an intelligent decision. I also tend to discount early stage chip samples, float samples, anomalies, or channel sampling from outcrops or trenching…all important data but still in the very high speculative realm…probably 10,000 failed properties all had some good showings on surface…it’s just not enough. Until you have multiple drill results and the direction of those holes and some handle on the lithology (rock formation) and other geological data you really are still in a crapshoot.

GE: Long term, where do you see the price of gold and silver?

KG: Gold will do what everything else has done in this world…go up in price...and for the same reasons; Printed money. Paper and credit created out of thin air. Investment demand for gold will have three phases. It looks to be a long bull market. The first phase is happening now, the US dollar weakness. Gold correlates to the dollar 56% of the time in opposite directions. The weak dollar reflects two fundamentals regarding the U.S.: a debt ridden economy and a paper money dependent nation...two fundamental economic tidal waves that will not go away any time soon.

After this phase will be global inflation…that will propel gold up most likely in terms of all currencies. The third phase will be based on fear of a banking and credit collapse and this could cause the largest move up. When people fear that their monetary assets could actually desinigrate by default or bankruptcy they will turn to gold for insurance.

Even a small percentage of the global investment or savings community doing this would be very bullish for gold. Homestake Mining going from $40 in 1926 to $544 in 1935 was because of fear of debt defaults and banking collapses not inflation.

GE: Do you see any changes with the Central Banks position on gold as a reserve asset?

KG: It’s hard to believe that these guys think they can print wealth…and also think that interfering with a free market in interest rates, and currency values is a viable economic option. Sooner or later this will all fail. Some country will break ranks eventually and revert to sound money and hence validate gold as the only reserve asset. It will probably take another generation to finally expose the many flaws of paper money and central bank policies.

I am hoping the Chinese and Indians take the lead here in the next decade. The non-monetary establishment is still being hoodwinked by the financial and banking establishment. The recent Argentina crisis was promoted to everyone as a debt crisis when in actual fact it was a currency crisis…a printing press crisis. None of the major newspapers in our country called it like it really was. They either didn’t understand it or didn’t want to rock the boat.

Someone needs to get an editorial board meeting with the NY Times and get them to understand just two things…printing paper money is bogus…and a gold standard is a lot simpler and easier than people think. It’s like a ruler…a standard of measurement…12 inches to the foot..every day…every year….it never changes. The gold standard is also simple, it’s a standard of value for a medium of exchange…money…and the standard shouldn’t change either. If the NY Times “gets it”, then the world changes.

GE: Will interest rates going up be negative for gold?

KG: Interest rates are very low and gold in my opinion is undervalued…. so both can go up from here together for sometime. In the late 70’s I remember rates going up dramatically and gold exploding upwards also. Gold holders who own 5% or 10% of their assets in gold as an asset class for diversification or insurance will not sell gold because they can get 8% in a money market. ...They may sell conventional stocks and bonds to get that 8% return but the typical gold holder globally would most likely add to his/her position over time regardless of interest rates. Don’t forget most gold above ground is on women’s bodies or in jewelry cases…interest rate insensitive.

As far as central banks go…yes, they have been selling off their gold reserves but they have more or less kept their selling to about 300-500 tonnes per year for decades. European central banks just signed a deal limiting sales to 500 tonnes a year for 5 years. This was seen as a non-event in the market. Getting back to interest rates… remember that interest rates will go up when inflation goes up because interest rates must keep up with inflation or the banks would become illiquid. So as rates go up due to inflation so will gold, as it is an inflation hedge.

GE: Where do you stand on the Inflation-Deflation debate?

KG: There has never been an economy or country ever that has had a multi-year deflation with a paper money system. End of argument. Paper money increases always brings on inflation….always. Japan in the early 90’s had stock and real estate prices collapse …that is not a deflation that’s investment sectors collapsing ……totally different animal. Inflation is a decrease in the purchasing power of the currency not your net worth. The whole deflation argument was started, as it always has been throughout history, by those institutions that want to print more money to bail out various big and powerful institutions that are failing. To justify inflating, they scare people about deflation…a slick strategy that still hoodwinks the non-financial establishment. Printing money depreciates the currency and redistributes wealth from the lower and middle class earners of a society to the big, the bad and the ugly. Anyone interested in reading more about this can go to my website at www.kengerbino.com and read my commentaries.

GE: Thanks for your time Ken and good luck.