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Gold: Part of Every Portfolio (Streetwise: THE GOLD REPORT)

By John Embry 
For The Gold Report
April 11, 2003

John Embry is of President of Sprott Asset Management, in Toronto, and manager of the Sprott Gold and Precious Minerals Fund. Mr. Embry, an industry expert in precious metals, has researched the gold sector for over 30 years and has accumulated industry experience as a portfolio management specialist since 1963.

Q: Why do you think that at least a part of an investor's portfolio should be in precious metals?

A: Basically, gold acts contrary to how financial assets act. People have forgotten that gold can be an important part of portfolios. It wasnít important in the 1980s and 1990s, a period of disinflation, increasing productivity and great profit growth in the United States. This underwrote a terrific period in stocks and in bonds. In that environment we certainly didnít need gold.

But what people donít remember, perhaps because a lot of them were not around, was the decade of the 1970s when conditions were materially different. Stocks and bonds did poorly, and there was inflation and a huge budget deficit. There were a lot of things wrong in the American system and in that decade, gold went from $35/oz to $800/oz. Obviously, anyone who realized what was going on bought gold early on and made a lot of money. I would say that in the wake of the tech bubble, conditions will be much more difficult in the United States, and they begun to manifest themselves already.

This is the type of environment in which gold thrives. The budget surplus has turned into an enormous deficit, and there is a debt problem at all levelsĖ consumer, corporate and government, and in the state government in particular. As a result there is going to be an awful lot of money printed. Because there is so much upside leverage in gold and gold shares, if you put 10% of your assets in gold, you can offset most of the problems that may be occurring in the rest of your portfolio. So, I just think in the decade of 2000 to 2010, some exposure to gold would be a very correct thing to do.

Gold is very inexpensive as a commodity right now. And it is a monetary commodity. I believe, against most currenciesĖ particularly against the U.S. dollar, which I think is the most vulnerable Ė the price of gold is going to rise. And it is going to rise a lot.

Q: In your fund you invest in small to mid-cap companies. Is that where you believe the leverage is going to be, as opposed to bigger companies?

A: I think the big boys will work; you can make good money in the big stocks because they have lots of ounces in their reserves. But the real leverage will come in the smaller ones because they have growth capacity ó the capacity to dramatically increase their reserve bases and increase their production. They tend to be more cheaply valued to begin with. If you can find the combination of a reasonably valued mid-cap or small-cap company with an interesting ore body that is in a growth phase, you are going to make an enormous amount on your money. We did that in the recent period, and it was interesting that very few people noticed what was going on. There wasnít a significant inflow into gold funds. That is still to come ó I believe in the next up-leg in the gold market, the public will take notice.

Q: Can you tell us about some of the companies youíre excited about?

A: Eldorado Gold Corp. (ELD.TO) has a producing mine in Brazil, but more importantly, has a very large ore body that they just completed a feasibility study on in Turkey that will be coming into production in a reasonable timeframe. And Minefinders Corp. (MFN) has been very successful. It has a large ore body, roughly 4 million ounces equivalent of gold, in their Dolores project, a gold/silver property in Mexico, which is under a feasibility study so it is well advanced. High River (HRG.TO) is basically developing and has producing mines in Russia. This still has not been fully recognized in the price and to date it has been a successful venture.

Q: Goldcorp (GG) is one of your holdings as well?

A: Yes, Goldcorp has been one of the great success stories of the gold cycle to date. They operate arguably the richest mine in the world and they are accumulating enormous amounts of cash and are very hopeful of finding greater amounts of ore in their current mine. It doesnít have the same leverage as the others because it is expensive in relation to its existing reserves, so it is a good holding, but not something I would be looking to for maximum leverage.

Q: Any other smaller companies youíre excited about?

A: One of the names that I am excited about is Orvana Minerals Corp. (ORV.TO), which operates in Bolivia. They are just bringing a mine into production, and it will be a 70,000 ounce producer right at the start, with operating costs of probably less than $100/ounce to take it out of the ground. The greater appeal is that the ore body is open at depth and the last hole that they drilled at depth is the richest or richer than the existing ore body. There is a lot of potential at depth and a lot of potential along strike because the company, for the longest time, didnít have enough money to explore. Now they will throw off a lot of cash flow. They also have second ore body, so that if the gold price rises into the $375 area, it represents another couple of million ounces. It has everything that I am looking for ó production coming on, as well as a great amount of potential in the existing areas where production is going to be, and a secondary ore body that will provide more leverage in the event that the gold price goes higher.

One that isnít anywhere close to production but is probably one of the most exciting plays in the world is called Southwestern Resources (SWG.TO). The company is earning a 90% interest in the Boca Project in southwest China near Kunming, a city of about 4 million people. I just returned from China where I actually observed the potential ore body. The company, headquartered in Vancouver, is run by a couple of really smart geologists who have been putting together properties from all over the world for a number of years. They generally use other peopleís money to explore. This one was so exciting they are spending their own money because they want to retain the maximum exposure possible. Chinese operators already put in 133 tunnels, and these tunnels are just crawling with gold. The Chinese have a small mining operation going on and it confirms the richness of the ore. They have been drilling into the mountain and at this point, just based on what they have found already, they probably have 10 million ounces. So this is just one of the potential home runs. The price has moved up a lot - from $3 to $14, but the $14 reflects what they have already found and it is open all over the place. Again China tends to be discounted, because people are a little concerned about China, but I donít think they should be. I think since China got into the World Trade Organization, they are taking in enormous amounts of foreign capital, and I donít think they will start not respecting property rights. It is cheap to operate over there, obviously. I think it is a really exciting story.

NovaGold (NRI-TSX) has also been a great success. They have the Donlin Creek project that they got from Placer. Placer retained the back-in rights, but Nova Gold did a terrific job exploring the property and getting a significant resource base that they talk of in terms of 10 to 20 million ounces. Placer had an existing back-in right when they turned the property over to NovaGold and they have backed in for 70% of the property by agreeing to spend $30 million to take it to feasibility. NovaGold is not as interesting now as say, a year ago, when they went from $1 to $5, but it is still a solid story. There are a lot of ounces; even their 30% of the ore body is significant.

Another company I like is a company called QGX. It is priced around $1, which is a nice price. They have a large land spread in Mongolia, and they also have an interest in three advanced exploration prospects in the south Gobi desert of Mongolia that are being actively explored by Ivanhoe Mines Ltd. I think it is a very inexpensive exploration play and we own a lot of that stock.

Q: What about some mid-tier companies?

A: Two mid-tiers that I like are IAMGOLD Corporation (IAM) and Wheaton River (WRM.TO). And Glamis Gold (GLG), if you go up the scale a bit. Cambior is also interesting óthe stock is very under-priced. There is still an issue with their hedging. We have a large position and I like it because it is very cheap and I think that the hedges will be addressed. When that happens I think that will unlock the value in the company.

Another interesting company is Central Fund (CEF-AMEX). For the bullion players, it is a very clean way to play it, a great way for individuals to buy gold and silver bullion without all the hassles of storing it. Buying and selling gold is difficult, and there is also the issue that if you buy gold certificates you donít know if the gold that is allegedly behind thema is really there. So you want a fund where you know the gold is in the vault, with your name or the fundís name on it. I think that what you will see in the not-too-distant future is more vehicles of this type emerging as the public begins to recognize that gold bullion is a good thing to own. Right now, the Central Fund has the stage largely to themselves.

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