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Banking on a gold stock and worrying about banks

This U.S. advisory has the inside story on a Canadian gold mine in Mexico and some stern words on the way the credit crisis is unfolding.

Banking on a gold stock and worrying about banks

This U.S. advisory has the inside story on a Canadian gold mine in Mexico and some stern words on the way the credit crisis is unfolding.

It would be easy to launch into yet another dirge on an unhappy day on the markets. But we’re not sure a great deal could be accomplished at the moment by re-hashing this sadly familiar scenario. Why not talk about a stock instead?

We admit this stock is not for everybody. (We wonder if any stock is for everybody, especially in today’s troubled markets, but we don’t want to get too philosophical.) It is a Canadian gold mining firm with properties in Mexico that is recommended by a U.S. advisory.

The advisory, Doug Casey’s International Speculator, specializes in these stocks and the editor never fails to give a detailed report on the people, properties and prospects of the juniors he follows. This advisory’s reports represent a sort of “how-to” primer on investing in juniors. You can never know too much.

We won’t avoid harsh realities altogether. Mr. Casey has turned to one of his associates to assess the financial crisis that is behind the market mayhem, and that assessment is not kind to the banking community.

Getting the story out

People get first billing in this advisory’s report on junior gold miner Pediment Exploration (TSX/V-PEZ), which also trades on the Over-the-Counter Bulletin Board in New York and on the Frankfurt exchange.

Some observers are concerned that the president and CEO has made his mark in investor relations, not in mining or geology. Not Mr. Casey. He gives the CEO high marks for being “absolutely relentless in getting the story out.” The absence of promotion is a serious weakness for many juniors.

In the editor’s opinion, the stock chart clearly shows the consequences of the top man’s promotion of “the company’s technical team’s excellent results on the ground.”

On the ground, Pediment has a director and vice-president of operations who spent many years as the head of Mexican exploration for copper giant Phelps Dodge before it merged with Freeport-McMoRan Copper & Gold Inc. The key Mexican geologists are an impressive lot as well, reports Mr. Casey.

So far, so good. What about the gold?

Million-ounce potential

Pediment has ten 100-per-cent-owned properties and more work ongoing. Most are in northwest Mexico along well-established gold and silver belts. One is in the San Antonio gold district at the tip of Baja California.

This is a long-time mining town with good infrastructure, including power lines running through the project zone. This is no small point. Having such amenities as established transportation routes and a power supply in place can be a big advantage for a junior, in cost savings alone.

When Pediment started up, San Antonio had a 350,000-ounce historical gold resource, owned by current major Kinross Gold (TSX-K) when it was still known as Echo Bay. Pediment has done additional work in this area, but has found an even more important strike a few hundred metres away.

Unless you’re a geologist, the drilling numbers won’t mean much to you. Suffice it to say they are highly encouraging to Mr. Casey and his colleagues. While the project is still in its early stages and needs more work (it may even connect with the historical deposit cited above), “there’s no question in our minds that PEZ has found something that looks economic,” states the editor.

While the company must frame its press releases in conservative language that won’t run afoul of regulators, “we have no qualms in saying the project has multi-million-ounce potential,” adds Mr. Casey. “It may not, of course — this is speculation we’re talking about — but we’d be very surprised if the first resource calculation didn’t yield well over a million ounces of gold.”

Three things stand out: the deposit is getting larger, the average grade is superior to most bulk tonnage targets, and the oxidation reaches deep, which means that much of the gold should be relatively cheap to produce.

The news from Mexico

Politics always figures into Mr. Casey’s calculations. Are the local politicos friendly to miners, or is there a chance they will turn on them? Mexico gets full marks as a stable, pro-mining jurisdiction, as does the state government in Sonora.

Next on the agenda is news. When the drilling pauses and a first estimate is done, it will catch a lot of attention. It’s important to stay on top of the press releases. The company has other projects on the go, too, and they will surely be heard from.

Not least, you have to have the money to keep the drills working. Pediment seems fine in this regard. It has a relatively tight share structure, says Mr. Casey, and it has just completed a C$17.5 million financing, consisting of 5.8 million units at C$3 per unit.

More ounces than the market realizes?

Finally, the share price. “Pediment is a straightforward speculation,” concludes Mr. Casey straightforwardly. “Good people picked up highly prospective properties while they were cheap and now the work seems close to yielding results.”

The share price has already given the company credit for ounces it can’t yet prove it has, he adds. “Our speculation is that PEZ has more ounces than the market yet realizes — and that gives us the upside from the company’s other projects for free.”

The stock had retreated in December, and sat at $2.69 when this issue was published. This is a good entry point in Mr. Casey’s view, although “there’s every reason to try and get in under the current market.”

In fact, the share price opened at $2.62 this morning. Many investors will not be all that eager to invest in a junior in times like these, but those who should find out at least as much as we have detailed here, and probably more. It doesn’t matter who does the homework, as long as you get the right answers.

Give with one hand, take with the other

On the international banking scene, the European Central Bank rode to the rescue of the continent’s banking system with a $500 billion package in December. Except for one thing: what it was giving with one hand, it was taking away with the other.

This is the conclusion Mr. Bud Conrad comes to in an article for the International Speculator. Even as the central bank was sending a flood of new money into European capital markets (partly to keep the euro from overpowering the dollar), it was taking money away from the same markets. That is, it continued to collect the fixed-term deposits it receives from commercial banks.

“A dead-beat brother-in-law might look rich by spending a lot of money,” says Mr. Conrad. “But if he’s just borrowing to spend, he’s not rich. To see how rich he is, you need to see the difference between his spending and his borrowing.”

According to Mr. Conrad’s calculations, the results came down on the dead-beat side. While the central bank was making news for its big loans, it was quietly taking in more than it was putting out. So much for stimulating the system.

Does this mean the central banks aren’t up to the job?

A solvency crisis

There are two problems to contend with in the credit crisis: solvency and an unregulated financial structure.

Here is how Mr. Conrad describes the first problem. “Paul Krugman, the economist, describes the difference between liquidity and solvency for the case of a bank that is rumored to have lent a big sum to a losing enterprise. If the public panics and wants their deposits, there could be a run on the bank.

“If the rumor is false, the bank may need short-term liquidity to tide it over until the loans are paid back and everyone is made whole. That is a liquidity crisis. But if the loan is really a loss, the loan (liquidity) won’t help, as the bank may go out of business. That’s a solvency crisis.”

And that is what we have on our hands, says the author. Dealing with liquidity problems may be old hat for the Federal Reserve Board, but that ‘s not the problem now.

“Banks have taken losses, and may be hiding still more losses that threaten their very existence.” Even without actual bank failures — although it wouldn’t be surprising to see some — a solvency crisis cripples the ability of banks to lend and thus cripples the economy.

“Closed For Vacation”

Collecting the numbers from various sources, Mr. Conrad estimates the total writedowns since the crisis got under way last summer at $100 billion dollars. And that’s just in the U.S. The problem is, nobody really knows the size of the problem.

The aggregate net worth of U.S. banks is $1.2 trillion. That seems like a lot, says the author, until you consider the size of the losses they may face. If they lost just 10 per cent on their real estate loans, they would be out $400 billion, or a third of their net worth.

“The banking system would be forced to put up ‘Closed for Vacation’ signs on loan departments — and the vacation could last for years.” Some banks that seemed too big to go under just a short while ago may be judged too far gone to be saved.
The Fed has the right solution — but for the wrong problem.

Running wild without supervision

“Expanding reserves by modest amounts, which the Federal Reserve usually does when it smells a recession approaching, is the standard cure for liquidity problems,” says Mr. Conrad. “But it won’t help a solvency crisis.” The Fed simply cannot monetize the banks’ downgraded assets, and those assets won’t cover the losses.

If the Fed’s tinkering doesn’t work, it’s a lack of regulated tinkering that has helped to bring this crisis about.

“The crisis has revealed a new game of accounting and structured engineering that is even less well understood: banks have not been keeping all of their loans on their books.” Structured Investment Vehicles (SIVs) and collateralized debt obligations (CDOs) seemed like investments without risk, with no capital investment requirements. We know how this house of cards collapsed, but there’s another aspect to the problem.

“Another result is that the official money supply quoted by the Fed doesn’t include this off-balance sheet financing,” explains Mr. Conrad. “That’s why the money supply doesn’t track debt and mortgage growth. It is also why derivatives grew so much.

“To me, this is an amazing insight into the structure of our financial system. These financing vehicles have been running wild without supervision.”

In short, what the financial system can’t keep track of ensures that what it can keep track of isn’t accurate anyway.

Mr. Conrad is not optimistic that the Fed and other agencies can keep up with the debt implosion. Debt losses have running ahead of the bailouts. “But as the recession becomes more apparent, you can expect to see the bailout machine shift into high gear.” This race, he concludes, is not likely to end with a strong dollar or a strong economy.

The concept that what you don’t know can’t hurt you has rarely seemed so flimsy. We’d like to know about all the hidden debt in the financial system as soon as possible, thank you very much. Banks, come clean.