This is a must listen interview with Eric Sprott. Summary: He is super bearish still on the sustainability of the recovery and very bullish on gold and silver.

Eric Sprott Interview

A very, very strange thing happened to a company I follow called Contango Oil & Gas (AMEX: MCF). This is an extremely well-run company that generates tons of cash from natural gas in the Gulf of Mexico. You couldn’t ask for a more efficient and well run company. Consider that Contango has raised $60.5 million in its life and yet has already bought back $65 million, thus having a negative capital situation due to negative dilution. Quite an astonishing task for a commodity company. Further the company’s costs are the lowest around with their find, develop and acquire costs at a measly $1.36 per mcf (thousand cubic feet).

Mr. Ken Peak, the CEO, is a straight shooter, no-nonsense kind of CEO. In fact, I wish most CEOs were more like him. In their last press release for earnings, Mr. Peak said, “Concerning natural gas prices, the weather is cooperating on the demand side, but natural gas supply continues to hold steady. I wouldn’t be surprised by either $3.00 or $6.00 natural gas over the next year or so, but we have good prospects and are aggressively moving forward to drill.” Now how many CEOs would have the guts to say that $3 mcf natural gas prices could happen? Compare him to Chesapeake Energy’s rather repugnant CEO, Aubrey McClendon, who is a perma-bull who enriches himself at shareholder’s expense and has created no value for shareholders.

For disclosure purposes, I have invested in Contango in the past and wrote a research report on it at $38.30, exclaiming how cheap it was. I have since taken my profits with its move to over $50 per share and reallocated my money elsewhere. I still follow Contango, in case it sells off again, and to see what Mr. Peak is doing.

So imagine my surprise when I see Monday’s press release, which has been getting absolutely zero press or news. Contango, which has been strictly an oil & gas company, announced that they were making an investment of up to $3 million in looking in Alaska for gold!

Here is what Mr. Peak said:

“This investment does not signal, foreshadow or represent a change in our natural gas and oil exploration business model. We recognize that the risks and challenges inherent in gold exploration are quite different from our natural gas and oil exploration business and were attracted to invest in this project solely by what we perceive to be its reward/risk ratio, where a relatively small amount of initial exploration risk capital ($3 to $5 million is envisioned) could potentially lead to a more extensive gold exploration/development project. Our 2009 exploration program found relatively few samples of commercial grade gold ore – generally considered to be 0.5 grams per tonne or more – but we believe our results merit an expanded exploration program for the summer of 2010.”

Mr. Peak continued, “Our planned 2010 exploration program will be directed toward additional rock sampling, trenching and drilling core holes. Shareholders are reminded that at this early exploration stage our investment should be considered as nothing more than an ‘interesting speculation’ and that the odds of our ultimately being successful in finding gold in a volume sufficient to support a commercial gold mining operation are quite low. To put it in oil and gas parlance, this ‘play’ is the rankest of ‘wildcats’ that is currently only at the ‘idea’ stage and we are hoping, based on our 2010 work program, to learn if we can mature it to the ‘prospect’ stage in order to justify committing additional risk exploration capital. After we have taken our core, rock and pan samples, they will be assayed in an independent lab and then evaluated for prospectivity and commercial development potential. This process will likely take until December 2010.” Here is the link to the release: Contango Gold Investment

I think this is a big warning sign. Neither Contango, nor Mr. Peak, as far as I know have any experience looking for gold, and the company has made all of its money on natural gas. This investment raises a host of questions. What also does it say about the natural gas market, or Mr. Peak’s view of it, that he would be willing to spend $3 million on gold instead of drilling for natural gas? What does it say about the value of Contango’s stock, that Mr. Peak would rather search for gold and not buy his own stock back?

But then I pause my this line of questioning and remember that Mr. Peak has been an excellent allocator of capital and has an excellent eye for value. So, I turn the question around and ask, what does it say about Mr. Peak and Contango’s thoughts on gold and the future of gold?

I think this news deserves a lot more attention and analysis. I know Contango is much smaller, but could you imagine if Exxon announced they were looking for gold? Ken Peak and Contango have an excellent reputation and are held in high regard, their decision should be viewed no less important than if a major such as Exxon had announced it.

Run to watch this investment roundtable from Russia with Marc Faber, Hugh Hendry and Nassim Taleb. It is fantastic.

I cannot recommend this hour long video enough.

Investment Roundtable from Russia

Kevin Bambrough is the CEO of Sprott Resource (Toronto: SCP) and he also works at Sprott Asset Management. He just posted a fantastic defense of gold. But in defending gold, he actually turns the argument around and instead says that paper money should be on trial, not gold. I have bolded the parts that I think are most compelling. This is a must read (for full disclosure my fund owns shares in Sprott Resource).

Beware Counterfeiters

By: Kevin Bambrough & David Franklin

Long time readers know that we have written about gold many times over the last ten years, starting with an October 2001 article entitled “All that Glitters is Gold”. We first invested in the precious metal based on the belief that central bank sales were filling a fundamental supply deficit that existed in the gold market. We also wrote that if you believed in gold as a financial instrument you might envision a gold price appreciation of 45% to US$400 per ounce, or even higher, as investors sought to protect their wealth in the ‘bear market’ that followed the 2000 stock meltdown. What a difference nine years have made. In 2010, Central Banks are now close to becoming net buyers of gold while mine output continues to decline. With major indices returning nothing to investors over the last ten years it has been a lost decade for stocks but an excellent decade for gold.

Gold’s recent appreciation in US dollars has led some market commentators to question its fair value. This is nothing new for gold – it has been criticized and downplayed as an asset ever since it came off its previous peak in 1980 of US$850 per ounce. In our view, however, it is not gold’s value that is in question; it is the value of paper money.

Let us consider the supply and demand fundamentals of paper money. Clearly, the supply of paper money is technically infinite. This has, of course, not always been the case. For millennia, money was commodity based – its value was linked to goods produced from land and labour. It was impossible to counterfeit wheat, nickel, copper or other commodities and therefore impossible to counterfeit money. Money was viewed as a link to, or representative of, productive capacity. If you had money, you had the right to trade it in for something real, and therefore possessed real wealth.

Historically, gold, principally because of its preciousness, has been the commodity into which paper money has been convertible. Each paper note represented tangible, stored gold and included a promise to convert that piece of paper into a specific quantity of gold on demand. That “promise” provided an inherent protection to the holder and ensured that governments couldn’t print money indiscriminately.

The link between paper money and gold has been lost for many decades. With respect to the US dollar, the world’s reserve currency, it was severed during the last century during two stressful economic periods. The first official break took place during the Great Depression. The second break took place during the Nixon-era in the 70s. These events are instructive and warrant brief consideration.

While there are several contributing factors to the Great Depression, it was the money supply growth in the preceding years under the supervision of the Federal Reserve that was, in our opinion, the greatest contributor. The Federal Reserve System was created in 1913 on a promise of stabilizing the banking system. What followed instead was an unprecedented growth in fractional reserve banking, as well as the money supply, which helped fuel the roaring 20’s. The aggressive money printing created inflated values in bonds and stocks, which peaked in 1929. When the market began its precipitous slide, and the public began to realize that stock and bond values were artificially high, the populace began to convert its cash holdings into gold. The government lacked the ability to satisfy that demand and was thus forced to renege on the currency’s founding promise of gold convertibility. It’s important to point out that without this original promise of convertibility for citizens, the currency may never have been adopted.

In 1933, The Gold Reserve Act was passed by Congress and formalized into law the breaking of the gold standard. This law provided for a controlled-currency issue through the Federal Reserve System which was non-redeemable in gold. Although the link to anything tangible had been broken, the citizens had little choice but to continue using these non-redeemable dollars as a medium of exchange. The currency had already been broadly accepted, proven convenient and a perception of safety had already become entrenched.

After forty years of continued dollar printing, in August, 1971, President Nixon effectively declared the US dollar to be a completely “fiat” currency by refusing to allow foreign governments to convert their US dollar holdings into gold. The right of conversion which had been granted under the post World War II, Bretton Woods agreement could not be honoured because of decades of money supply expansion. The original ‘promise’, which had vaulted US dollar to its status as a global reserve currency and a stable store of value, was now completely broken.

These historical events resulted in a world in which all currencies are fiat; they are not backed by gold or any other tangible asset. The supply is infinite. In fact, the production of today’s newly created paper money in relation to historical commodity-based money is akin to counterfeiting. A US dollar printed today has no ties to anything tangible and as a result carries only four cents of the equivalent purchasing power of a gold-backed dollar of 1913. It is ironic that in a poor choice of wording on Wikipedia, the definition of counterfeiting states that “it is usually pursued aggressively by all governments.” It is only because the evolution of money has occurred slowly over generations that the obvious flaw with fiat currency is not widely understood.

The demand for paper money in its various forms has remained, in our view, surprisingly high. The public has, for the most part, been content to trust paper money and hold it in various forms (cash, money-market funds and bonds), even without any yield. Presumably, this is because it is perceived as being “safe”. Bonds continue to be viewed and treated as highly conservative and ultimately “safe” monetary instruments. We are of the view that long-dated government bonds are one of the most speculative asset classes commonly held today. In order to truly value a long-dated government bond one must speculate what its future proceeds will be able to purchase in real goods and services. A prospective purchaser must try to determine the expected “real return”. In the current environment of excessive government deficits and increased debt issuance, we feel certain that long-term bond holders will be disappointed. Quantitative Easing, a radical form of monetary policy which allows for the direct printing of money by central banks in order to purchase government debt (or other undesirable bonds of even lower quality) will ensure all varieties of paper money will not enjoy nearly as much purchasing power in ten or twenty years as they do today. We believe the yields being offered today on such instruments, when compounded over their duration, will prove to be immaterial considering the total loss of purchasing power suffered by their holders.

We are gold investors because we have made a specific and calculated bet against paper money. Simply put, we are betting against paper money as a store of value. We believe its supply will continue to increase. We do not believe that the world’s major governments have any stake left in protecting it.

Government debt loads have grown so massive that printing them away has become obligatory – there is no longer any other feasible option left. In our view, the savers of the world should already be outraged by the dilution they have been forced to suffer at the hands of the Central Banks. Are we to infer that the limited reaction of savers to the combination of zero interest rates and debasement of currency is a result of “learned helplessness”?

For those that don’t accept savings dilution as the ordinary course of business, how do investors protect themselves from this loss of purchasing power? We feel a conservative approach would be to ignore nominal prices entirely and focus on building real wealth with a strong weighting towards tangible investments. As currencies are debased it is ‘relative values’ that investors should use to make investment decisions, since nominal prices can be distorted. In the case of gold, it is pointless to debate its value in US dollars. There is no longer any tie between the two and it’s clearly the value of paper money that should now be on trial, not gold. In future editions of Markets at a Glance we will continue to explore the investment themes and businesses that we feel that meet this strong relative valuation criteria.

We also wanted to prepare our readers and clients for the next leg of the gold bull market as it will prove to be extremely volatile. Gold bull markets are unique in that buying becomes driven by both fear and greed. Gold is quickly moving into the hands of those who are unwilling to gamble on fiat currencies or bonds as a store a value. The new owners of gold are unconcerned with its lack of yield but instead are focused on its historic ability to preserve wealth and its unquestionable value. Given the difficulty we have valuing paper money, it becomes extremely difficult to come up with a reasoned price target for gold. Today’s gold market is significantly different from the gold market of the 1970s for two reasons: 1) Central Banks are more likely to be buyers of gold today and 2) They clearly have little ability to dramatically raise interest rates with the massive increases in government issued debt. Thus, it is easy to envision a similar twenty-five fold increase in the gold price that was seen between 1970 and 1980, which would result in a gold price today above $6,000 per ounce. We expect the often quoted “1980 inflation adjusted high” of approximately $2,200 to be achieved in short order. These targets may well prove to be irrelevant, however, as the quality of our lives will be more greatly impacted by the continued evolution of our money and how the general public chooses to value it, or not.