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Savvy investors and central banks in Asia are accumulating physical
gold, the most stable form of value. In an exclusive interview with The Gold Report, Dave Kranzler, founder of Golden Returns Capital, contrarian
gold investor and newsletter writer, shares his investment outlook and
explains what he looks for when investing in gold miners poised to profit
from economic turbulence.
The Gold Report: You started your
career, Dave, in the fixed income securities division of Goldman Sachs. And
you worked as a junk bond trader before founding Golden Returns Capital. What
prompted you to move into precious metals?
Dave Kranzler: After working as a bond
trader on Wall Street, I was day trading. A friend suggested that I look at
gold and silver. I initially poo-pooed that idea,
as I was more interested in shorting technology stocks during the Internet
bubble. I thought the tech valuations were based on nothing more than hopes
and dreams, not on real wealth. The enormous growth in paper investments was
driven by the incredible amount of money supply thrown into the system by
Alan Greenspan's Federal Reserve.
But in late 2001, my
friend finally convinced me to get serious about mining stocks. So I
investigated the reasons why there had been a 20-year bear market in precious
metals and why a long-term bull market was in the offing.
TGR: Why should we invest in
gold instead of, say, Facebook?
DK: People like Warren
Buffett, Charlie Munger and Bill Gates characterize
gold as an investment. It's really not. It's a monetary metal. Gold
represents the embodiment of real wealth. By contrast, Facebook has a
sustainable business model based on revenues derived from advertising. But
there's an extreme differentiation between what Facebook might be worth on
the basis of long-term historical market capitalization measures versus what
the market was willing to pay at its IPO. It quickly dropped in value, and it
has a lot further to fall. Gold is more real.
TGR: How does gold as money
differ from paper currency?
DK: Paper currency can be
created at the whim of a central bank. The "fiat" currencies are
politicized and based only upon the issuing entity's promise to pay. Gold is
the world's oldest currency; it was used as a medium of exchange before the
Roman Empire. Historically, gold replaced barter by providing the fungibility to enable widespread trade and commerce. Gold
is very hard to produce, let alone counterfeit. It represents a true measure
of wealth exchange.
TGR: You mentioned that gold
is a medium of exchange, so it's a repository of value. It embodies a
standard of value that represents the usefulness of other commodities, like a
bushel of wheat. But if the gold itself is not the source of value, then what
is the ultimate source of the value that it represents?
DK: Globally, the value of
gold is rooted in supply. The supply of aboveground gold represents
economic wealth, which is embodied in the price of gold, when there is a gold
standard in place. A gold standard fixes the price of gold. Therefore, under
a gold standard, the money supply can be increased by pulling more gold out
of the ground. But if the price of gold is not fixed, then the price
must rise and fall as new wealth is created or destroyed—regardless of
the amount of aboveground gold in existence.
Unlike gold as money,
paper currency is easy to reproduce. If the government wants to spend more
money, it doesn't have to base that increase in spending upon incremental
economic output. It can just decide to issue bonds and print money to pay for
those bonds. Inflation occurs when the paper money supply is increased over
and above marginal economic output.
TGR: So why is the price of
gold volatile?
DK: The price of gold has
steadily gone up every single year for 11 years. That's not really volatile; its one way, to the upside. The gold market is small and
not very liquid. When someone wants to sell a lot of paper gold, and there
are not many buyers, the price goes down, and vice versa to the upside. So we
see large swings in price over short periods, but over the last 11 years, the
price has only gone up. It has been less volatile than the S&P 500 over
the last 10 years.
TGR: Large and institutional
investors are showing some interest in gold. For example, George Soros has
significantly increased his position. J.P. Morgan and other banks are
investing in junior gold and silver mining companies, as are large mutual
funds. Is this a significant change?
DK: Soros bought SPDR Gold
Trust ETF (GLD:NYSE) shares, which is a derivative
form of gold. It's not physical gold. SPDR Gold Trust is a decent way to
index the price of gold over short periods, and I think that is what Soros is
doing with his fund. But I'm also sure that Soros, himself, is accumulating
physical gold.
A very, very small
percentage of the institutional investment world is in gold—less than
1% of institutional funds globally. Very few of those institutions have taken
physical delivery of gold. There are exceptions: Northwest Mutual took
delivery of 400 million ounces (Moz) gold a few
years ago; Texas Teachers Retirement keeps physical gold. There is a small
institutional interest in accumulating gold via SPDR Gold Trust and other
exchange-traded funds. But if you look at the three cycles of a bull
market—smart money, the institutions and then the public—there is
potentially a huge wave of institutional investing in gold yet to come.
TGR: Is J.P. Morgan's
investment in Orezone Gold Corporation (ORE:TSX) a sign of increasing
institutional interest in physical gold? Or is it just an aberration?
DK: We are starting to see
some institutions wade into the world of junior mining stocks. If you look at
the asset valuation of Orezone versus its market
capitalization, it's very, very cheap. Its market cap is at a big discount in
relation to its implied value.
TGR: What's the core
investment strategy of Golden Returns Capital?
DK: My partner and I
started Golden Returns Capital and our Precious Metals Opportunity Fund in
2008. We enable investors to accumulate physical gold and silver while also
investing in a carefully selected portfolio of mining stocks. Our base case
model is 50% physical metal and 50% mining stocks. We buy gold and silver
bullion. It's either 1 ounce (oz) sovereign-minted
coins like gold eagles or gold maple leaves, and we take delivery off the
COMEX of gold and silver bars. We keep physical gold in a segregated account
in a private, non-COMEX depository. Our fund directly owns the metal. The
other half of the portfolio is invested in mining stocks. The breakdown is
50% large-cap mining stocks, like Goldcorp Inc. (G:TSX;
GG:NYSE) and 50% junior mining
stocks.
Importantly, when
investors cash out, they can take delivery of their pro rata share of the
gold and silver in the fund. If they want to cash out a couple hundred grand,
and the breakdown is 50% bullion, 50% stocks, they have the option of
receiving $100,000 in physical gold and silver. We'll deliver it, or we can
arrange depository safekeeping.
TGR: But investors cannot
cash out the value of the stocks as bullion, right?
DK: They could take
delivery of the stocks, but it is easier to take the cash. The feature makes
our fund unique. It's one of the few funds that have the ability to deliver
bullion. Some of the ETFs can deliver, but an investor has to own a very high
amount of shares—several million dollars worth.
TGR: What's the minimum
investment in Golden Returns?
DK: Minimum investment is
$100,000.
TGR: What metrics do you
use to assess the value of junior mining stocks?
DK: We look at a range of
firms: from companies poking holes in mineral lease claims to companies that
have proved resources and are on the verge of becoming producers. I define a
junior as a mining exploration company that's not producing and is depending
upon the market for financing. I do not invest in evergreen companies. I look
for a company that has a track record of drilling results. And, I want those
results to come from areas that are proven producing areas, such as the
Carlin trend in Nevada or the Durango silver belt in Mexico. Ideally, I like
to see an NI 43-101–compliant mineralization report showing some Proved
or, at least, Measured resources. I want a company to have on hand at least a
year's worth of cash under normal operating and capital expenditure
scenarios. Ideally, I want to see a large mining company as a sponsor. I want
management to hold 5–10% of the equity. And the company must be
operating in areas of relatively low political risk.
TGR: Are there are any
junior firms that you like in particular?
DR: One of Golden Return
Capital's largest positions is Rye Patch
Gold Corp. (RPM:TSX.V; RPMGF:OTCQX). Management owns roughly
8% of the company. Kinross Gold Corp. (K:TSX;
KGC:NYSE) owns about 15% of the equity. It has a little over 3 Moz in NI 43-101–compliant resources proved up. It
is poking holes in the ground in a trend in Nevada that could potentially
become the next Carlin trend. It has a $55–60 million (M) market cap.
It trades around $0.60/share, and I see it as, at least, a $3/share stock
down the road. It has about a year's worth of cash. The managers are
experienced geologists, with a history of success in developing mining
companies. Rye Patch is the perfect junior mining company model.
TGR: What about outside the
United States or North America? Do you have any companies that you like?
DK: Orezone,
which I mentioned, is in West Africa, a region that carries more political
risk than Nevada. But the Chinese are buying up mining claims all over
Africa. That lends the region stability. Orzone's
market cap is about $136M. I have tentatively valued its crown jewel
asset—the Bomboré deposit—north
of $150M. Investors get the rest of the company for free, including a uranium
exploration subsidiary that has a lot of upside. Management owns a decent
amount of equity. It doesn't have a large-cap mining sponsor, per se, but
various institutions own more than 50% of the equity. That's a stable
investing base.
There may be some
metallurgy risk regarding Orezone's ability to
convert the resource into mineable gold at $1,700/oz,
but I don't think that's a problem with the quality of its deposit. The
company has already done a preliminary economic assessment (PEA); it is a
couple of years away from putting in a mine. Management has a track record of
developing a resource and then selling it. They just did that with one of its
subsidiaries. It was a 450 Koz gold deposit, and Orezone sold it for the equivalent of about $45/oz in the ground. If I apply that metric to the Bomboré asset, I get an implied asset valuation of
$155M versus the $136M current market cap. By definition, that's a value
investment. That is why institutions are attracted to Orezone.
TGR: In March 2011, Orezone was trading at $5/share, and now it's roughly
$1.75.
DK: It is a fact that the
junior mining stock sector is down 60–70%. The whole sector has been
beaten into the ground and, unfortunately, the babies are being thrown out
with the bath water. We started accumulating Orezone
when it was around $2.50/share. We are currently underwater, but we've been
adding to the position as the price falls. When the pendulum swings back the
other way, a lot of capital will flood into the juniors. I predict that
junior gold stock prices will double and triple from their peaks a year and a
half ago.
Let's say gold goes to
$2,500/oz. What kind of market cap do you think investors are going to give
companies with gold resources in the ground when gold is at $2,500/oz? If they're capping Orezone
at $5/share when gold is at $1,500/oz, they're
probably going to cap it at $10/share when gold is at $2,500/oz. If it gets
back to $5/share in the next 12–24 months, we've had a hell of a return
on our money.
This brings me back to
what attracted me to precious metals back in 2001. In his newsletters, James
Dines was pointing out that the total market cap of every publicly traded
mining stock in the world in aggregate was less than the market cap of each
of the Top 10 companies in the S&P 500. That's a staggering statistic.
His thesis was that at some point, a massive wave of institutional money will
flood into the precious metals sector, and it's going to be like trying to
push Niagara Falls through a funnel. There will be a huge price explosion
when that happens. We're probably a long way from that point. It's taken a
lot longer than I expected, but I think eventually we'll get there.
TGR: What happens if we have
Quantitative Easing (QE) 3?
DK: Some people would argue
that the market's already pricing that in, and that's why the entire stock
market hasn't gone lower right now. But there's a high expectation that the
Fed will not do a QE3. If it does do it, gold and silver and the mining
stocks will explode as they did when QE1 was announced in 2008 and QE2 in
late 2010.
TGR: China, Russia, India
and the Gulf States are accumulating massive amounts of bullion. How is that
affecting the market?
DK: The Western central
banks have been selling off bullion for the last 15 years. What I like to
call the "Eastern Hemisphere central banks" have
been accumulating that bullion. There has been a transfer of bullion from the
Bank of England, the European Central Bank and the Fed to central banks in
China, Russia and India. A lot of people don't realize that Vietnam is the
fifth largest gold-importing country in the world. Obviously, the Gulf States
have started accumulating it pretty aggressively. Recently, Mexico and some
of the South American countries are showing up as large accumulators of
physical gold, not through ETFs or any of the other paper forms, but actual
physical gold.
TGR: How does that affect
pricing?
DK: The steady climb of
gold over the last 11 years reflects this accumulation by very wealthy
interests in Europe and Asia. China has been voraciously accumulating gold.
The International Monetary Fund sold 400 tons of gold a couple of years ago.
But a lot of these central banks, instead of selling gold, are leasing
it out. They rent their bullion to banks like J.P. Morgan and Deutsche Bank
that turn around and sell it into the marketplace. That gold is going
somewhere. It is going to these quiet accumulators of physical bullion. At
some point and, again, it's impossible to measure when, the central banks and
investors that have been buying physical gold will have to get more
aggressive with what they are willing to pay. That will be the next stage in
the bull market.
TGR: When you talk about
leasing, these companies that lease the gold aren't actually taking physical
possession of it?
DK: They're borrowing it.
Then they go onto the London Bullion Market Association and sell it. It's a
legal transaction, but it's a paper transaction.
TGR: Is it a form of
derivative?
DK: That's correct. Say
that you are J.P. Morgan and you've sold me some gold that you leased from a
central bank. If I ask for delivery of the metal, you will have to find it
and deliver it. That's where the problems are going to start.
TGR: That certainly could be
a problem. Do you want to talk about any other junior mining firms that
you're interested in?
DK: Our second largest
junior position is Eurasian Minerals Inc. (EMX:TSX.V). It calls itself a
project generator, but it's more analogous to the royalty model of companies
like Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) and Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX). Eurasian explores the
world for properties that have been discarded by the larger mining companies
because they did not contain enough mineralization to make it worth their
while to develop at the time. For example, Eurasian has been accumulating
land in Haiti. Up until a few years ago, Haiti was considered taboo because
it was extremely politically unfriendly, unstable and corrupt. After a recent
leadership change, Eurasian bought potential mining properties on the cheap.
Then it sold a development interest in these properties to Newmont Mining
Corp. (NEM:NYSE). Eurasian got its investment out of
the properties, plus it retained a 30% interest in the Newmont properties.
Also, Newmont owns 10% of Eurasian. It gets even better than that. The CEO of
Eurasian, Dave Cole, worked for 18 years at Newmont. So you can probably see
where this is going down the road.
Eurasian also has joint
ventures in other properties around the world, including with Newmont. It has
a huge potential copper deposit in Arizona that Vale S.A. (VALE:NYSE) is developing. I never thought Kazakhstan was a
potential gold mining belt, but Eurasian has several properties there with
the same type of deal.
TGR: You have described
yourself as an investment contrarian. What is your parting advice on mining
stocks?
DK: Mining stocks are at an
extraordinarily cheap level vis-à-vis their historical valuations,
especially when you measure them versus the price of gold. Large and small
companies are basically trading at the same valuation levels in relationship
to gold that they were when gold was at $400/oz
back in 2003–2004. To me, it's the ultimate contrarian and value play
to hold your breath and invest in these companies now. I think if you do it
now, you're going to be rewarded with a lot of money down the road, especially
if the fundamentals for supporting gold and silver only get stronger.
TGR: OK, Dave. Thanks for
your time.
DK: Thank you, Peter.
Dave Kranzler spent many years working
in various analytic jobs and trading on Wall Street. For nine of those years,
he traded junk bonds for Bankers Trust. He has a Master of Business
Administration from the University of Chicago, with a concentration in
accounting and finance. Currently he co-manages Golden Returns Capital, a
precious metals and mining stock investment fund based in Denver. He writes a
blog to help people understand and analyze what is really going on in our
financial system and economy: www.truthingold.blogspot.com
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Disclosure:
1) Peter Byrne of The Gold Report conducted this interview. He
personally and/or his family own shares of the following companies mentioned
in this interview: None.
2) The following companies mentioned in the interview are sponsors of The
Gold Report: Orezone Gold Corporation, Goldcorp
Inc., Rye Patch Gold Corp. and Royal Gold Inc. Streetwise Reports does not accept stock in exchange for services. This
interview was edited for clarity.
3) Dave Kranzler: I personally and/or my family own
shares of the following companies mentioned in this interview: Rye Patch Gold
Corp. I personally and/or my family am paid by the
following companies mentioned in this interview: None. I was not paid by
Streetwise Reports for participating in this story.
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