Gold investors have been through a nuclear winter, but the future looks
bright as mining companies bask in the glow of lower costs, better exchange
rates and a flurry of mergers and acquisitions. In this interview with The Gold Report,
Tocqueville Asset Management fund managers Doug Groh and John Hathaway share
the names of the mid-cap companies in their portfolios that could emerge
successful and one truly contrarian play that could be a tenbagger if their
forecasts are correct.
The Gold Report: Since we last talked in
August, have precious metals bullion and mining shares bottomed?
John Hathaway: It looks as if they are trying to make a stand. In
early November, we got down to $1,140/ounce ($1,140/oz). Only time will tell
for sure.
What we do know is that the industry can't produce any more gold at these
prices or lower prices, so that impacts the supply side of the picture. It
certainly meets the test of being a contrarian investment. In our opinion,
sentiment is pretty much rock bottom. It has gotten better with this rally,
but in the bigger scheme of things, people still scoff at the idea of gold.
That is one sign of a bottom.
TGR: What is the range you expect for gold in 2015?
JH: The 200-day moving average right now is $1,244/oz. If gold can
break above that, I think it would gather strength and surprise people on the
upside. Seeing as how so many people are betting the other direction, I think
you'd have a lot of short covering. So $1,400/oz or $1,500/oz wouldn't
surprise me.
TGR: Are you as bullish on silver?
JH: The magic number on silver is $18/oz. The 200-day average on the
iShares Silver Trust (SLV), an exchange-traded fund, is roughly $17.29/oz. If
silver closes above $18/oz, that will be a strong signal that it has changed
its colors. For both gold and silver, the moving average keeps coming down,
so it gets easier to surpass it.
TGR: Gold has intermittently run up with the dollar in recent weeks
rather than in opposition to it. Is that a new trend?
JH: No. The correlation between the U.S. Dollar Index (DXY), which is
the comparative strength of the dollar compared to the euro and the yen, and
the gold price is very low. It's a meaningless relationship over time. From
time to time, commentary will refer to one causing a movement in the other,
but if we look at the relationship over a long period of time, it really
hasn't mattered.
And if we go back 20 years, the dollar has been weak relative to gold.
Gold is up in dollar terms quite substantially.
TGR: You have commented that the Shanghai Gold Exchange may likely
provide a challenge to the U.S. dollar as the world's reserve currency over
the next several years. What impact would that have on gold?
JH: The Shanghai Gold Exchange could replace the London Bullion Market
Association, the London gold fix. Western market conventions such as the gold
fix and the Comex will eventually play second fiddle to price discovery in a
place like Shanghai, Singapore or Dubai. That's where physical gold is being
traded. That's what I meant by that statement.
At the same time, it's important to pay attention to how many more deals
the Chinese are doing in renminbi, their currency. It could be some time
before China's currency replaces the dollar as the leading reserve currency,
but it is already starting to crowd out the dollar's unquestioned status, particularly
for trade deals. Many people, particularly in the emerging markets, really
don't like the dollar, and that is encouraging competition for the top spot.
It's not going to happen overnight, but it's something to watch.
God forbid the dollar ever loses its monopoly on reserve currency status.
It would change the world. People would have less of an interest in owning
U.S Treasury bonds, for one thing. It may mean that inflation numbers, which
have benefitted from the strong dollar, could turn less favorable, which is
what all the central banks are trying to do anyway.
TGR: What impact would that transition process have on gold?
JH: The impact on gold is due to a loss of trust in the dollar-reliant
system. Jim Grant, publisher of the Interest Rate Observer, said it
best: "The price of gold is the inverse of confidence in central
banking." If dollar strength continues relative to other currencies, for
a while that's not a bad thing because competition keeps prices low in U.S.
dollars. But ultimately, it's a destabilizing factor because it's bad for
emerging markets that have borrowed in U.S. dollars.
To the extent that the strong dollar actually becomes a headwind for
economic growth in places like Brazil and India, it's a negative for global
growth and it becomes a problem. And it becomes a destabilizing factor for
the global economy because it means that the U.S. economy will be challenged
by imports and loss of market share because of cheaper European and Asian
currencies. Let's not forget that gold has already risen in every currency
except the dollar in the last year and a half.
TGR: What impact will Greece renegotiating its debt or pulling out
of the euro have on gold?
JH: What is going on in Europe is very unsettling to those with
savings and capital in that part of the world. If Greece pulls out of the
euro or if the Eurozone makes huge concessions to Greece, then it would
become increasingly difficult to view the euro as a serious currency.
We all saw what happened in Switzerland. The Swiss bank balance sheet just
ballooned beyond any sort of reasonable measure. Debt was five times Swiss
gross domestic product (GDP), whereas the U.S.'s debt is only 25% of GDP. The
Swiss couldn't just keep printing francs like crazy. So despite promises to the
contrary, the Swiss pulled the rug out from the feet of a lot of people who
bet on that. It was an important lesson. You can't take central bankers at
their word. No matter what they say, currency manipulation is ultimately
something that can't be sustained. One by one, those tricks will fail, and
then we'll see the real economic consequences of our actions. When that
happens, one thing you can own to protect you against massive currency
devaluation is gold. It has been proven time and again.
TGR: Is this a good time to buy gold or should people wait and see
if it goes even lower?
JH: It seems to be a good time. Gold is already strong in every
currency other than the dollar. Negative interest rates in much of the world
and the overly strong dollar should eventually result in political pressure
to cheapen the dollar, but against what? The only monetary asset left
standing will be gold.
TGR: What is the relationship between mining share valuations and
commodity prices?
JH: In Australia, Canada and South Africa, countries with currencies
that have been weak compared to the dollar, earnings are going through the
roof. The industry is actually doing very well because it has lower costs
based on currency and oil.
TGR: In the Tocqueville Gold Fund, what is the role of physical
metals versus mining shares? It looks as if you're at about 12% physical gold
right now.
JH: We did buy more gold a couple of months ago. It was time to do so.
We own maybe 20% more physical ounces than we did a year ago. We don't expect
it to perform as well as the mining shares on the upside, but it's certainly
an element of value in the portfolio. It differentiates us from most of our
peers and it makes sense.
On the mining share equity side, Tocqueville invests in companies that add
value even when the gold price is going sideways or down. These companies are
either discovering more ounces in the ground or in the process of building a
cash-producing mine, which is potentially very accretive to shareholders as
long as it's done in a way that doesn't destroy the balance sheet. That may
not translate into a higher share price when the gold price is going sideways
or down. But they will be the leaders on the upside when people want to own
gold stocks again. Everyone thinks about the industry as a monolith, which is
incorrect. There are so many differences between companies and countries, and
every situation is different. We own a very select group of companies.
One strategy that has really worked for us is that we've been heavily into
the royalty stocks, which come down to four names. Royal Gold Inc.
(RGLD:NASDAQ; RGL:TSX), Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), Silver Wheaton
Corp. (SLW:TSX; SLW:NYSE) and Osisko Gold
Royalties Ltd. (OR:TSX), the spinoff from Osisko Mining Corp. that has
been reborn as a royalty company. That's a great business model when the
industry has a difficult time raising money. These companies provide capital
and do a lot of deals with very favorable terms. Their pipelines are
particularly robust now because most mining companies have a hard time
advancing projects through the regular sources that the capital markets
provide.
The royalty model is very efficient. Instead of holding 10 mines scattered
all over the world like Newmont Mining Corp. (NEM:NYSE) or Barrick Gold Corp.
(ABX:TSX; ABX:NYSE), royalty companies participate in 70 or 80 mines with
none of the management challenges. If a mine or a country has a problem, it's
less significant and moves the needle less than it does for a producer.
That's the notional difference between royalties and typical mining
companies. Having said that, there are plenty of companies that are pure
miners that we think are very good.
TGR: When we talked last, Doug, you pointed to the upside you
enjoyed during a number of mergers, including the Osisko Mining Corp. sale to
Yamana Gold
Inc. (YRI:TSX; AUY:NYSE; YAU:LSE)/ Agnico Eagle Mines
Ltd. (AEM:TSX; AEM:NYSE). The sector has seen a number of other sales in
the last six months. Are you anticipating more mergers and acquisitions
(M&A)? Are there any candidates in your portfolio that are ripe for being
bought out?
Doug Groh: The gold sector is really ripe for a plethora of M&A
activity. In fact, we've already seen that this year. Goldcorp Inc.
(G:TSX; GG:NYSE) is purchasing Probe Mines Limited (PRB:TSX.V). SEMAFO
Inc. (SMF:TSX; SMF:OMX) has made a bid for Orbis Gold Ltd. (OBS:ASX). Tahoe Resources
Inc. (TAHO:NYSE; THO:TSX) and Rio Alto Mining
Ltd. (RIO:TSX; RIOM:NYSE; RIO:BVL) have announced a merger. I think the
Tahoe acquisition of Rio Alto is an indication that geographic
diversification is a benefit to a gold and silver mining producer. Tahoe
currently has one operation in Guatemala. Rio Alto's operation in Peru,
another fine mining district, gives it exposure to another part of the world.
Certainly, it's a market environment where miners are finding it very
difficult to operate with limited capital. They can't access the capital
markets as effectively as they did some years ago so mergers become more
attractive.
For the same reason, joint ventures such as the Premier Gold
Mines Ltd. (PG:TSX)/ Centerra Gold Inc. (CG:TSX; CADGF:OTCPK) announcement
several weeks ago in which they intend to pool resources to work on the
Hardrock project together, will probably also be more common. The industry is
recognizing that, in some cases, going it alone is not possible. In fact, I
spoke to Seabridge
Gold Inc. (SEA:TSX; SA:NYSE.MKT) recently and management there is getting
creative about adding value to entice larger mining companies to foot the
financing bill on building out projects. I'm sure we're going to see very
dynamic transactions across the space as the year progresses.
TGR: How are investors being treated? Are they getting a premium
for their patience?
DG: On the announcement date of the transaction, there's typically
a premium from the last traded equity price, anywhere from 20% to 35% or from
the 20-day average weighted value approach. That has to come through if the
shareholders are going to accept any type of transaction.
What is interesting is that management teams are more willing to have a
discussion now than they were some years ago. Now, the market is coming
closer together on valuations and there are likely to be more transactions.
TGR: You mentioned last time that you were emphasizing the mid-cap
sector. What have been your best performers?
DG: Detour
Gold Corp. (DGC:TSX) has been a healthy performer. I think there's a lot
of anticipation in the marketplace that Detour, similar to Osisko, could
become a target of M&A activity. It is in Canada, in a safe jurisdiction,
it's a new project working some of the kinks out of the initial operation and
reaching a steady state.
Rubicon
Minerals Corp.'s (RBY:NYSE.MKT; RMX:TSX) Phoenix Gold mine should go into
production within the next year or so. Similar to Detour, it is operating in
a known gold-producing district in Canada, the Red Lake District. As it gets
up and running, it becomes even more compelling for investors. A number of
new names have become more interesting than some of the older names that have
been around for a while.
Dalradian
Resources Inc. (DNA:TSX) in Northern Ireland has performed very well
lately. It is not a district that people think about for gold production
aside from a place where leprechauns keep their gold. But clearly it is
enjoying some success, not only finding gold, but developing its resource,
getting permits and getting financed. The local population and the government
have shown they are willing to embrace gold production.
TGR: Another thing you mentioned last time is that the market is
recognizing North American companies with a premium. What are some portfolio
companies that fit this description?
DG: Romarco
Minerals Inc. (R:TSX) in the United States just did a financing of
CA$300M (~US$240M) to fund the build out of the Haile mine in the Carolina
Slate Belt. The fact that it was successful in raising capital indicates that
investors are more comfortable in a jurisdiction like the Southeastern U.S.
TGR: When could Romarco be in production?
DG: The company is in the process of raising another $200M and then
we could expect production in late 2016, with commercial production during
2017.
TGR: What are some other North American companies that are in the
portfolio?
DG: NOVAGOLD
(NG:TSX; NG:NYSE.MKT), which has the Donlin project in Alaska, has been a
core position for some time.
TGR: J.P. Morgan analyst John Bridges recently theorized that a
senior gold producer might find a project that size in a politically safe
jurisdiction interesting. The market seemed to agree. Have you been adding to
NOVAGOLD in your portfolio based on some of this?
DG: We do add from time to time to rebalance the exposure in the
fund. We're long-time investors and anticipate production from NOVAGOLD in
the future but the company has a ways to go as it is now working on
formalizing the permits. Bridges is correct that it's in a safe jurisdiction.
It is also a very large deposit that major producers will be interested in
developing, such as Barrick, which as a joint venture partner has recently
publicly re-affirmed its commitment to that project.
At some point, the large gold mining producers—Barrick Gold, Newmont
Mining or AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE)—which
are producing 4, 5, 6 million ounces (4, 5, 6 Moz) a year will need to
replace that production. That was certainly one of the main drivers for
Goldcorp's Probe acquisition. If you think about Goldcorp producing over 3
Moz/year, it needs to make a Probe-size acquisition once a year to replace
what it's producing.
TGR: What about projects in Mexico?
DG: Almaden
Minerals Ltd. (AMM:TSX; AAU:NYSE) recently announced it is spinning off
the Ixtaca project in Mexico from the rest of its exploration portfolio. It's
a real tribute to Duane and Morgan Poliquin, who have worked very hard doing
grassroots exploration and have been successful in finding something in a
part of the world that others had ignored. They recognized that in order to
create the most value for their shareholders, they need to allow the Ixtaca
project to have a life of its own and to evolve to the next stage of
development, in which exploration is not as important.
Duane and Morgan are outstanding explorers. They recently received the AME
BC Colin Spence Award for Excellence in Global Mineral Exploration. While
they have a portfolio of properties and royalties, they recognize they can
best serve their shareholders by putting more of their time to the part of
their asset portfolio where their skill set is more appropriate and allow the
Ixtaca project to move on to the development stage, which requires
permitting, engineering, financing and construction. So they are positioning
the Ixtaca asset as a spinout. It is a good outcome for the company and for
Duane and Morgan and for shareholders.
TGR: Is this a good time to pick up deals on South American
explorers and developers?
DG: I think it's a great time to pick up deals around the world,
whether it's in South America, North America, Africa, Asia or Australia.
Right now, there is an interest in the gold space, but there is a reluctance
to execute. The capital is not available the way it was some years ago.
Valuations are extremely low. Some of these projects are not all the way to
the goal line. They need more capital, more time, more of a commitment. But
if a company has the right skill set and the right financial backing, some
very good transactions can be realized and some good property values can be
accessed.
TGR: Are producers outside the U.S. benefitting from lower
operating costs due to shrinking oil prices and non-dollar currencies?
DG: They are without a doubt. To U.S.-based investors, the gold price
looks to be languishing, but gold is hitting record levels in the euro, peso
and Canadian dollars. For companies operating in non-U.S. dollar regions,
their operating costs are much less relative to the dollar. In addition,
lower oil and gas prices will eventually benefit the bottom line. Operating
costs could be 5% to 10% less, not an insignificant amount. That is
equivalent to the gold price rising $30–70/oz. And the benefit from lower oil
and energy costs goes straight to the bottom line. In some cases, for some
companies, the stronger dollar/weaker local currency impact can be even more
significant.
In addition to currency and oil and gas prices savings, cost pressures
from inputs such as chemicals, equipment and steel are abating. Labor costs
are rather sticky, but some of the material costs are coming down. Miners are
getting better terms across the board.
TGR: Is there an example from your portfolio of a company with a
share price that reflects these savings?
DG: Agnico Eagle has done really well year to date. It operates in
Canada, Europe and Mexico. So it is getting the benefit from operating in
weaker currencies and lower oil prices. It is flat out getting more for its
money and I think investors have recognized that. The stock has done well.
Goldcorp, Newcrest
Mining Ltd. (NCM:ASX) and Newmont all have international exposure so
their costs are largely in local currencies, but they realize their profits
in dollars. So they're enjoying that benefit, too. The first month of the
year, the sector had quite a good run as the market translated the benefits
from lower currency and lower oil prices into the valuations on these stocks.
That may not be over with as some of those benefits have yet to be realized.
B2Gold
Corp. (BTG:NYSE; BTO:TSX; B2G:NSX) also has international operations, but
in addition to benefiting from favorable exchange rates and lower energy
prices, it has a growing production portfolio. Growth in spite of a difficult
capital market appeals to investors. B2Gold is in a position to generate real
cash flow this year because of a combination of lower operating costs and a
growing production profile.
TGR: The Tocqueville Asset Management philosophy stresses
contrarian value investing. Give me a really contrarian name that could play
out in the long run.
DG: We have a significant exposure to International
Tower Hill Mines Ltd. (ITH:TSX; THM:NYSE.MKT), which has the Livengood
gold project in Alaska, a very safe jurisdiction. The company has identified
a mineable ore deposit, but it really requires a higher gold price to make it
work as currently planned. Management is going through the process of trying
to optimize the project to improve the economics now and we are confident
that somewhere down the road, when gold prices are $1,500–1,700/oz,
International Tower Hill is going to become a very compelling opportunity for
investors. When people talk about five- or tenbaggers, International Tower
Hill is a name that should come to mind. But it takes time. This is a
contrarian type of environment for that kind of stock.
TGR: What final insights can you give us on surviving the current
market?
DG: I think in this environment, it's important to recognize that
companies have a challenge getting capital to build out their projects. So in
assessing a company or its project, it's very important to consider the
capital requirements carefully. Does the company have access to capital or a
means to build its projects? What does the balance sheet look like? Does it
have cash? Does it have debt? Does it have the ability to raise funds?
Second, the grade and the quality of the asset are always important. But
it's not always just about grade. It can be about recoveries. It can be about
the geology. It can be about the difficulty of actually mining. But the asset
quality is certainly important.
Finally, I think investors should think about M&A activity and consider
that some of these projects may not really have merit in this type of
environment, but the company may have merit in its potential to become part
of something larger.
TGR: John, what wisdom can you share with our reader/investors?
JH: We have done our research and we believe that over time, investing
in gold and gold mining is an investment strategy that makes sense in a world
of currency debasement. We've been through sort of a nuclear winter the last
couple of years, but we outperformed our benchmarks by a wide margin. When
the sector comes back in the U.S., contrarian investors will be sitting in a
pretty good position competitively.
TGR: You've given us lots to think about. Thank you for your time.
Institutional Investor and The Wall Street
Journal. He holds a Master of Art in energy and mineral resources from the
University of Texas at Austin and a Bachelor of Science in geology/geophysics
from the University of Wisconsin—Madison.