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Is gold preparing for
another shot up to $2,500/ounce heights or on the way down after being
overbought? In this exclusive interview with The Gold Report, two respected names in
the investing world share their arguments for what could happen in the coming
years and how to profit from it. Financial Adviser Peter Grandich predicts a
lot more upside while AlphaNorth Asset Management Chief Investment Officer
Steve Palmer has a more cautious outlook on the shiny metal. Where are you
putting your money?
The Mother of All Gold Bulls
The Gold Report: Peter, you have called this the mother of all
gold bull markets and predicted $2,500/ounce (oz) gold prices. What is
driving the price of gold? Is it China's growth? Is it a weak U.S. dollar? Is
it global fears? Is it central bank currency printing? What's going on?
Peter Grandich: This mother of all gold
bull markets was built on a foundation of dramatic changes in the gold market
itself that began in earnest 10 years ago and propelled it up to where it is
now. First, two significant negatives turned into positives. The gold market
had basically capped due to constant central bank selling and producers being
aggressive forward sellers of future gold production. However, starting with
the Washington Accord in 1999, the central banks dramatically changed
direction and agreed to limit gold sales. In fact, in the last two years the
central banks have actually become net buyers. At the same time, gold
producers have made hedging a thing of the past. Hedging has really become a
four-letter word among investors.
TGR: What convinced companies
to stop forward-selling their production?
PG: The gold market finally
started to rise and people realized that companies that were hedging were
making less money than companies that were not hedging. In the '80s and '90s,
the old American Barrick was almost a commodities trading house rather than a
gold producer because it used the hedging derivatives to make money. But the
great mother bull market made that counterproductive and investors began to
shy away from any company that pre-sold gold.
The other factor fueling
the bull market for gold is the introduction of exchange traded funds (ETFs).
They brought in an enormous amount of new gold buying. In the '80s and '90s,
institutional investors found it cumbersome to take a large position in gold.
Physical gold purchasing was not only expensive, it involved storage costs
and carrying costs. People tried to use mining shares as a proxy until they
realized that when the market went down, mining shares went down with it.
ETFs allow people to have direct exposure to the gold price. ETFs also offer
tremendous liquidity and the ability to sell at reduced costs intraday.
Central bank gold
selling, lack of hedging and the creation of ETFs are the main reasons why
the gold bull market has done what it has done. The gold permabears who have
not recognized these changes have missed out.
TGR: Will those conditions
continue?
PG: There is no sign of
change. In fact, despite the permabears cries to the contrary, we saw in the
first quarter that central banks continued to be net buyers. I suspect that
when the second quarter is over, we will see that central banks stepped up
again as buyers.
TGR: So, why are you
predicting $2,500/oz? Why not $2,000/oz or $5,000/oz or $10,000/oz?
PG: I'm actually not a big
fan of a target number. I'm more interested in the direction of the gold
price. My feeling during this price rise has been that gold will eventually
reach not only a nominal new high in price, but an inflation-adjusted,
all-time high. Right now that is somewhere in the $2,300-2,500/oz area
depending on what factor you use for an inflation rate. And, that's what I
think is the minimum target that we can look for before this great bull
market even comes close to an end.
TGR: How do you respond to
people who say that gold doesn't really have any value, that it's not an
industrial metal and its value is arbitrary?
PG: I give them a very
simple answer. I have thousands of years of history on my side. Mankind, for
whatever reason, over thousands of years has seen many paper currencies come
and go. Regardless of the economic framework, gold was used to buy the things
that were important while other means of value went by the wayside.
A hundred years ago an
ounce of gold bought a good man's suit and it still does. There isn't really
anything else I could point to, financial assets or oil, wheat or any other
commodity that has managed to do that. So, I think it's absurd when people
say gold doesn't have value.
TGR: What about the people
who say it's in a bubble? How will you know when gold is overbought? What are
some indicators that you watch?
PG: The definition of a
bubble of any kind is when so many people have gotten so involved in
something that it has been driven beyond any reasonable price. This gold
market has surprised us in how high it has gotten with so few members of the
general public and the professional community investing in it, particularly
in North America. If this is a bubble, bring more on for me because there
just aren't enough people participating in this. The only bubble I see is in
the number of people predicting the end of the gold bull market. That is
overloaded. Gold is not.
TGR: Well, it sounds like you
are definitely bullish on the gold commodity price, but what about equities?
Are equity valuations too low or too high based on where the gold price is
now and where it could go?
PG: There has been a
dramatic change on the equity side with some bearish developments. I'll go
through them with you.
The first change as we
discussed was the shift to ETFs for exposure to the gold price. The single
biggest change, particularly in the junior resource sector, has been the
adjustment in the financial industry from a commission-driven business to an
asset-gathering business. A decade ago, thousands of so-called financial
stockbrokers built their books of business on buying and selling individual
stocks. Some of them specialized in mining shares. Each one would have 100 to
500 or 1,000 clients. That created a market for mining and exploration
companies to get exposure to the end-user. That is all but gone now. Most
people in the financial industry today are asset gatherers. They gather an
asset, turn it over to a third party money manager and the individuals no
longer buy or sell or recommend individual stocks. That has been the single
biggest hit to our market.
The other thing that
changed dramatically is the regulatory and compliance environment. In North
America, the NI 43-101 rule required companies to follow specific reporting
guidelines in order to classify exactly what kind of reserves or potential
reserves they may have. Before that went into effect, companies could almost
say anything, sizzle their story into looking like steak if you will. While it
was a good change in many ways, it also removed all the sizzle. Companies are
now very limited to how they can describe their resource, thus limiting some
stock price growth.
The regulatory end
changed as well. In the United States, it's almost impossible to find a
brokerage firm that would allow solicited or even unsolicited orders on
stocks that are not trading on the major markets, the New York Stock Exchange
or the NASDAQ. Even though the Toronto Stock Exchange may be the fourth or
fifth biggest exchange in the world, it's very difficult for U.S. investors
and the investment community to buy and sell stocks that trade there because
compliance departments don't allow it any more.
The holding time for
private placement is something else that has changed. Private placements are
the life blood to the junior resource market. It is where companies raise
money to continue drilling and exploring. When I first entered the business,
placements came with a two-year hold. Then it became a one-year hold and now
it is only four months. A four-month hold brings more paper into the public
trading market faster than most companies can demonstrate results. Therefore,
it has become a depressant because that stock is getting ahead of company
growth.
Add to the challenging
equity picture the emergence of discount brokerages. Many individuals can
literally trade for a penny or two share movement and make money. Before
people had to have a 10% or 20% move in the stock before they would even
consider taking profits. Now they think nothing of trading multiple times a
day.
Throw in the political
difficulties that mining companies have around the world, environmental and
now even labor shortages, and you can see why there is a disconnect. Those
are some of the reasons why even though we have had a three-, five- or even
sometimes tenfold increase in underlying metal prices over the last couple of
decades, but it is far more difficult now for the typical mining company to
realize increased stock prices. It is far more difficult today for the
typical mining exploration company than in any other time in the 30 years
that I have been around them.
TGR: Do you see that
changing? How will the demand for gold be fulfilled if it isn't profitable to
pull it out of the ground?
PG: That is going to be a
challenge. The bears have predicted that 80% of juniors are going to be wiped
out because the gold price is going to go so low. That would mean 80% of the
gold that might have been found will not be. That would actually improve the
fundamentals for the gold price by decreasing supply.
What will happen is what
happens in all cycles. Juniors don't really die. They become born again. They
recapitalize. They change names. They may even change properties. But they
never truly die.
The world is going to
need new cars and electronics and that will require metal and energy and
mining companies to find those materials. More than 80% of metals found in
the world are found by small companies. If they are not around, who is going
to discover the ore to build the world of tomorrow? That is why I still
maintain a very bullish attitude toward commodities in general.
Add in the pressure for
a store of value safe from increasing world debt and political turmoil and
you have a strong argument for gold. So, it's not because I wear a tinfoil
hat or sell log cabins or dry food that I'm bullish on gold. I'm bullish on
gold because all the fundamentals point toward it still going dramatically
higher.
TGR: If the juniors are
having trouble finding love in the stock market during these record-high gold
commodity prices, what about the producers? Are they reaping the benefits of
a higher gold price?
PG: Not to the extent that
they should be in the short term, but I know it will be all right long term.
My bellwether is Barrick Gold Corp. (ABX:TSX;
ABX:NYSE). It has gotten to a
single digit price-to-earnings ratio. This was unimaginable when I first
entered the business because mining shares traded anywhere from 30 to 50
multiples. When a major producer is below a general market multiple, but
continues to do well on the corporate side, that is where the undervalue is
in the general market. So, I think we're pretty well done in this
corrective/bear market phase for mining shares. People have priced companies
to a level where gold might have been 10 or 15 years ago. So, either the gold
price has to come way down to match that or these things have been way
overdone on the downside. I'm in the latter camp.
TGR: Do you have a bellwether
for the juniors if Barrick is your bellwether for the producers?
PG: It is a much more
difficult environment for the mining and exploration business than it was 20
years ago, even though the metals themselves have gone up a lot. Throw in all
the political risk and the environmental, social, economic and financial
challenges and I would have to say, "If I had a child I wouldn't want it
to be a junior resource company because it has so many things going against
it." So many good juniors like Sunridge Gold Corp. (SGC:TSX.V) have net asset values at
multiples of their market cap. But those things happen at the bottoms of
markets, not the top. The first focus of the market when it rebounds is on
the companies that got way overdone. There will suddenly be a recognition
that not only will they survive, but they will prosper because there will be
less overall competition.
Sunridge is a classic
case. It has positive news with new studies, a feasibility study and lots of
new value created. There are lots of Sunridges out there. That is why I
believe anyone who thinks there is a lot more to the downside in the junior
market is badly mistaken.
Let me be clear: I do
not expect a V bottom. I'm looking for an L bottom. We won't go dramatically
up and it will take several months for confidence to build again through
mergers and recapitalization.
TGR: You started trading more
than 30 years ago. You have been through the wild ride of the '80s and '90s.
What is the best advice you've ever received?
PG: Hope is a wonderful
spiritual personal strategy to have because without it, it's very difficult
to live. But, hope is a horrible investment strategy. When all you have is
the hope something is going to get better or if I hope I get my money back
rather than relying on fundamental and/or technical factors to justify that
hope, then it's a very poor investment strategy.
The ultimate crime in
investing is not being wrong, it's staying wrong. I had to look at myself in
the mirror a couple of weeks ago and say, have I made that mistake? Have
things really changed in the metals and mining industry? Have I ignored the
facts because I make a living in the market? Do I need to stop being wrong? I
made a conscious decision after evaluating everything that this was just
another of the corrections that occur. That
isn't hope. That is reality.
A
Muted View
TGR: Steve, your AlphaNorth Partners Fund is a long-biased, small-cap
hedge fund focused on Canadian companies. You've been on the buy side since
1997 and adjust your outlook and portfolio based on fundamental and technical
analyses. In the last year, you have shifted to a more bearish outlook on
gold and bullish outlook on equities. What changed your mind?
Steve
Palmer: I've had a relatively muted
view on gold for a couple of years now, not so much anymore though given the
underperformance of both bullion and gold equities over the past couple of
quarters. I'm not so much negative right now but, rather, I believe that
there are better opportunities to invest in. So, in terms of new companies to
invest in, the last sector that I would be looking in would be gold.
TGR: Is there some technical indicator on which that
conclusion is based?
SP: I noticed that almost all investors had become
unanimously bullish on gold, so sentiment was at an extreme. It's not quite
as bad now with the underperformance in the last couple of quarters. But
everybody you talked to was bullish on gold, and if you didn't think gold was
going to multi-thousand dollars per ounce, they stared at you like you were
from outer space.
The
valuations of gold stocks were way out of line with other resource companies.
They have underperformed considerably of late though, so that's more in line
now. But it used to be that companies like Goldcorp Inc. (G:TSX; GG:NYSE) and
Barrick Gold would trade at 30x earnings while Teck Resources Ltd. (TCK:NYSE;
TCK.A:TSX) and Alcan Inc. [purchased by Rio Tinto (RIO:NYSE) in 2008] would
trade at 9x earnings. That didn't make any sense to me. That valuation
discrepancy has largely been corrected at this point, so I'm not as negative
on those anymore.
That
leaves two reasons why I remain not bullish on gold. There is still a lot of
retail money that believes in gold as something that they need to own to
protect against whatever is going to happen—inflation, deflation,
death, whatever. It seems to be a cure-all for everything. The supply-demand
picture on gold is not favorable. It's the retail money that has basically
propped up the gold price, all the ETFs that have been created to hoard gold.
I saw some data that investment demand over the last 10 years has increased
17% while total demand for gold is up only 1%. So that implies that
fabrication demand, a real end-use demand, for gold is negative, negative 20%
over that time. If you took away the investment demand, the picture for gold
would be a totally different story. We've seen many times before how retail
piles into an asset class, creates a bit of a bubble and when it gets out, it
causes significant correction.
TGR: What do you think is a reasonable price for
gold?
SP: I don't know. Because there are so many factors
and variables, it would just be guesswork. It all depends on what the
sentiment of the retail investment does that's going to drag gold. I don't
know the timing of that. So I use technical analysis to predict shorter-term
swings. I know there will be a big bust in gold at some point, but I don't
know when it's going to occur.
I
think it will still go up this year along with the other commodities, but
it's unclear what will prompt the big downturn in gold. I would imagine at
some point, if the equity markets are generating decent returns as I think
they will, investors will re-evaluate their portfolios and wonder why they're
holding gold, which is only costing them money because it doesn't generate
any return like a bond or a stock with a dividend. It just costs money to
store it.
TGR: When you say a big bust, how big of a dip could
it be?
SP: It could be in half. A few months ago we saw
gold drop $100/oz in one day. That just gives you a sampling of what could
happen when things unwind.
TGR: What impact will any quantitative easing (QE) 3
or inflation have on your projection?
SP: In the short term, the markets believe that QE3
will be positive for gold. It remains to be seen whether QE3 happens or not.
It would be beneficial to gold over the following few months if it were to
occur.
TGR: You've called your "muted" view on
gold an out-front, lonely maneuver, quoting Army Colonel John Masters:
"Only if you are far enough ahead to be at risk do you have a chance for
large rewards." How far ahead do you try to go?
SP: Not too far. Time is often the most difficult
component to predict. In my mind, there is no question that there will be a
big down-move in gold. It's just getting the timing right that is difficult.
So I don't put on positions, hoping for something like that, waiting two to
three years for it to happen because a lot can happen in the shorter term. On
occasion when the technicals looked very unfavorable, we have shorted it.
TGR: Are you short gold now?
SP: Currently, we are not short. I don't think a
collapse is going to happen this year.
TGR: You mentioned that one of the signs that gold
was overvalued is that everyone was investing in gold. Do you consider
yourself a contrarian?
SP: Yes. I try to be whenever possible because that
speaks to that quote you just mentioned. If you're always doing the same
thing as everyone else, you're not going to stand out in terms of
performance. You're just going to generate the same returns as everyone else.
TGR: Has it been working for you?
SP: So far it has been working, yes.
TGR: What were your returns last year?
SP: Last year, we were +2.4% in the AlphaNorth
Partners Fund. The Toronto Stock Exchange Venture Index was -35% and most of
the small caps were negative for the year, so I consider that a big win.
TGR: In December 2011, you said, "Our strategy
of avoiding the precious metals sector has added value over the last couple
of quarters as gold and silver remain entrenched in the downtrend. Both of
these commodities peaked in the summer and have continued to hit new lows
since that time. We prefer to invest in other sectors with more favorable
supply-demand fundamentals." It looks as if you've reduced your precious
metals holdings from 11% to 6% of your holdings, but you still hold 20% in
industrial metals. Are you more upbeat about copper and nickel?
SP: Yes, I am.
TGR: Why is that?
SP: Gold is not really used for any meaningful
purpose other than jewelry, which is not a critical item, whereas many of
these other commodities are. Once you use oil or copper, it is gone. Gold
just sits around.
TGR: So are those industrial metals more dependent
on global economic trends?
SP: Yes. The biggest factor would be Chinese
growth.
TGR: Are you worried about slower growth in Asia?
SP: I think the concern over Chinese growth rates
is overblown in the short term. I find it funny that the concern a few months
ago was inflation in China. Inflation was getting out of control, so the
government instituted some policies to control the growth and make sure
inflation didn't become a problem. It was successful, but now everyone is
complaining about the growth slowdown.
TGR: Other than industrial metals, what sectors do
you see as more favorable and why?
SP: I have been focusing on the energy sector, the
major base metals, specialty metals like graphite—those stocks have all
been performing very well lately—iron ore, coal, all those types of
commodities. The supply-demand outlook is much more favorable. You don't have
a looming potential risk of all of the retail money unwinding out of the
ETFs.
TGR: If you were to give our readers some investing
advice for the rest of 2012, what would that be?
SP: I view this year as the time to buy on
weakness. Don't get whipped by the headlines about the end of the world.
There are always problems. When the news is bad is the time you should be
adding to positions. Once these positions have a significant move as we saw
from October to January, when the Standard & Poor's index was up over
20%, you should take some money off the table.
Financial
Adviser and Market Analyst Peter Grandich
started publishing The Grandich Letter—now a blog—without
a high school diploma or even a day of formal training. His ability to
interpret and forecast financial happenings, which once earned him the
moniker "Wall Street Whiz Kid," has led to hundreds of media
interviews. He is regarded as one of the world's foremost market strategists.
He's also published a new book called Confessions of a Wall Street Whiz
Kid.
Steve Palmer is a founding partner
and chief investment officer of AlphaNorth Asset Management. Prior to founding
AlphaNorth in 2007, he was employed at Canadian Equities, one of the world's
largest financial institutions, as vice president where he managed the
Canadian equity assets of approximately $350 million. Palmer managed a pooled
fund, which focused on Canadian small-capitalization companies from its
inception to August 2007, achieving returns that were ranked #1 in
performance by a major fund ranking service in their small-cap, pooled-fund
category. He also managed a large-cap fund, which ranked in the first
quartile of performance among other Canadian equity pooled funds. From
1997–1998, Palmer was employed as a portfolio manager at a
high-net-worth investment boutique. Palmer earned a bachelor's degree in
economics from the University of Western Ontario and is a Chartered Financial
Analyst.
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DISCLOSURE:
1) JT Long of The Gold Report conducted this interview. She personally
and/or her 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: Sunridge Gold Corp. and Goldcorp Inc. Streetwise Reports
does not accept stock in exchange for services. This interview was edited for
clarity.
3) Peter Grandich: I personally and/or my family own shares of the following
companies mentioned in this interview: Sunridge Gold Corp. I personally and/or
my family am paid by the following companies mentioned in this interview:
Sunridge Gold Corp. I was not paid by Streetwise Reports for participating in
this story.
4) Steve Palmer: I personally and/or my family and/or AlphaNorth own shares
of the following companies mentioned in this interview: None. 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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