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.
"NOVAGOLD has a very large deposit that major producers will be interested in developing."
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.
"One strategy that has really worked for us is that we've been heavily into the royalty stocks, which come down to names like Silver Wheaton Corp."
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.
"Tahoe Resources Inc.'s acquisition of Rio Alto's operation in Peru, another fine mining district, gives it exposure to another part of the world."
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.
John Hathaway, senior portfolio manager of Tocqueville Asset Management, manages all gold equity products and strategies at Tocqueville Asset Management. He holds a bachelor's degree from Harvard University, a Master of Business Administration from the University of Virginia and is a Chartered Financial Analyst. He began his career in 1970 as an equity analyst with Spencer Trask & Co. In 1976, he joined investment advisory firm David J. Greene & Co., where he became a partner. In 1986, Hathaway founded Hudson Capital Advisors and in 1988, he became chief investment officer of Oak Hall Advisors.
Douglas B. Groh is a portfolio manager and senior research analyst at Tocqueville Asset Management and has 30 years of investment experience. Before joining Tocqueville in 2003, he was director of investment research at Grove Capital. While an analyst for JP Morgan and Merrill Lynch, he was recognized by 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.
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DISCLOSURE:
1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Tahoe Resources Inc., NOVAGOLD and Silver Wheaton Corp. Goldcorp Inc. and Franco-Nevada Corp. are not affiliated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services.
3) John Hathaway: I own, or my family owns, shares of the following companies mentioned in this interview: Tocqueville Gold Fund. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: the Tocqueville Gold Fund owns all the companies mentioned in this interview except Barrick Gold Corp., AngloGold Ashanti Ltd., Probe Mines Ltd., Orbis Gold Ltd., Rio Alto Mining Ltd., Centerra Gold Inc. and Seabridge Gold Inc. Funds operated by Tocqueville Asset Management hold shares in all the companies mentioned in this interview. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Doug Groh: I own, or my family owns, shares of the following companies mentioned in this interview: Tocqueville Gold Fund. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: the Tocqueville Gold Fund owns all the companies mentioned in this interview except Barrick Gold Corp., AngloGold Ashanti Ltd, Probe Mines Ltd., Orbis Gold Ltd., Rio Alto Mining Ltd., Centerra Gold Inc., and Seabridge Gold Inc. Funds operated by Tocqueville Asset Management hold shares in all the companies mentioned in this interview. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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