Gold has had a difficult few months. After a modestly upward trend until
mid-April, gold then started its downward trajectory, falling from $1,350 to
well under the psychologically important $1,200 mark in a (final?) collapse
the last week. The U.S. economy, stock market, and particularly the dollar
have all been broadly positive for most of the year, making it a difficult
environment for gold, with demand for the metal sliding; U.S. coin sales hit
10-year lows, reflective of this lack of demand.
Turkey responsible?
But indifference has now turned to hostility, as, in the last couple of
weeks, amid its currency crisis, Turkey is thought to have been a heavy
seller of physical gold. It makes sense; after China and India, Turkey and
Russia have been the largest buyers of physical gold since 2008, with a
pick-up over the last three years. In a crisis, one sells liquid assets, all
the more if the price has gone up in local currency terms (viz. Venezuela).
If this is the main cause of gold's sharp decline in the last week or so,
then it is of necessity a temporary phenomenon. The U.S. economy, stocks and
the dollar may stay reasonably strong—for now at any rate—so gold won't suddenly
explode upwards, but we could reasonably expect a near-term return above
$1,200 towards the mid-$1,200s. (On Friday, gold bounced $11 from its low of
$1,174.)
Vanguard out of gold business
Amid this gold decline and a collapse in sentiment, Vanguard decided to
get out of the gold market. The largest precious metals fund by far—virtually
twice the size of the next largest—is to change its name and mandate from the
Precious Metals Fund to the Global Capital Cycles Fund; it has already
replaced its London-based gold manager to a U.S. firm not known for any gold
expertise or interest.
We suspect that the heavy volumes on many gold stocks reflect the new
manager cleaning house, a typical phenomenon when a new manager takes over a
fund. This has been going on since the new manager took over at the end of
July, with the XAU index down from over 77 to under 66 this month. But in the
last week, amid the drop in gold, this decline changed to a cascade, with
some big-cap miners seeing one-day declines of 5%–9% on heavy volume.
Vanguard shunning gold at this point may prove to be a contrary indicator
of historical proportions. Again, if this is the explanation for much of the
gold selling, then it too is a temporary phenomenon, and we can equally
expect a bounce in the gold stocks once the selling precious is off. (The XAU
moved from 64.29 to 65.92 on Friday.)
Capitulation in gold
Amid all this, sentiment has turned extremely negative, as evidenced by
the latest CFTC data, showing speculators went net short for the first time
since the end of 2001. At that time, gold was $275 an ounce and within a year
was at $348, within six years at $900.
Peter Boockvar of Bleakley Advisory Group, to whom acknowledgements for
pointing out the data, comments "it's tough to find a more contrarian
indicator."
This, plus the largest gold fund changing its mandate, is as close to
capitulation as one can get. The short-term recovery could be as sharp as the
decline, once the selling pressure is gone. This gives us the opportunity to
buy great companies on sale, as well as to make some short-term trades is
grossly oversold stocks.
Buy the best at bargain levels
Friend Rick Rule likes to say "don't buy hamburger when the fillet is
on sale." The fillet, nay, the wagyu of the gold market is Franco-Nevada
Corp. (FNV:TSX; FNV:NYSE), on sale now at under $67 (FNV, NY, 66.78), its
lowest price in over a year. The stock fell as low as $64.57 on Thursday.
Significantly, Franco fell 2.5% on a day when other gold stocks plunged by
two or three times that amount.
You can run but you can't hide
The royalty business model limits risk in the gold mining business, but
does not eliminate it, and certainly does not mean that royalty companies are
not exposed to lower gold prices. Thus, in latest results just released,
Franco said its "gold equivalent ounces" declined on the previous
year, and revenue was also marginally lower.
The decline in ounces resulted primarily from lower grades and recoveries
at one of its major assets, the Candelaria mine. Franco expects this to be a
short-term problem, while also pointing out that the mine is now delivering
more ounces than originally expected at the time of Franco's acquisition of a
royalty on the mine. Another of its major assets, the Antamina mine,
delivered fewer silver ounces than expected. These are two of Franco's
cornerstone assets, four large copper mines from which the company receives
gold and silver by-product streams, which together account for some 50% of
total revenues.
Oil and gas to the rescue
The average gold price in the second quarter was also the lowest of the
past five quarters, driving down the metals revenue received. Offsetting that
were the oil and gas revenues, which saw a very strong quarter with both
increased production and higher prices than both the previous quarter and the
year-ago quarter.
Franco has just boosted its exposure by a new strategic relationship with
Continental Resources essentially to fund exploration in Oklahoma. Franco has
made an initial payment of $220 million and will pay $100 million per year
for the next three years.
Taking on debt again
With its cash at low levels—just $72 million—Franco will draw into its $1
billion credit facility for the acquisition as well as the final payment due
later this year on the Cobre Panama stream acquisition. Next year, with
revenue starting from that large copper mine in Panama, as well as other
revenue, Franco expects to "easily pay off" the credit line. This
will be only the second time in its history that Franco has gone into debt,
and, as with the last time, it will be only for a very short term.
Franco's objective remains to generate at least 80% of its revenue from
precious metals, and despite the recent acquisitions in oil and gas, it is
still above that goal today.
We have discussed before the advantages of the royalty model as well as
the reasons we consider Franco-Nevada to be the premier gold company around.
Diversified assets, a deep pipeline, a strong balance sheet, and disciplined,
counter-cyclical management make Franco a sleep-well-at-night gold stock.
Down from $75 at the beginning of last month, Franco is a strong buy at the
current price, under $67.
Difficulties at mines affect Royal's results
Royal Gold
Inc. (RGLD:NASDAQ; RGL:TSX, US$78.09), also had a difficult quarter,
experiencing problems at both its largest and its newest mine. As previously
discussed, the operators of the Mt. Milligan mine, representing about 27% of
both NAV and revenues for Royal Gold, are experiencing water supply issues.
The mine was forced to shut down earlier this year, and could experience
production shortfalls if there are delays in receiving a permit to draw water
from nearby sources.
The newest mine, Rainy River is "not yet hitting on all
cylinders," as the company put it, with significant start-up issues. The
operator also said it now expected higher costs for the life of mine. Since
production should be the same, this won't affect Royal Gold, as the stream
holder, but there is always a risk that the problems eventually affect
production.
Royal has a strong balance sheet, with modest net debt, and, like Franco,
over $1 billion in available credit. As a U.S. company, Royal is also the
only one of the major royalty and streaming companies not affected by Canadian
tax audits on offshore streams. If you do not own Royal Gold, this is a good
price to buy.
Trade the gold stocks
In addition to Franco Nevada, among other senior gold stocks on our list, Osisko Gold
Royalties Ltd. (OR:TSX; OR:NYSE, US$8.05) is also a strong buy. Goldcorp Inc.
(G:TSX; GG:NYSE, US$10.74), Royal Gold Inc.
(RGLD:NASDAQ; RGL:TSX, US$78.09) and Wheaton
Precious Metals Corp. (WPM:TSX; WPM:NYSE, US$18.43) are good trades.
Most of the other gold companies on our list are good buys now, in
particular Almaden
Minerals Ltd. (AMM:TSX; AAU:NYSE, US$0.625), Midland
Exploration Inc. (MD:TSX.V, 0.79) and Vista Gold Corp.
(VGZ:NYSE.MKT; VGZ:TSX, US$0.516); and among resource companies Altius Minerals
Corp. (ALS:TSX.V, CA$11.90), and Lara
Exploration Ltd. (LRA:TSX.V, CA$0.60).
Adrian Day, London-born and a graduate of
the London School of Economics, heads the money management firm Adrian Day
Asset Management, where he manages discretionary accounts in both global and
resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX).
His latest book is "Investing in Resources: How to Profit from the
Outsized Potential and Avoid the Risks."
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