Gold equities are in
competition with gold ETFs for shareholder dollars. In this exclusive Gold Report
interview, Goldman Sachs Managing Director Ian Preston discusses the steps
gold companies must take to pull investors back from the ETF space and shares
Goldman Sachs' outlook for the gold price over the next year or so.
The Gold
Report: Your recent commodity price research shows a gold
price of around $1,811/ounce (oz) for 2013. Could
you talk with us about how some of the macroeconomic issues influence that
forecast?
Ian Preston: When
we look at gold, we don't have in mind a specific supply/demand balance going
forward. It's easy enough to see the supply side. In trying to forecast a
price for gold, we tend to run out a 4% per annum contango
from the current gold price until we think U.S. interest rate policy will
reverse and rates will start to climb. That stage just keeps on moving
out—as it has with Quantitative Easing (QE) 3.
We look at the
gold price to forecast earnings, and over the next 6 to 12 months, we'd
expect $1,650/oz at the lower end and, if it breaks
through, $1,850–1,900/oz at the upper end. If
accommodative fiscal policies continue globally, it could go significantly
higher. But bear in mind that as equity analysts we're trying to forecast
earnings, and to do so we want to be as close as possible to where the gold
price will be for the next three to six months, even if the range is quite broad.
TGR: And
in your world, it's better to be conservative than hyperbolic.
IP: It
doesn't do our investors any good if we use a $2,000/oz
gold price for the next six months and it ends up averaging $1,780/oz. It's
more meaningful to say we have a positive view around gold. And we do.
Considering such accommodative fiscal regimes, very low interest rates
globally and central banks buying gold where previously they have been
sellers, it's pretty difficult to take a negative view on the gold price over
the next 12 to 18 months.
TGR: Many
analysts at the Denver Gold Forum last month echoed that sentiment. They
don't see any catalyst that would push the gold price down appreciably. Let's
talk about gold equities and exchange-traded funds (ETFs) in the context of
the backdrop you described.
IP: From
a risk diversification point of view, the ETF clearly gives investors
exposure to gold. So the gold majors aren't competing with each other for
investors; their competition is the gold ETF. Over a 10-year timeframe, the
correlation between gold equities and the gold price is very strong, but more
recently—say the last 12 months—gold equities, certainly for the
majors, have underperformed the gold price. That's partly due to the fact
that, certainly among the majors, earnings per share (EPS) hasn't reflected
the leverage to an improving gold price.
TGR:
Underperformance relative to the gold price actually goes across the board,
not just the gold majors. In fact, it's magnified in the juniors and the
smaller companies. Just to clarify your point, though, what are some of the
majors you're talking about?
IP:
We'd put Newcrest Mining Ltd. (NM:TSX; NCM:ASX) in there with
the likes of Barrick Gold Corp. (ABX:TSX; ABX:NYSE), Goldcorp Inc. (G:TSX; GG:NYSE), Newmont Mining Corp. (NEM:NYSE),
etc.
TGR: In
the environment you described earlier—QE, European sovereign debt
issues, central bank buying and so on—what can these companies do to
make a more compelling case for themselves with investors?
IP: First,
they must deliver on whatever guidance they've given the market. That's an
imperative to have investor confidence. They also must maintain long-life
reserves and be able to replace them on an annual basis to keep a perpetual
gold production chain going. That's what the gold ETFs give investors.
TGR: But
gold ETFs have grown dramatically over the past five to seven years. What's
given them such an edge?
IP: An
ETF costs investors a small amount to hold but carries no risk as compared to
a gold equity that comes with operational risk, acquisition risk and
potentially political risk. On the other hand, ETFs cannot pay dividends, so
meaningful shareholder returns that offset a lot of the operational risks
inherent in the gold equities could bring back some of the investors who have
gone to ETFs.
I think the
gold seniors are aware that the return to shareholders is among the key
criteria. All of them were talking about it in Denver. Whether the return
takes the form of a payout ratio or a percentage of the payout ratio or free
cash flow or is tied to the gold price, the majors got the message loud and
clear that they have to do more than rely on the gold price to see share
price appreciation and shareholder returns.
To be more
attractive to investors than the ETF, the gold seniors also must grow EPS.
Increasing volume when gold prices increase accelerates EPS growth, but
volume growth must drive EPS growth—not simply higher gold prices. With
volume-driven EPS growth, improving gold prices also give investors more leverage
to gold than they would have in an ETF. And I think perhaps we're starting to
see recovery in the gold equities. But it all starts out with meeting the
guidance they give the market.
TGR: Of
the companies that you cover, tell us about those you feel will do that.
IP: In
our markets, you'd have to start with Newcrest Mining, the fourth largest
gold company by market cap globally. Its resource and reserve base put this
company in a league of its own. It has longer-life assets than any other
major, and its four largest operations each produce more than 400,000 oz gold per annum. But despite that very good starting
base, the company unfortunately has not had a good track record recently of
meeting production guidance, nor shown EPS growth.
That said, it
somewhat depends on the timeframe, but if you're looking forward 20 years,
this company will be around for that long and potentially could grow through
that whole period from the asset base that they already have, let alone any
new assets it finds. Newcrest has been extremely successful in adding
resource and reserves to its portfolio.
The next
biggest after Newcrest in our market is Regis Resources Ltd. (RRL:ASX), which is not well known in North
America. The management team that bought into this company changed the board,
delivered one mine already in Western Australia and is well on the way to
delivering a second. It has driven quite significant volume growth in a very
short space of time. Its share price performance certainly has been very
strong over the last three years and is likely to continue growing provided
Regis keeps meeting its targets.
TGR: How
many producing mines does Regis have?
IP: Two
at the moment. Moolart Well was the first mine
Regis developed and it's been in operation just over a year. Garden Well, the
second, just commenced production. That means tremendous volume growth with
no EPS dilution.
TGR: Does
Regis have any other assets?
IP: It
recently bought a third project, a joint venture between Newmont's Australian
subsidiary and Alkane Resources Ltd. (ALK:ASX), a small Australian-listed
company. With this new project, called McPhillamys,
Regis will soon be producing 400,000-plus ounces. Two years ago they weren't
in production at all. Now, that's attractive to investors.
TGR: Very
attractive.
IP: And
in terms of cash flow, Regis certainly will be in a position to become a
dividend payer. That's also an attractive element for a mid-tier producer.
TGR: Do
most of the companies you cover have North American listings or are most of
them exclusively listed in Australia?
IP: I
only cover the ASX-listed companies, although some—for example, OceanaGold Corp. (OGC:TSX; OGC:ASX), Perseus Mining Ltd. (PRU:TSX;
PRU:ASX), Alacer Gold Corp. (ASR:TSX: AQG:ASX) and
Teranga Gold Corp. (TGZ:TSX; TGZ:ASX)—have
Canadian listings as well, and Newcrest is now listed on the TSX.
TGR: Oceana's
growth profile has been an impressive one, similar to what you described with
Regis.
IP: And
Oceana's at the point now where it's about to commission the Didipio project in the Philippines. That's a very big leg
of growth—a company-changing asset. My colleague just returned from a
site visit, and Oceana will be commissioning in this current quarter.
Going from
mining low-grade refractory ore underground in New Zealand, which is where
Oceana's current operations are, to an open-pit copper-gold project in the
Philippines will dramatically change its cash generation, and it's on the
cusp of production as we speak.
The market has
been skeptical about delivery because that project has been around for a very
long time and was supposedly going to be developed a number of times over the
years. Under these circumstances, you'd expect the market to be looking at
Oceana as a re-rating opportunity.
TGR: This
Philippine asset is a game changer for Oceana. Do you see the Philippines
more as an emerging gold district than in the past?
IP: There's
no question that the Philippines has the resource base that might have hosted
a lot more development over the last five or six years. Given the resource
endowment and a quite skilled labor force, you would have expected the
Philippines to have participated more in the resource boom.
It's really
starting to come to the fore now, though, because mining companies have to go
where the deposits are. I think activity will increase in the Philippines as
some of the global majors get involved there. Xstrata Plc (XTA:LSE) has
a controlling stake in the Tampakan project. In
March, Gold Fields Ltd. (GFI:NYSE)
from South Africa exercised an option to take a 40% stake in Far Southeast in
the Philippines, and soon afterward announced an option to acquire 100% of
the Guinaoang deposit. There are some major nickel
operations in the Philippines too.
TGR: In
another fairly major acquisition, B2Gold Corp. (BTO:TSX; BGLPF:OTCQX) bought CGA Mining Ltd. (CGA:TSX; CGX:ASX),
which has an asset in the Philippines, the Masbate gold project. So it looks
as if quite a bit is bubbling in the Philippines.
IP: And
the government has done a lot of work in clarifying the legal issues
surrounding ownership rights. Once miners are comfortable with that, you're
on the road to more significant development. The smaller companies usually
start moving in first because they're a bit more nimble. Then the midtiers and the seniors follow. Once the whole spectrum
is involved, you really start to see quite significant development.
TGR: Speaking
of spectrums, let's move to another sector in the resource arena and another
company you cover—Lynas Corporation Ltd. (LYC:ASX)
. With North American interest in rare earths and
specialty metals magnified over the last few years, we've been watching Lynas's story in Malaysia unfold.
IP: Lynas has gone
through everything necessary to be able to operate the Lynas
Advanced Materials Plant in Malaysia, the so-called LAMP facility but one
final challenge remains. It's a legal challenge brought by parties who oppose
the operation of that facility in Malaysia. Under no circumstances do they
want it to operate. Of course, it's always difficult to make a call on legal
proceedings.
Everything Lynas has done in terms of the development has been
within in the Malaysian guidelines for a project of that nature and also
within the International Atomic Energy Agency (IAEA) guidelines. I don't
think anyone would say that Lynas has cut corners, that it hasn't disclosed environmental
information or that it hasn't adhered to best practices globally. From that
perspective, the company has gone as far as it can.
If the
court rules in Lynas' favor, the company will be
able to start importing the concentrate from the facility in Australia and
actually start producing the rare earths as early as December as the final
court ruling is due Nov. 7. It's that close. But at the moment, investors are
waiting to see a product actually being produced from the plant.
TGR: So Lynas is facing the final hurdle in the
race, and we'll be waiting with bated breath. Do you have any suggestions for
our readers on the investment environment going forward?
IP: We certainly sit in the camp that believes the commodity boom is not
over in the sense that volume growth will continue. Still, we've probably
seen the best of most metal prices already and each of the metals will react
differently over the next few years. For example, in iron ore, we expect the
seaborne-trade market to be in oversupply probably in two or three years'
time. Copper, in contrast, could well have upside remaining because China's
demand will grow. Even though its growth rate has declined, it's off that
much larger base, so, volume growth for copper is still very much
intact—and the same goes for seaborne-traded iron ore.
From an
equity investor's perspective, with a few exceptions the easy part of
earnings going up because prices were going up is pretty well behind us now.
But we'll still see earnings growth driven by those companies that can grow
volumes.
TGR: That suggests that investors have to be pickier.
IP: Absolutely. You have to be much more focused on, first, the commodity.
Clearly, we think gold still has a very favorable outlook. Then you have to
focus on the companies that can grow volumes without actually issuing fresh
equity.
TGR: And volume growth without blowing out your per-ounce cost structure.
IP: Absolutely. But cynical clients would say, "Yes, everybody is
talking the talk. We need to see them walk the walk now."
TGR: Well put, Ian. Thank you so much for your time and your thoughts.
Ian Preston is a resources analyst for Goldman Sachs' Global
Investment Research in Australia and New Zealand. In 2000, he joined JBWere, a private wealth management firm that in 2003
partnered with the Goldman Sachs Group Inc., as a research analyst covering
the gold sector. Mid-cap base metal companies came under his coverage
umbrella later in 2000, and Preston assumed responsibility for emerging
small- and mid-cap mining companies in 2004. He was named managing director
in 2010.
Prior to 2000, Preston was a resource specialist,
working on both buy and sell sides of the financial
services industry in Johannesburg and Brisbane. Following graduate school, he
spent four years analyzing and implementing new mining projects in diverse
metals, and earlier in his career, he spent six years working for copper and
gold mining companies in operational and management capacities.
Preston earned a degree in mining engineering from the
University of the Witwatersrand in Johannesburg in 1974 and a Master of
Business Administration from the University of Cape Town in 1980. He is a
registered professional engineer in South Africa and an accredited member of
the Securities and Derivatives Industry Association.
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DISCLOSURE:
1) Sally Lowder 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: Goldcorp Inc. and B2Gold Corp. Streetwise Reports does
not accept stock in exchange for services. Interviews are edited for clarity.
3) Ian Preston: I personally and/or my family own shares of the following
companies mentioned in this interview: Newcrest Mining Ltd. 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 interview.
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