The Gold Report: In a report from RBC Capital Markets in
late January, the firm said gold could reach as high as $1,200/ounce
($1,200/oz) in the short term but remains in an overall downward trend. Does
ROTH Capital Partners share that view?
Joe Reagor: A lot of people are reacting to a bounce in the gold
price here in early February and need to set a number, but they still believe
the factors that have held gold down over the last few years remain intact.
Our view is a bit different. Gold at $1,100/oz is not a sustainable long-term
scenario. The costs of production are still relatively high, and they're only
going to get higher as companies mine higher grades to lower costs. Miners
did this in the late 1990s, and that's why gold moved higher for 12 straight
years in the 2000s before we had a healthy pullback. We think we're heading
toward the end of the 1990s time frame again, where the fundamentals will
drive the gold price higher.
TGR: Please explain those fundamentals.
JR: Gold can't go much lower without costs having to adjust lower.
The strength of the U.S. dollar helps non-U.S. producers somewhat, but in
general, the fundamentals suggest that if you want an industry to survive, it
needs a 20% profit margin. If all-in sustaining cash costs are $1,100/oz for
gold, then you already need over $1,300/oz to sustain the business. That is
where gold needs to be in the long run or we won't have as much gold
production for the world to consume.
TGR: The Bank of Japan recently cut its interest rate on bonds to
minus 0.1%. In fact, much of the global economy now is in a negative interest
rate environment. Is deflation now the global economy's greatest threat?
JR: Deflation and inflation are difficult to peg. The governments
of the world are good at spinning numbers to make them look like what they
want them to look like. But loose monetary policy usually drives inflation-it
just doesn't always drive the type of inflation that the government is
seeking. Governments might insist we're in a deflationary environment, but
that doesn't mean that the consumer or the investor is seeing deflation.
Loose monetary policy is usually good for gold, and gold generally goes up
with inflation. It's hard to say exactly what side of that fence we're on.
The inability of lower interest rates to drive more economic growth is a real
concern in the near term.
TGR: The global economy clearly has more faith in the U.S. dollar
than in gold. Is that a case of misplaced faith?
JR: Yes. We're the best of the worst, and the U.S. dollar is
valuing up as most other currencies are devaluing. That can only go on for so
long before the global recession finds its way back to the United States.
Eventually the U.S. dollar momentum trade could come to an abrupt end and
that would be good for gold. People know that but they're making money in the
U.S. dollar trade. Similar to mortgage-backed securities and credit default
swaps, people are taking advantage of it and hoping that they aren't the last
person into the trade.
TGR: How does ROTH Capital Partners expect gold to fare amid all
this uncertainty and fear in the global economy?
JR: In the near term, we expect to see a slow, steady recovery in
gold prices-$1,200/oz seems reasonable. A healthy, slow, steady recovery in
gold is possible based on more and more people moving away from the U.S.
dollar and into gold as a store of value. If there is a global recession and
it becomes obvious that it is going to be a multiyear issue, gold could see a
big increase in value.
The big key is China. If China's growth rate continues to decline, that
would significantly impact the world economy. Perhaps China can find new ways
to spur its economy to continue to grow at closer to Third World than First
World rates. If it does, there's some question as to how it funds that. It
could sell our debt, which would likely result in a devaluing of the U.S.
dollar and give it the funds it needs to start public works projects. The
rest of the world could, in a sense, come out of recession but at the same
time still cause gold to go up by devaluing the dollar. There are lots of
avenues where gold goes up, and very few where we see further decline toward
that infamous $1,000/oz level.
TGR: So you don't dismiss what's happening in gold as a strictly
seasonal event.
JR: There's usually a bounce in January following a down year, and
in December we were talking to our clients about this possibility. But at the
same time, we expected that without the world economy slowing and the U.S.
stock market pulling back. Now there are potential concerns about how the
U.S. Federal Reserve reacts or overreacts to the pullback in the market. The
first move from $1,050/oz to $1,100/oz was seasonality. Now it's a little bit
of a fear trade, in our view. Therefore, there's more room for it to run.
TGR: Silver typically fares worse than gold in a bear market given
its heavy industrial use. How do you expect silver to perform in 2016 and
into next year?
JR: A lot of silver production comes from byproduct production, but
the straight silver producers are not in a position to weather a lower silver
price. The silver-only producers are near break even with their all-in cash
costs. Maybe the silver-gold ratio could expand to 80:1 or 82:1, but we're
expecting gold and silver to start to recover, and then as you get a recovery,
the ratio usually contracts. The gold market is so many magnitudes larger
than the silver market, so as people try to buy into the silver market, they
can really move the needle. Once the recovery takes hold, we expect some form
of contraction of the silver-gold ratio back to 70:1 or 65:1.
TGR: Do you see the U.S. adopting a negative interest rate policy?
JR: I don't think the Fed would re-lower rates. If the Fed decides
to do some additional form of quantitative easing, it would do so in other
ways. Lowering interest rates would send a very negative signal.
TGR: Is it more imperative now for a precious metals research
analyst to have a firm grasp of the macroeconomic picture than it was
pre-2007?
JR: It's important for us to be aware of macroeconomic events but
the investment strategy that we are recommending to investors is not one that
relies on gold going up or gold going down in order for them to make a profit
on an investment. Our approach targets the right companies in the right
positions at the right times. That's been lost in this downturn. The
fundamental side of equities has gone by the wayside, and stocks are trading
very much with the gold and silver price until these companies make an
announcement that no one was expecting.
TGR: So it's a stock picker's game.
JR: In a down market it has to be. In an upmarket, everybody is a
winner. In a downmarket, it's a matter of picking the winners and avoiding
the really big losers. If you can avoid those and invest in names that have
upside, whether gold is up, down or flat, then you can still make money in
this market.
TGR: Please give us your investment thesis for precious metals
producers and development-stage equities.
JR: There are two types of producers that we look at as good
investments. The first type are generally larger-cap defensive names that
have succeeded in growing production and revenue, despite the down gold
market, like Randgold
Resources Ltd. (GOLD:NASDAQ; RRS:LSE). If you think a gold recovery is
coming and you invest in these names, you're holding them with a long-term
view on gold. We don't specifically cover these names because they're usually
above our target market-cap range.
Another type of producer is one that has made material changes in terms of
costs, production, acquisitions, balance sheet or a change in company
philosophy, yet really hasn't received much credit for those changes because
these stocks typically trade with the gold and silver price. For example, Coeur Mining Inc.
(CDE:NYSE) has made acquisitions that are key to the company's future and
it continues to make investments to lower costs and increase production to
get to free cash flow. But this year the company is not free cash flow
positive, so it trades with the gold and silver price. But you can see the
path to improvement. We like stories where the market has overlooked
fundamental changes made by management.
TGR: What is the thesis for developers?
JR: There are two types of development-stage companies we like to
target. First are those companies approaching a construction decision on an
asset. This generally results in some short covering. One example is Pretium
Resources Inc. (PVG:TSX; PVG:NYSE). Last year, after it made its
construction decision and announced its financing without any equity
component, its stock value improved significantly despite a flat gold and
silver price because there was short covering on the name. Stories like that
are easy to forecast. We like targeting those six months ahead of a
construction announcement.
The other comes down to companies that own assets that are clearly needed
by a neighbor that's a larger company. We used to cover Paramount Gold and
Silver Corp., which Coeur purchased in March 2015. Coeur needed to own the
asset for a number of reasons, and it was only a matter of time before the
valuation made sense. You can usually spot these ahead of time because
they're often close to existing assets that are nearing the end of their mine
lives or are transitioning, in the case of Palmarejo, to an underground
operation that needed additional ore to fill the open pit-sized mill. So we
target companies where we believe a buyout is coming.
TGR: Prior to our interview you talked about how larger companies
are increasingly taking positions in the junior market, even with the view
that the gold price will remain relatively stagnant for some time. What are
some examples?
JR: A perfect example would be Integra Gold
Corp. (ICG:TSX.V; ICGQF:OTCQX), which we cover. It received a 15%
investment from Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) in August 2015.
Eldorado is investing in what appears to be an elite asset early on with the
intention to be at the front of the line to acquire Integra by already owning
15% of the stock.
TGR: Did Eldorado gain some influence with its cash infusion?
JR: It has had some influence on the company's approach to moving
the project forward. It clearly wants Integra to continue to conduct
underground infill drilling, exploration drilling and a bulk sample to
continue to derisk Triangle.
TGR: Integra continues to hit solid gold grades in the C zone
structures that it has outlined at about 1,000 meters below surface at its
Triangle deposit in Val-d'Or, Quebec. Are these results changing the market's
perception of Integra?
JR: The market is starting to realize the potential of Lamaque
South, but Integra has yet to see much of an improvement in valuation. We
attribute this to what occurred last year with Rubicon
Minerals Corp. (RBY:NYSE.MKT; RMX:TSX). In our view Rubicon rushed into
production and it backfired, to say the least. Now investors are more
cautious about assigning value to high-grade intercepts. They want companies
to go underground and do bulk sampling to make sure that drills are not
accidentally hitting the best grades or that the geological structures do not
have such an orientation as to make the company believe that its intercepts are
wider than their true width. Once the results of bulk sample come out, the
market would assign the correct value to the potential in the C zone
structures.
TGR: What's the next milepost for Integra?
JR: The next big step would be to get the permits for its
underground bulk sample and exploration drilling. Obviously, the company will
have lots of drill results as it continues to drill more than any other
Canadian company on a single project.
TGR: You mentioned Coeur Mining and its takeover of Paramount Gold
& Silver. When will investors start to see that acquisition's positive
impact on the balance sheet?
JR: The key to that acquisition was the Independencia vein, the
majority of which was on Paramount's property. Production from Independencia
will be unencumbered by the Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) streaming
agreement, which will mean a big change for the company's cash flow starting
later this year. The all-in cash costs from Independencia should be
significantly below that of Guadalupe, which is 100% on Coeur's property next
door and subject to the Franco streaming agreement. With both veins producing
simultaneously, Coeur should see improved operating results, and then investors
should be able to assign a better valuation to Palmarejo. The first
production from Independencia is expected early this year. Coeur is drifting
underground from Guadalupe to Independencia, while still producing from
Guadalupe and the Palmarejo underground mine.
TGR: Why do Coeur shares continue to underperform?
JR: Our position is that Coeur has made significant improvements
through acquisitions, which have been underappreciated by the market. It
falls into that second group of producers in that it has made the necessary
changes but the market generally is ignoring the fundamentals of the company.
We believe this is a "show-me" situation that could result in a
significant improvement in the valuation.
TGR: Are there other companies that fit your "larger
neighbor" thesis?
JR: MAG
Silver Corp. (MAG:TSX; MVG:NYSE) has a new discovery that is different
from the bonanza zones that make up the existing preliminary economic
assessment (PEA) and resource estimates at its Juanicipio project in Mexico,
a joint venture with Fresnillo Plc (FRES:LSE). The intercepts so far on the
new deposit tend to be closer to 20 meters thick versus perhaps 6 meters on
the bonanza zones. The grade tends to be a touch higher, too. In a sense, it
could be a second mine, which demonstrates to Fresnillo that there is upside
beyond the Juanicipio and the Valdecañas veins and leaves some meat on the
bone for a potential acquirer. Also, as we mentioned earlier, we like companies
that are nearing construction decisions and MAG Silver is roughly six months
away from making one.
TGR: Could the new deposit alter the relationship between Fresnillo
and MAG Silver?
JR: Under the joint venture agreement Fresnillo can't make a hostile
bid to acquire MAG Silver. It would need to make a friendly offer. I don't
expect any tension in the relationship created by the upside of that deposit.
TGR: What's next to come in the MAG Silver story?
JR: There's going to be an updated PEA that will include an
additional resource and a rework of the mine model, which should show
improved economics even with flat gold and silver prices. By the middle of
2016, MAG Silver should have all the necessary permits to break ground on
construction. MAG Silver was responsible for 44% of the $312 million capital
budget originally estimated for the project. That should come down in the new
PEA, given the money already spent to date. The next step after the PEA is a
construction decision.
TGR: What are some other names that you're following?
JR: I mentioned Pretium. A lot of investors expected it to be
bought by now but the Rubicon situation has deterred companies from acquiring
high-grade but highly variable deposits. Highly variable deposits are always
difficult to estimate. Pretium's Brucejack has a unique geological structure
that is more geologically similar to a Pacific Island than a traditional
high-grade Canadian gold deposit. As such, a lot of Canadian producers have
balked at acquiring Pretium-they'd rather let it prove itself in production
and pay more later than have it underperform and be punished by the market.
The company is in a holding pattern until it reaches production, but it
trades at a healthy discount to its net asset value.
TGR: Pretium negotiated a deal last year with a private equity
group. Does that limit the potential for a takeover?
JR: We don't think so. If this company were able to get to the
production levels and cash costs in the current mine model, it would be
remarkably similar in size and cost level to what used to be Osisko Mining
Corp.'s Canadian Malartic mine. Something close to that valuation would
probably make the private equity folks very happy. It would be a multiple of
what it paid for its investment.
TGR: Does it give you greater confidence in the Brucejack deposit
given that private equity took such a significant stake in Pretium?
JR: Any large private equity investment in a company is usually a
vote of confidence, but it's not to say that they were privy to anything that
the rest of us weren't. Pretium is still using the same models and
information. There may be confidentiality agreements to get additional
information, but in a project of this nature, the vast majority of the
information you want to know to make an investment is publicly available.
Private equity is just confident that management is derisking it as much as
it can before production.
TGR: Investors remain nervous about precious metals equities and
the resource sector in general. What would you tell them to allay their
fears?
JR: It's a matter of risk tolerance and time horizon. If you're
expecting to invest in gold and silver stocks and see an immediate return,
it's probably not the right investment for you. But if you have the mentality
that you're going to buy some defensive positions or some positions where
there's a clear catalyst 6 to 12 months out and you're going to hold them
with that time horizon, things could work out.
TGR: How do investors muster the courage to dip their toes in these
waters?
JR: Any investments in this space need to be part of an overall
portfolio that balances out the potential swings in the overall economy. When
the economy is pulling back, generally speaking, that's good for gold and
silver, and you need to have a small piece of those investments to properly
balance out your portfolio so that when things slow down-as they are this
year-not everything on your screen is red.
TGR: Thank you for talking with us today, Joe.
Joe Reagor is a research analyst with ROTH Capital
Partners, providing equity research coverage of the natural resources sector.
Prior to ROTH, he worked in equity research at Global Hunter Securities and
at Very Independent Research, covering a wide array of resources companies
including metals (steel and aluminum), mining (gold, silver and base metals)
and forest products (containerboard, OCC, UFS, and pulp). Reagor earned a
Bachelor of Arts in economics and mathematics from Monmouth University.
