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John Doody doesn't run off chasing down
Indiana Jones' lost gold mines in Peru. He focuses on producers or
near-producers whose reserves have been verified as economic to produce. A
former professor and the author of the Gold Stock Analyst, Doody has been lying in wait for the market to reach
bottom, at which point he'll be ready to deploy the one-third of his
portfolio he's been holding in cash into his top 10 stocks. In this exclusive
interview with The Gold Report, Doody
shares the metrics he uses to nail down those companies.
The Gold Report: After a couple of big
pushes up last year to $1,900/ounce (oz), the gold
price has been bouncing around $1,600/oz. You've pointed to a lack of
investor enthusiasm for the stall. Do you see that changing any time in the
near future?
John Doody: In this now 11-year
bull market, gold actually ran up to several tops before the most recent one
of $1,895/oz in August 2011. In 2006, it topped out
at $725/oz and it was 27 months before it moved
higher. Then in 2008, it topped out at $1,011/oz,
and it took 26 months to go higher. Running up and settling back is typical
of any market that gets overenthusiastic. We're in the same basic formation.
What drives the gold
price is still the major factor in this market: real interest rates. The U.S.
real rate of return (risk free Treasuries minus inflation) is negative, and
ultimately, that number will come to the fore and drive the gold price
higher. Unfortunately, it drives everybody crazy that the economics and the
gold price aren't linked like Siamese twins, nor are the stock prices and
gold price. That's why investors need guidance and help. If they were linked,
people wouldn't need to buy a newsletter.
TGR: Very true. How high
could gold go?
JD: Predicting gold's
future price is a fool's errand because nobody really knows. You can say what
the gold price would have to be for the gold at Fort Knox to fully back the
U.S. currency, which is around $9,000/oz. Maybe that's the high end of the
range. When people talk that number though, I'm always willing to agree with
the caveat of, "Well, in whose lifetime?"
I'd be very comfortable
seeing gold above $2,000/oz this year, but it's
partly a function of the macroeconomic environment, what Federal Reserve
Chairman Ben Bernanke does to get us out of our economic funk and what the
Europeans do to solve their currency crisis.
I'm pretty happy being on
the side for higher gold. The smart money is there. All the people whose
names we all recognize as intelligent money managers have their bets on a
higher gold price. The last thing one wants to do is get tied into some time
frame, though, because it is often easier to spot value than it is to pick
the time frame at which that value will be recognized.
That said, I should tell
you what I've been telling my subscribers since the middle of last year. We
have been in what we call our one-third portfolio position where we're
one-third cash, one-third gold and one-third the Gold Stock Analyst
(GSA) Top 10. We know that gold is less volatile than the gold stocks, but we
also know that the GSA Top 10 is by far and away the best performing stock
portfolio in the gold universe. We know we're going to catch the bottom with
our one-third in the Top 10.
"Predicting gold's
future price is a fool's errand because nobody really knows."
We're down about 6% this
year, which is a lot better than the indexes. We're down 6.3% for the GSA Top
10. The Philadelphia Stock Exchange Gold and Silver Sector Index (XAU:NASDAQ) is down 16.5%, the AMEX Gold BUGS Index
(HUI:NYSE) is down 17.9% and the Market Vectors Junior Miners ETF
(GDXJ:NYSE.A), which is the index of junior gold miners, is down 22.2%.
Our intent is to catch
the bottom—we're already in the right stocks—and spend the
one-third cash that we are holding when we're fully convinced that the bottom
is here. Even if we're 10% off, it's OK. We'll double down with that
one-third cash and go two-thirds into the GSA Top 10.
The last time we did
this, the GSA Top 10 gained almost 300% in the two years beginning in January
2009. Gold was up 61% and the XAU was up 83%.
TGR: Let's talk about some
of your success. You have stressed that good stock picking can beat the
indices. What are some of the factors you use to create your Top 10 list?
JD: Yes, it can. For years,
we've proven it. We focus on a unique sector of the stock market that doesn't
lend itself to Indiana Jones' lost gold mines in Peru stories that other guys
focus on. We focus on 60 gold mining stocks that have data, are either in
production and have reserves and current production or a feasibility study
that shows that a site is economic and is in the process of raising the money
to build it or is in the middle of construction. This is a market segment in
which the stocks are generally larger. In the Top 10, the smallest has a
market cap of $200 million (M), with the largest at $11 billion (B).
Unless you know how the
whole industry is valued, you don't know what's undervalued and overvalued.
We know how the market values the average ounce of production and the average
ounce of reserves. Then we can take an individual stock and look at that
versus the averages and say, "Well, gee, this stock is really high
versus the average so maybe we don't want to own it, or it's really low
versus the average."
How come? Maybe it's
being overlooked. Maybe it doesn't have any sponsorship. Maybe it doesn't do
any financing so the brokers aren't interested in it. The brokers are still
all whores and there's no such thing as a Chinese wall. They cover companies
that are going to do deals just as other newsletter guys cover companies that
pay them. We're totally 100% subscriber supported. We do objective analysis.
Then we take a look at
how the market is capitalizing an ounce of a company's Proven and Probable
reserves, and an ounce of their production. We incorporate the mine's
profitability by looking at the operating cash flow from the mine and what
the ratio of market cap to operating cash flow is.
The average ounce of
production among our 60 stocks, as of July 30, is valued at $5,332 by
"Mr. Market." The average cash flow multiple is 5.2, in other
words, the market capitalization divided by the profitability of the mines.
The average ounce of Proven and Probable reserves is valued at $247.
TGR: Which number would you
say is the most important one?
JD: All three. The
operating cash flow multiple tells you how the company is doing now based
upon its production and cash costs versus the market. The reserves represent
how the market is valuing the future production, because companies typically
have 10 times or more of current production in their reserves. Current
production tells how a company is doing now versus its competition. All three
of those are important metrics.
TGR: Are those numbers lower
than they were, say, three years ago?
JD: The average operating
cash flow ratio since October 2008, which was the market low, has been 8.7x. Now at 5.2x, Mr. Market is
not rewarding the gold miners for the profits that they're earning.
We're seeing this in the
executive suites. Companies are doing pretty well in terms of profits, but
the stock prices are doing very poorly. Aaron Regent, the head of Barrick Gold Corp. (ABX:TSX;
ABX:NYSE), got fired. The head of Kinross Gold Corp. (K:TSX;
KGC:NYSE), Ty Burt, just got fired. There is a lot of executive turnover
because boards are unhappy with the stock prices. They're looking for people
who can lead them to higher stock prices.
TGR: Sounds as if there is a
lot of room for upside there.
JD: A tremendous amount.
TGR: Are you buying and
selling a lot in that third that you have invested in stocks, or are you
holding?
JD: We make changes in the
Top 10, but we're not a trading letter. We look for situations that can
double based upon the analyses that we do. This year we've made two sells and
one buy. We're currently holding 10% in cash in that Top 10 as well as
one-third cash in the overall portfolio.
TGR: Because you're waiting
for that bottom.
JD: We're waiting for that
opportunity. We've been doing that for a year now.
TGR: You recently launched a
new Silver Stock Analyst newsletter. The silver
price is down by about 40% for the year. Why are you doing this now?
JD: Silver is gold on
steroids. It's extremely volatile, much more volatile than gold. In the
October 2008 crash, silver fell 54% from its July 15 high, and gold fell 28%
from its July 15 high. On the other side, from January 2009, when the market
finally got some footing back, until June 15, 2012, silver gained 158%
whereas gold gained 87%.
TGR: So, there's more
downside and upside.
JD: The macroeconomic stage
is set for gold to go higher, and that should mean that silver should do even
better. I've told people to put 5–20% of their money into silver
stocks. We're doing essentially the same fundamental analyses with silver
that we do for gold stocks. We look for production and reserves, at who's
cheap and who's not cheap. We don't look at exploration plays. We don't know
anything about some stock in Peru that's drilling holes. Those juniors are
basically just lottery tickets. We analyze 25 primary silver producers in the
Silver Stock Analyst. From those, we pick what we call our "Fave 5."
"The macroeconomic
stage is set for gold to go higher, and that should mean that silver should
do even better."
TGR: It's been a challenge
for gold and silver juniors this last year to access capital. Do you see that
changing?
JD: Not until there's
enough investor enthusiasm to attract new people into the market and it
filters down to the juniors.
TGR: With all the bargains
out there right now, do you foresee a lot of mergers and acquisitions for the
rest of this year?
JD: We talk to companies.
We know what they're looking at. We identified in advance for subscribers an
acquisition that New Gold Inc. (NGD:TSX; NGD:NYSE.A) made two years ago, in
which it bought Richfield Ventures Corp. (RVC:TSX.V). We knew what New Gold
was looking for and we told subscribers. We never covered Richfield as a Top
10, but we told them as sort of a bonus that we thought that New Gold would
buy it. The stock was around $6.60, and New Gold took it out six weeks later
at $10.
New Gold is in the
market for another company because it has flat production. The market hates
flat production. It wants to see gold miners increase production every year.
New Gold has a flat period of production coming up from 2014 to 2017 of about
500,000 ounces (500 Koz)/year. After that, in 2018,
the British Columbia-based Blackwater deposit,
which has about 10 million ounces, is going to kick in along with El Morro in
Chile. It's going to buy something to fill that hole. We've made some
speculations about what that could be in our newsletter.
If you're talking to the
companies, you can see that they're all looking. Primero Mining Corp. (PPP:NYSE; P:TSX) made a bid for Northgate
Minerals Corp. (NGX:TSX; NGX:NYSE.A) and got trumped by AuRico
Gold Inc. (AUQ:TSX; AUQ:NYSE). It is in the market, and we have some ideas
who it might buy.
Yamana Gold Inc. (YRI:TSX;
AUY:NYSE; YAU:LSE) made a pre-emptive cash
bid for Extorre Gold Mines Ltd. (XG:TSX;
XG:NYSE.A; E1R:FSE) in Argentina recently.
That company was on other companies' radar screens, but Yamana
had the synergies and we know it pre-empted another company.
We're going to see
mostly cash bids. Companies have learned to be cautious about issuing shares,
which is good for shareholders. If you can buy incremental production and not
get dilution, that's very good for shareholders.
TGR: And these acquisitions
can help both the share price of the acquirer and of the acquiree,
right?
JD: Yes, particularly when
it pays cash. Yamana paid maybe $400M in cash and
it still had some $500M left over. It has a mine operating cash flow of more
than $1B/year. This was not a major deal. It was a 200 Koz/year
acquisition that will fit nicely into its portfolio of mines.
A couple of the stocks
we have in the Top 10 are acquisition targets. They're either building a mine
or are fully permitted to build. They're turn-key ready, and we expect
they'll get acquired.
TGR: Royalty companies make
up a good portion of your Top 10. Do you expect there to be more of these?
JD: Not so much more
companies, but I do expect the existing ones to get bigger. The way that some
of the explorers or want-to-become producers are getting financed is through
the royalty companies. Banks will give you financing, but they want hedging.
They want to be protected, but the royalty companies will take the risk. They
have geologists on staff and they understand the nature of the deposit. They
understand the nature of the processing.
"Right now, the
numbers show, on average, the gold stock industry is 35% undervalued to where
it should be at $1,600/oz gold."
In a sense, when
"Miner A" sells a royalty to Franco-Nevada Corp. (FNV:TSX) or Royal Gold Inc.
(RGL:TSX; RGLD:NASDAQ), it is hedging it because it is giving up either some
portion of its production for a fixed price—that's called a
stream—or it is giving up some portion of revenues, like a sales tax on
revenues. It's giving up some of the upside. But the market doesn't penalize
them the same way that it perceives a hedge being put on by a lender.
Companies that need financing are predisposed to want to do a royalty deal as
opposed to a bank deal.
TGR: Do you evaluate royalty
companies the same way you do a miner?
JD: It's a little bit
different. They have much bigger portfolios. The royalty portfolios for
Franco and Royal are 20–30 mines. We look much more at how the market,
in general, values them on a growth royalty per share basis, and we focus
more on their dividend-paying abilities. We run a database of how the market
has valued them in the past versus the gold price.
The gold stock sector
generally trades between a 10% overvalued and a 10% undervalued range. That's
normal. Right now, the numbers show, on average, the gold stock industry is
35% undervalued to where it should be at $1,600/oz
gold. That's a screaming buy. The last time it was that undervalued was
October 2008.
When the gold market
gets lit, the Top 10 will take off. Last time, as I said earlier, we were up
285% in the two years following that market bottom. We beat gold and the XAU
gold index by a factor of three or four times in that period of time. We can
be cautious, but we're ready. We're primed.
TGR: When the market comes
screaming back as you predict, will the large caps or the small caps come
back first?
JD: The large caps because
big money will be going in. The retail investors in small caps will have been
killed unless they've been subscribers and following what we've told them to
do. If they've been invested in the junior explorers, such as the Market
Vectors Junior Miners that is down 22% for the year, they don't have any
money.
It always starts with
the big guys. As the big guys start getting fully valued and some enthusiasm
comes back into the market, investors start getting greedy and start looking
at the lottery ticket stocks. What can I buy for $1/share that might go to
$5/share? That doesn't come first because the funds that are going to drive
the gold stocks higher aren't interested in lottery tickets. They can't buy
enough of them.
TGR: Thank you, John, for
taking the time to talk to us today.
An economics professor
for almost two decades, John Doody became
interested in gold due to an innate distrust of politicians. Success with his
method of finding undervalued gold mining stocks led Doody
to leave teaching and start the Gold Stock
Analyst newsletter in 1994. The newsletter covers only
producers or near-producers whose reserves have been verified as economical
to produce. It is believed to be the world's only newsletter to have independently
audited results, the same as required of mutual funds by the Securities
Exchange Commission.
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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: Primero Mining Corp., Extorre Gold Mines Ltd. and Franco-Nevada Corp.
Streetwise Reports does not accept stock in exchange
for services. Interviews are edited for clarity.
3) John Doody: I personally and/or my family own
shares in all of the companies mentioned in this interview. 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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