The Gold Report: U.S. Global Investors recently published a report outlining the two trades that
drive gold demand: fear and love. Which one is more powerful right now?
Ralph Aldis: The love trade is the foundation of owning gold stocks and gold
because 70�80% of gold goes into jewelry. On
the margin, the fear trade is driven more by the headline risks that we've
seen in the Ukraine and the Middle East, or by inflation spikes. That's what drives
people to take action.
TGR: Do you expect recent events in the
Ukraine and Middle East to further spur gold's fear trade over the course of
the summer?
RA: Yes. We have some geopolitical
situations where the tension is elevating. It's unfortunate. There are
different brokerage firms saying that investors don't need to own gold or
gold stocks because the S&P 500 is going to be much higher later in the
year. That's assuming we live in a perfect world. Unexpected geopolitical
events happen that make gold a reasonable thing to have in a small part of
investment portfolios.
The fall season is always
a strong demand driver for gold as the jewelry industry returns to replenish
its stocks.
TGR: Could we see a
better-than-expected late summer gold rally as these two demand drivers
converge?
RA: It's hard to say. We normally see
about a 10% seasonal uptick in gold in the fall. But these geopolitical
issues are problems that are not going away in a matter of weeks.
TGR: Improved U.S. employment numbers
and the expectation of further U.S. economic growth has pundits offering
forecasts on the impact of inflation on investments. What's yours?
RA: The general consensus is that
inflation is not going to be a problem, yet wage growth has been very
stagnant. People are pushing for a higher minimum wage, while businesses will
have to pay more to retain workers as the economy improves. The costs of
things have gone up over time, yet wage growth has not. When
that wage growth starts, we'll see some inflation. But I don't expect it to
be extremely strong inflation in the near term.
TGR: The current U.S. rate of inflation
is 2.1%; when you combine that with interest rates that are even less, you
get negative real returns. That's typically a positive environment for gold
prices, isn't it?
RA: Historically, low interest rates
have been fairly positive for gold because when Treasury bills earn 6%,
that's going to pull money away from gold. Federal Reserve Chairman Janet Yellen is talking about having low rates for a lot longer
than we expected. That has set the stage for a positive environment for the
gold price. When gold gets down to $1,230 per ounce ($1,230/oz) or even $1,300/oz, half the
industry doesn't make money. That's another issue where we have good
fundamentals on the support side.
TGR: Goldbugs have been predicting
hyperinflation for six years or so. Are we any closer?
RA: When you hear hyperinflation
that's not because you have growth�that's because there is no growth.
In places like Zimbabwe, which is operating on a socialist model and people
don't know where their next dollar is going to come from, inflation continues
to skyrocket because there isn't any economic growth. If someone is selling
something, he better get as much money as he can. In the U.S. we have some
growth and we'll continue to have reasonable growth. We could still see some
inflation from wage growth but certainly not hyperinflation.
TGR: What's your current pitch to
investors given the malaise in the gold space?
RA: Gold stocks really fall into an
asset class that's largely uncorrelated with the S&P 500. That makes it a
great asset for portfolio diversification. Our recommendation is that
investors should have something around 5�10% of their portfolios in assets
that are uncorrelated with the S&P 500. Gold or gold stocks fit that very
well.
Investors should also
rebalance every quarter or at minimum once a year. When the S&P 500 is
soaring they should take a little money off the table and buy some gold
stocks and vice versa. The gold stocks had a big rally in H1/14. It probably
wouldn't hurt to take some money off the table and rebalance to an asset mix
that's appropriate for one's investment horizon.
TGR: Do you recommend raising the
percentage of gold and gold equities in an investment portfolio during times
of greater global uncertainty?
RA: That would be contrary to what I
would normally think if you always have a gold allocation. Gold prices
typically rally when the broad market falls. That may be your opportunity to
take some money off the table and buy another asset class that's lagging. If
you're adding to your portfolio during a period of higher global uncertainty,
you may be buying when the price has jumped as much as 5%. As soon as that
uncertainty goes away, you've lost money. It's better to have that allocation
on a consistent basis and then take advantage of the volatility.
TGR: The U.S. Global Investors Gold
and Precious Metals Fund (USERX) is up about 28% year-to-date and has
averaged about 6% over the previous 10 years. Do you have a code when it
comes to positions in your fund?
RA: First and foremost, we try to
focus on the fundamentals. We're looking for that growth in revenue, which is
normally a derivative of the growth in metals production.
We also want to make sure
that these companies have positive margins, that they're not just growing
production and losing money.
We look, too, at the
relative value of these companies versus their resource statements. We find
that there's a very high correlation between the valuation of a company and
its resource statement.
Then we try to balance
those things with what the market is telling us. Everybody has access to
balance sheets, but the current action of that stock tells us something else.
If the stock is outperforming its peers, there may be something that's not in
the historic financials, but that may be influencing what's happening now.
Likewise, stocks sometimes hit on all of our metrics, but the performance
isn't there. That's when we need to dig and find out why.
When it comes to stocks,
I want a performance-based relationship. Companies may have great
fundamentals, but if the performance tells me something is wrong, I'm
probably going to walk away. We have to marry the metrics of the fundamentals
with the price action.
TGR: Are valuations lagging the size
of the resource more in this market than would have been the case perhaps
five years ago?
RA: Yes. The markets got pretty frothy
in 2008 and are risk averse now. We've seen that with transactions. Goldcorp Inc. (G:TSX;
GG:NYSE) was
willing to buy Osisko Mining Corp. because it was
fully derisked. There were probably no more hiccups
to expect and Goldcorp was willing to pay a premium to access that cash flow.
Detour Gold Corp. (DGC:TSX), with similar Canadian assets, wasn't derisked
at that point but was probably the company Goldcorp should have been buying.
Now Detour has gone from about $2.50 to $13/share�a great move, but there are still some
obstacles ahead.
Stocks in the junior
space that aren't in production are selling for less than they should. The
issue is that no one wants to be the person who buys a company and takes on
the risk of getting that project into production. About 30 mining CEOs have
lost their jobs in the last 24 months. I think mining CEOs look at Kinross
Gold Corp.'s (K:TSX; KGC:NYSE) takeover of Red Back Mining Inc. in 2010 for
$7 billion ($7B) and get nervous�that's when people started
thinking about the cost of capital. You can't spend $7B to buy something
that's worth $7B and then spend another $5B to build it. In this market the
capital requirements often get priced into the valuation.
TGR: Are there other tenets in your
code?
RA: Management is one thing that is
difficult to put a dollar value on but we can estimate it by looking at the
resource statement to determine what the company is worth and then seeing the
premium the company sells for. One example is Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE). CEO Mark Bristow has done a phenomenal job.
Some might say the stock is expensive but here's a company with a manager
that delivers�and he owns quite a bit of Randgold stock. Quality of management is another factor
that fits into our model.
TGR: As of June 30, 2014, about 16% of
the fund was in cash. Is that about where you prefer to be?
RA: That was probably just timing.
Right after a quarter ends it's not uncommon to see hedge fund managers dump
their stocks because they've already locked in their quarterly bonus. So we
had a slight move in the gold stocks and there was some repositioning
happening. That is not the normal cash position.
TGR: Should retail investors keep 10�15% of their portfolios in cash?
RA: A retail investor should always
have some cash available to take advantage of any opportunities. Warren
Buffett is a vulture investor in the sense that he likes to see turmoil and
pain because that's when he's going make a sweet deal for his shareholders.
TGR: What companies does the fund have
large positions in?
RA: One of the largest positions in
the fund is Klondex
Mines Ltd. (KDX:TSX; KLNDF:OTCBB). It's up almost 30% year-to-date.
This is a great story. Most people haven't woken up to it yet. In 2013, Klondex was up about 28% when the Market Vectors Junior
Gold Miners ETF (GDXJ) was down 61%. That's an example of stock performance
signaling that something is going on.
At the end of the year, Klondex, which originally had just the Fire Creek mine in
Nevada, was toll milling ore at Newmont Mining Corp.'s (NEM:NYSE) nearby
Midas mill. Klondex then negotiated to buy the
Midas mine and mill from Newmont for $83 million ($83M). (Note: $55M to
Newmont, $28M to replace the reclamation bond and 5M common share purchase
warrants at an exercise price of $2.25/share.) At that time the company's
market capitalization was just under $100M and it raised
close to that to complete the transaction. The stock did not get knocked down�it's up 30%.
The people at Klondex are key. CEO Paul Huet was the mine manager at the Midas mine for about 10
years. He knows that asset extremely well. The other key player is Chairman
Blair Schultz. He left hedge fund K2 Partners to be the full-time chairman. Klondex recently raised more cash to drill vein
discoveries at Fire Creek and other targets at Midas.
TGR: About 66% of Klondex
is held by institutional shareholders, and about 8% is held by management and
insiders. What are your thoughts on that mix?
RA: That's a pretty good mix. We find
that when management doesn't own enough shares it seems to deliver mediocre
to bad performance relative to companies with management that owns a
significant percentage of stock.
TGR: Klondex is targeting free cash flow by
the end of the year. Does it get there?
RA: Yes. I don't see any hiccups on
that side at all.
TGR: What other companies is the fund
holding large positions in as of June 30?
RA: Northern Star Resources Ltd.
(NST:AUX) was a
100,000 oz (100 Koz) gold
producer in Australia and then about seven months back it bought a 52% stake
in the East Kundana joint venture, as well as the Kanowna Belle and Plutonic gold mines in Australia, from Barrick Gold Corp. (ABX:TSX; ABX:NYSE). Now it should be
a 200 Koz producer. In our models, Barrick's Australian assets were worth about $1B. In two
separate deals, Northern Star paid a little under $100M for them.
Barrick wanted to exit Australia and
those were considered small assets, sold based on the Proven and Probable
reserve value�that meant that the Measured,
Indicated and Inferred resources were essentially gravy. Northern Star's
valuation has moved up a lot since those transactions. It has a great
management team, too. These people are great operators.
Another holding is Dundee Precious Metals Inc. (DPM:TSX), a stock that got hurt in 2013 when the markets crashed on gold
stocks. Originally led by Jonathan Goodman, Dundee brought Rick Howes into the fold a few years ago, and he has since
become CEO. There are two primary assets. One is the Chelopech
copper-gold mine in Bulgaria. The other asset is the Tsumeb
smelter in Namibia. Both of these assets were underperforming. It's taken
some time, but the company turned the Chelopech
operation around. With the cash it was generating Dundee modernized the Tsumeb smelter to handle Chelopech's
high-arsenic copper concentrate�only a couple of smelters in the
world can handle it. Dundee also expanded the capacity at Tsumeb
to 240,000 tons per year (240 Kt/year) from 180 Kt.
In 2013 the company was getting $450/ton and its operating costs were
$433/ton. In Q1/14 its revenue per ton was $569, with operating costs of
$307, a margin of $262. Raymond James recently launched coverage on Dundee.
TGR: Dundee also has the Krumovgrad gold project in Bulgaria. When will that asset
reach production?
RA: It's basically in the final
permitting stage; it will go into construction in the next 6 to 12 months.
The grade at Krumovgrad is about 4 grams per ton
gold and it will cost less than $250M to build. That's another leg of growth
for Dundee. It also owns stakes in Sabina Gold & Silver Corp. (SBB:TSX.V; RXC:FSE), Dunav
Resources Corp. (DNV:CVE) and Avala Resources Ltd.
(AVZ:TSX.V).
TGR: Other major holdings?
RA: Comstock Mining Inc. (LODE:NYSE.MKT), which is a very interesting story. The man behind it is John
Winfield, a self-made billionaire in the real estate market. He recognized
the potential of the former Comstock mining district in Nevada and spent time
getting all the property interests in the region locked up.
Comstock started
production over a year ago at about 10 Koz/year. It
doubled that and now it's targeting a 40 Koz run
rate in H2/14. In H1/14 the strip ratio was about 7:1. That ratio is going to
drop in the second half of this year and with the expanded production volume
I think Comstock is going to turn a profit. The company has permits to reach
4 million tons per year so Comstock should be a 100 Koz
producer by 2016. It's a situation where people are creating value and John
Winfield knows how to make money.
TGR: There are about 65 positions in
the U.S. Global Investors Gold and Precious Metals Fund. Tell us about some
of those.
RA: Orex Minerals Inc. (REX:TSX.V) is relatively new on the scene but its management is not. CEO Gary
Cope and his team sold Orko Silver to Coeur d'Alene
Mines Corp. (CDM:TSX; CDE:NYSE) in 2012. Gary now
has four properties with Orex�one in Sweden, two in Mexico and another in
Canada. One of the properties in Mexico is a joint-venture option with Fresnillo Plc (FRES:LSE). Gary
will probably end up partnering with another company in Sweden or spin those
assets into a separate company to unlock value. It's not just a one-property
company. There is probably more opportunity than there is risk at these
prices.
We're still big fans of Pretium Resources Inc. (PVG:TSX; PVG:NYSE). Brucejack is
going to be a mine. This is the real thing. It's just going to take time.
It's going to have a small mine footprint but be very profitable.
TGR: Pretium took a credibility hit based on
some resource work that was being conducted on Brucejack.
Did that make you question management?
RA: No. The engineering firm had
processed maybe 3�4% of the bulk sample when those
comments were made. It's insane to me. Yes, it is a complicated resource
estimate and the mine plan will be complex, too; it's not a simple
bulk-mining situation. There is some complexity but Pretium
is probably one of the best takeout candidates out there. Nobody knows for
sure but if that resource calculation is correct, then it's a tenbagger.
The other company we're
big fans of is Virginia
Mines Inc. (VGQ:TSX). That's run by Andr� Gaumond. Virginia
has the royalty on the �l�onore project that Goldcorp will put into
production later this year. Royalty companies have been one of the better
performing sectors in the gold space and Virginia Mines is no exception. It
was up about 6% last year, while Franco-Nevada Corp. (FNV:TSX;
FNV:NYSE) was down about 20%. Virginia has lagged some this year, but some
important things are going to start there pretty soon.
TGR: Do you think that Andr� Gaumond
would ever monetize that royalty and dividend it to shareholders?
RA: If Andr� is going to monetize it, the driver would be
how much would a Franco or a Royal Gold Inc. (RGL:TSX;
RGLD:NASDAQ) pay for it? It's a fantastic royalty. Goldcorp updated its �l�onore resource statement at the
beginning of this year. We calculated $1B worth of value created by the
additional drilling of the resource that Goldcorp originally defined, plus
there are some additional parallel zones. I don't think Andr� will get rid of it any time soon.
TGR: With the exception of SEMAFO Inc. (SMF:TSX; SMF:OMX), the U.S. Global Investors Gold
and Precious Metals Fund's top 10 equity positions do not have projects in
Africa, or South America and few have projects in Mexico. Even in this
troubled market for small-cap resource equities, do companies operating in
safer jurisdictions offer greater upside?
RA: Atico Mining Corp. (ATY:TSX.V; ATCMF:OTCBB) is in Colombia and it is run by the brothers
that run Fortuna
Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE). Other than that I think
companies operating in safer jurisdictions are probably more desirable as
takeover targets.
TGR: Are there any gold stocks out
there that deserve a second look at this point, considering that gold prices
seem to have bottomed?
RA: Yes, one that comes to mind is Gran Colombia Gold Corp. (GCM:TSX). Its share price is off 95% from its first financing in August 2010.
For the last couple of years Gran Colombia has been running with a production
run rate of about 100 Koz gold
per year with a current enterprise value of roughly $200M. The
positive changes that have recently taken place are the hiring of a new CEO,
Lombardo Paredes Arenas, in February 2014, and the construction of a modern
day milling plant at Pampa Verde. The new plant will allow Gran Colombia to
grow its production to 170 Koz
gold by 2015. A higher gold price, new management and increased
production will go a long way toward turning this company around.
TGR: Parting thoughts?
RA: As I said earlier, don't get
married to any stock. It's a performance-based relationship. If the stock is
not behaving and it's going down, you can probably make money someplace else.
TGR: Thank you for your time and
considerable insight.
Ralph Aldis, CFA, rejoined U.S. Global Investors as senior mining analyst in
November 2001. He is responsible for analyzing gold and precious metals
stocks for the World Precious Minerals Fund (UNWPX) and the Gold and Precious
Metals Fund (USERX). Aldis also works with the
portfolio management team of the Global Resources Fund (PSPFX) to provide
tactical analyses of base metal, paper, chemical, steel and non-ferrous
industries. Previously, Aldis worked for Eisner
Securities, where he was an investment analyst for its high net worth group
and oversaw its mutual fund operations. Before joining Eisner Securities, Aldis worked for 10 years as director of research for
U.S. Global Investors, where he applied quantitative skills toward stocks,
portfolio tilting, cash optimization and performance attribution analysis. Aldis received a master's degree in energy and mineral
resources from the University of Texas at Austin in 1988 and a Bachelor of
Science in geology, cum laude, in 1981, from Stephen F. Austin University. Aldis is a member of the CFA Society of San Antonio.
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DISCLOSURE:
1) Brian Sylvester 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 independent contractor. He owns, or his 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: Klondex Mines Ltd., Comstock
Mining Inc., Fortuna Silver Mines Inc., Gran Colombia Gold Corp., Pretium Resources Inc. and Virginia Mines Inc. Goldcorp
Inc. and Franco-Nevada Corp. are not affiliated with Streetwise Reports.
Streetwise Reports does not accept stock in exchange for its services.
3) Ralph Aldis: I own, or my family owns, shares of
the following companies mentioned in this interview: None. 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: None. Funds operated by U.S. Global Investors
hold the following companies mentioned: Atico
Mining Corp., Comstock Mining Inc., Detour Gold Corp., Dundee Precious Metals
Inc., Fortuna Silver Mines Inc., Goldcorp Inc., Gran Colombia Gold Corp.,
Kinross Gold Corp., Klondex Mines Ltd., Newmont
Mining Corp., Northern Star Resources Ltd., Orex
Minerals Inc., Pretium Resources Inc., Randgold Resources Ltd., SEMAFO Inc. and Virginia Mines
Inc. 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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