The Gold Report: John, you have studied the fundamentals of
gold through history. What is behind the current market prices, and what will
it take to move prices higher again?
John Hathaway: Adversity in the financial markets is the trigger
that will force the general investment world to become interested in gold
again. That is a nice way of saying it will take a bear market to push
investors to gold. Monetary policy has forced investors into riskier
assets—including junk bonds and overvalued NASDAQ stocks. When the tables
turn and people start experiencing losses, there will be finger pointing,
starting with the Federal Reserve's nominal interest rates. That whole
spectacle could balloon and cause conventional investors to throw up their
hands and run for liquidity.
TGR: We've talked to some people, including Brien Lundin,
who think that a Federal Reserve interest rate increase will be good for gold
because it will remove the question mark that's been overhanging the gold
price since it is pretty much already priced in. Do you agree?
JH: I agree that it has been baked in for years, but I think the
bigger story is going to be loss of confidence in the Fed and a general downturn
in financial markets, which is long overdue. That is when investors will look
at safe places to go. Gold has always acted as wealth insurance. Whenever we
have had extreme financial events throughout history, gold has always been
the last man standing. Gold's purchasing power lasted through the crisis in
2008 and every crisis before that. It's impeccably liquid. You can buy or
sell it on a very thin bid/asked spread 24 hours a day. There's almost no
other market you can say that about.
TGR: Why did you recently compare today's gold market to the London
Gold Pool of the 1960s when eight central banks worked together to try to
maintain a gold price of $35 per ounce before the scheme collapsed?
JH: It has been in the interest of public policy and the financial
establishment to operate in an environment of zero or nearly zero interest
rates, interbank lending rates and LIBOR. That is not unlike the manipulation
that occurred in the 1960s. Gold rocketing to new highs would upset that
whole scenario designed to force capital out on the risk spectrum.
An indication of this artificial market is the fact that the synthetic
market for gold—the COMEX, options, over-the-counter and LBMA—is traded
hundreds of times more than the actual metal. Investors actually short gold
by posting margin on the COMEX. That eventually drives the price of gold down
without any physical gold changing hands. It manipulates the psychological
market environment and then the high-frequency and algorithmic traders push
the price smashing to the extreme and it all happens with no gold actually
being sold.
TGR: What's the role of China in this retro-market scenario?
JH: It is playing a cat-and-mouse game. A huge amount of gold is
heading from Western financial centers to the East as demonstrated by the
withdrawals from the Shanghai Gold Exchange on top of the usual strong flows
into India and Turkey. Physical gold's shift to China is a big part of this
story as Asians buy on weakness.
However, the synthetic instruments—call options, short interest on COMEX
and over-the-counter deals—could be the precursor to a scramble to get
physical. That would be enhanced by a loss of confidence in counterparties by
a bear market in stocks. You have already seen sovereigns' call for physical
gold to be repaid. Germany was the highest profile, but many other countries
have asked for earmarked gold in London and New York to be repatriated.
That's a sign of a loss of confidence. That could affect the price in a very
big way. And the Chinese will have it.
TGR: I'm looking at your portfolio and you have quite a few
royalties. What is the benefit of holding royalties in the market scenario
you have described?
JH: It's a good business model. It's a way to get participation in
many more mines through one equity than you could get owning a large-cap
company, such as Newmont Mining Corp. (NEM:NYSE) or Barrick Gold Corp.
(ABX:TSX; ABX:NYSE). That's because the royalty business model makes
investments in numerous different mines. It's basically a financing tool for
companies that need to get capital to complete a project. Because we have
been through such a nuclear winter for financing large and small companies,
the royalties have very powerful deal flow, and they're able to set very
attractive terms. Investors have gone through a difficult period in the gold
equities market, but it has been advantageous for the royalty companies.
That's why we have such a strong representation in those names.
TGR: What are some of the ones you like the best?
JH: There are only four of them that are of any consequence. The
three big names are Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), Royal Gold Inc.
(RGLD:NASDAQ; RGL:TSX) and Silver Wheaton Corp. (SLW:TSX; SLW:NYSE). Osisko Gold
Royalties Ltd. (OR:TSX) has done some very interesting transactions
lately. I think it's a real player. They're all run by smart people. They
have a very lean business model. They're like the merchant bankers of the
precious metals sector.
TGR: You seem to be largely in the mid-cap and small-cap mining companies.
How do you manage the risk with the possible upside leverage?
JH: With the mid and smaller caps, there's more value creation for
mine building and discovery of new reserves. It moves the needle more than
you could get in a large-cap company. Those are very identifiable events.
That is where our research can really pay off, more so than with big-cap
companies where you have so many more moving parts and significant
developments are often obscured in the mix of assets around the world. More
important, with the larger-cap companies, a discovery isn't going to change
the outlook. It's just what they have to do to sustain the model. But with
the mid- and small-cap companies, a big discovery is value creating. When it
gets recognized, I think you get much more of a return than you would in a
large-cap name.
TGR: Let's look at some in your portfolio. You hold NOVAGOLD (NG:TSX;
NG:NYSE.MKT), which has announced it will be releasing a draft environmental
impact statement (EIS) on the Donlin Gold project in Alaska by the end of the
year. Is permitting going to be a major milestone or are there other
catalysts you're watching?
JH: Permitting is taking place. It's definitely a sign of progress.
It is not a market-moving kind of event, but it's necessary. I look at
NOVAGOLD as an option on the gold price. We know it has the ability to
produce half a million ounces a year. That's enormous. If you went to UBS or
Morgan Stanley and tried to get a 10-year call on gold prices, first of all,
they'd laugh at you, but if they did actually give you a quote, it would be
very expensive. If you compare that to what you get with NOVAGOLD, it's a
perpetual call on the gold price with what could be a world-class gold mining
asset, but it won't get built until the gold price is right.
TGR: Another company that you've had in the portfolio for a while
is Torex
Gold Resources Inc. (TXG:TSX). It just released its NI 43-101 on the
Minera Media Luna project in Mexico, and the market seemed to react quite
positively. Were you pleased with the new Inferred resource estimate?
JH: Yes, we're pleased but not surprised because this is a great
asset. There's a lot of discovery that still could be made there. We're
getting very close to launch for this company. It should be producing gold by
the end of this year and may declare commercial production soon thereafter.
That is a value-liberating sequence of events.
TGR: Are you worried about security risk?
JH: The market is. I think it's a risk you have with Torex, but
that's generally the case anywhere in the gold mining world. Some companies
have more of a problem than others. But this is going to be a huge tax
generator for Mexico, so the government has an interest in seeing this move
ahead securely. If the company hasn't already worked something out with the
feds, it will. It's what mining companies have to do. They're challenged in a
lot of ways, and one of the challenges is security. The better companies deal
with it successfully. Other companies don't do it as well.
TGR: You've also held MAG Silver Corp.
(MAG:TSX; MVG:NYSE) for a while. Where is the most immediate upside for
that basket of projects?
JH: MAG Silver has a tremendous suite of silver-rich assets in
Mexico, one of which is a joint venture with Fresnillo Plc (FRES:LSE), the
world's largest silver producer. It's hard to imagine that at some point
Fresnillo doesn't want to take over MAG for that asset. However, MAG's strong
shareholder base, including Tocqueville, won't let that happen at too low a
price. The dice are loaded for a deal and for a big move in the silver price,
which could come on the heels of a big move in the gold price. I think MAG is
one of the best pure silver stories out there.
TGR: Any other companies you want to mention?
JH: We have noticed that as the larger, over-indebted companies
have had to sell assets to reduce balance sheet risk and lower debt,
opportunistic buyers are stepping forward. B2Gold Corp.
(BTG:NYSE; BTO:TSX; B2G:NSX), Premier Gold
Mines Ltd. (PG:TSX) and the Australian company Evolution
Mining Ltd. (EVN:ASX) are three examples of companies taking advantage of
the distress among some of the larger-cap companies and buying quality assets
at very attractive prices.
TGR: Any other parting words of wisdom for veteran investors trying
to retain their wealth as they prepare for 2016?
JH: I think we are nearing the end of the pain. Stick to your guns
if you own gold mining stocks, certainly if you own physical gold or if you
own the Tocqueville Gold Fund, and think about adding more. I think the
financial markets are turning. We may be at the dawn of a recognition that
Fed policy and central bank policy worldwide is hollow, ineffectual and maybe
worse. It could lead us into greater problems than we saw in 2008. So be
prepared.
TGR: Thank you for the advice.
