Tan Khandaker: Hedging Strategies to Underpin Rising Gold Price
Managing Director Tan Khandaker, of New York-based Khandaker Morgan, thinks gold hedging strategies by large funds will underpin a rising gold price at least for the next few years and perhaps beyond.
Tan also sees junior gold companies as the best way to leverage rising gold prices. Khandaker Morgan has built an index of junior miners with near-term catalysts for growth, and it's up about 15% since March. In this exclusive interview with The Gold Report, Tan presents some of his favorite names from his exclusive index.
The Gold Report: Tan, please give our readers a brief overview of your company.
Tan Khandaker: Khandaker Morgan basically specializes in small-cap global equities. Within the small-cap sector, we focus on metals and mining, oil and gas (O&G) and healthcare; but we also have some interest in the cleantech sector.
Over the last eight years, we have focused on companies whose market capitalization is as small as $50 million and as high as $500 million. We look for equities with catalysts that are going to be near-term drivers for significant upside.
TGR: On the Khandaker Morgan website, it says you specialize in "equities, alternatives (hedge funds/private equity funds) and commodities strategy." What sort of gold strategy or strategies are you recommending to your clients right now?
TK: We are a fundamentals-driven company and we are very much focused on macro drivers and global trends. When it comes to specific commodity strategies, it's designed around the overall paradigm shift in the global market over the long term. When I say 'long term,' we're not looking at 12-month shifts—we're looking at 24-, 48-month shifts toward specific commodities either on the supply/demand side or on the overall hedging side.
Based on that particular outlook, we are bullish on gold because we believe that global economic turbulence is still not under wraps. We believe it's going to take at least 24 to 48 months, if not longer, to stabilize economic volatility around the world and, principally, in Europe and North America. While that's going on, we believe issues with currencies and inflation will be key catalysts for the gold price. Inflationary pressure on low interest rates is basically going to drive the gold price in a positive direction as a standard hedging strategy, if not a safe haven for investors.
TGR: Do you see a steady rise in the gold price? We've seen a couple of jumps over the last month. What sort of highs could we see and what's the path to get there?
TK: I see a very nice, almost inverse relationship between gold prices and equities markets. Because the equities markets are volatile, we are looking at gold as a nice hedging strategy. There's been some fluctuation in the pricing of gold but we believe that, from a macro standpoint, there will be a steady rise in the gold price because of the overall shift of money toward a more stable, safe place.
TGR: I would be remiss if I didn't ask you how high you see gold going in that first 24-month period, and then in the 48-month period to which you referred.
TK: In that first 24 months, I'm looking at gold easily crossing over $1,500/oz. After that, it could even go higher.
An important driver is the overall performance of the Asian markets. China has been performing pretty well. India is coming across well. Some countries like Brazil and other parts of South America are also clocking some good numbers. Based on Latin markets and the performance of Asian markets after those first 24 months, we could see even more of an upward shift or stabilization around the $1,500–$1,700 price range.
Then, once North America and the rest of the world establish economic stability, the gold price will stabilize around that number. But whichever way you look, I don't see gold prices falling sharply or anything like that. Gold will be used as a hedging mechanism against volatility. We are already seeing that with major fund managers across the world using gold as a good hedging tool.
TGR: In terms of gold-price catalysts, what sort of balance do you have between supply and demand fundamentals and, basically, fear?
TK: That's a great question. From the $250–$950 rise in the gold price, I would say it was mostly due to fear. Beyond $950, and what we're looking at now, is actually more about the stability of gold and using it as a hedging tool. I think the fear factor has come down quite significantly. If you break it down into percentages, I would say the drivers are between 30%–40% on the fear side and about 60% on the hedging side. On a long-term basis, about 80%–90% of the drivers will come from gold being used as a hedging tool.
TGR: How are you recommending clients gain exposure to gold?
TK: We don't deal with retail clients; we work with institutions or high net-worth individuals. Our overall outlook to institutions has been pretty consistent with the macro drivers and the macroeconomic slowdown.
For clients that want to invest in gold to preserve capital and see modest growth, we look at major gold producers and some mid-tier producers. For clients looking for more growth and more opportunity who have a high risk tolerance, juniors are the way to go. Some of the juniors will be taken out at a premium due to this overall paradigm shift. There are some great juniors that have near-term upside potential and are trading at a significant discount to their net asset value. These would be excellent targets for acquisition.
The recent merger between Lexam Explorations Inc. and VG Gold Corp. (TSX:VG; OTC:VGGCF; Fkft:VN3) is part of a very positive trend toward that sort of merger/consolidation market. There are many other companies, too. Most recently, we've seen the rise of NovaGold Resources Inc. (NYSE.A:NG; TSX.V:NG). It's not a producer, yet Paulson & Co.'s gold fund has invested in the company. That shows the confidence in gold from a savvy investor like John Paulson. The company has about $5 billion under management. That also shows how senior fund managers are coming downstream into the exploration market rather than just playing the majors.
TGR: You mentioned VG Gold and its merger with Lexam Explorations, a company led by Rob McEwen, the former chairman of Goldcorp Inc. (NYSE:GG; TSX:G), who, in addition to other roles, is a mine financier. VG has a number of properties in the Timmins area of Northern Ontario, which is an established gold camp. The merger happened after VG announced some good drill results in summer. If McEwen is investing in a company, that's usually a good sign.
TK: Yes, I think there's a lot of potential there. Paymaster West, joint ventured with Goldcorp, could be the project that really makes VG a recognizable story. There are the other areas of Paymaster where I think drilling can go even deeper and could be a homerun for VG.
TGR: Yes, because it's not far from Goldcorp's past-producing Paymaster mine, which operated at about 7,000 feet below surface and VG Gold's discovery is about 1,000 feet below surface. There's certainly potential at depth.
TK: Also very important is that there is a porphyry zone at Paymaster West. It's closest to Goldcorp's Dome Mine, which has produced 17 million ounces (Moz.) of gold. That's been mined at about 12,000 feet. I think there's a lot of exploration potential in the Paymaster area.
TGR: Goldcorp is using VG effectively as an exploration arm.
TK: Exactly. The seniors have to do that now. Their project pipelines are diminishing. They need to have those exploration arms to continue to clock in the earnings and their reserve numbers. Without that, the gold supply continues to dry up.
TGR: Let's go back to NovaGold, which is a really remarkable story. That junior has 15 Moz. in reserves—not just resources—and close to as many ounces in the resource category. Why hasn't NovaGold been taken out?
TK: Well, the stock has doubled in the last 12 months. I think it's about getting the right pricing. I think NovaGold's a great acquisition target, given the reserves; but, with current gold prices, there's a big premium there. I think it's only a matter of getting the right buyer to come in with the right pricing and the right management.
TGR: Are there any environmental or permitting issues there that have kept NovaGold from being taken over, or is it internal corporate politics?
TK: I can't comment on internal politics but I think there are issues. I know there have been some issues around infrastructure. I think that could be one of the clouds. Overall, NovaGold has been delivering on what it promised. NovaGold has done a pretty remarkable job of raising money—close to $500 million. I think you're seeing that acceptance in the market. Even in the last three or four months, you can look at the acceptance of NovaGold's share price.
TGR: But NovaGold's market cap is around $2.1 billion. You saw Goldcorp snap up Andean Resources Ltd. (TSX:AND, ASX:AND) for $3.5 billion. And you saw Kinross Gold Corp. (TSX:K; NYSE:KGC) buy Red Back Mining Inc. for similar dollars. Neither of those juniors had anything close to the proven resources that NovaGold has with the Donlin Creek project in Alaska and the Galore Creek project in British Columbia. Barrick Gold Corporation (NYSE:ABX; TSX:ABX) owns 50% of Donlin Creek. Do you think Barrick might take a run at NovaGold?
TK: I mean that could be the out right there, right? But any other major has to understand that Barrick is involved. That could be one of the deterrents for another major to come in but I don't see that as a major issue long term. But in the short term, I think there have been some issues with Galore Creek's financing.
Whoever the buyer is, are they going to buy gold, copper and silver, or will they want just gold? You have to take those two things into account. If that's the case you have to separate the two companies into two different companies. Then you end up with two different buyers. A buyer has to be willing also to take on the copper.
TGR: NovaGold could also do an offtake deal with an Asian smelter.
TK: Yes, exactly. Given what's going on, I think that could be a reality for NovaGold.
TGR: Let's move on. Khandaker Morgan builds indexes, one of which is the Khandaker Mining World Index. How many juniors are in that index?
TK: It's a combination of 100 juniors. Juniors being companies below a $500 million market cap.
TGR: How do you select the companies that make up that index?
TK: That's a great question. If you compare our index versus Russell, companies in the Russell Index are picked based on market cap mostly. Obviously, market cap is one of the factors in our index; but, far more importantly, we look at growth characteristics of companies within that market-cap range. We look for near-term catalysts that would qualify those companies to be in our index. A company may have the market cap but not the growth characteristics to fit in our index. So, in some ways, our index projects the overall growth perspective of the worldwide metals and mining sector.
TGR: And these aren't just gold companies; you also include base metal companies, uranium juniors and others, right.
TK: It's a metals and mining index. So we look at gold, precious metals and base metals. We also look at rare earth elements (REEs). I would say it predominantly focuses on precious metals, base metals and some of the long-term potential is in rare earths. For example, Avalon Rare Metals Inc. (TSX:AVL; OTCQX:AVARF) is a rare earths company that is in our index.
TGR: You launched this particular index in March 2010. How much has it gone up since then?
TK: It's picked up a lot, well into the double digits.
TGR: Has gold's run caused you to add more gold companies to the index?
TK: We don't necessarily use gold's performance as a guide when adding gold stocks. We look at overall sectors. If you look at exit and entry, you're looking at two criteria—market cap and growth characteristics. For instance, NovaGold is no longer in the index because it's already exceeded the market-cap limit; but Lake Shore Gold Corp. (TSX:LSG) is still in the index.
Now, in terms of the composition and weighting, there are more precious metals juniors than anything else. There are also base metals juniors and miscellaneous commodities like coal and rare earths juniors.
TGR: How do you go about investing in this index? Is there an ETN?
TK: That's a great question. This will be an actively managed index as opposed to a passive fund. With an ETF, you lay out a basket of stock and just invest in it as it appreciates passively. We want to create an actively managed index with quarterly updates on companies getting in and out based on growth and market cap. We plan to have a hedge fund around it that would present the investment vehicle for the index and are now in the final stages of putting the legal framework together. It should be in existence in the next couple of months.
TGR: Will it be available only to institutions?
TK: It will be available to institutions and high net-worth individuals.
TGR: Obviously, you follow the junior sector closely to find the right companies for your index. What are some other junior gold names with near-term catalysts for growth?
TK: I will just give you a few names. I think Lake Shore Gold is a good company. We believe it's in trajectory to become a mid-tier producer; so, there are some drivers there.
TGR: Well, Hochschild Mining (LSE:HOC) just placed its 35% interest in Lake Shore on the secondary market because the company made its money and wanted out. Should Lake Shore investors be concerned about that?
TK: No, I think Hochschild just saw the premium and wanted the money. I think it's a pretty simple business transaction.
TGR: What about some other names?
TK: Queenston Mining Inc. (TSX:QMI) is another company in our index. We carefully chose companies with growth characteristics, which is why our index has done well. I think Queenston definitely qualifies there. The company is well managed and has near-term potential. I think there's been quite a lot of progress, in terms of Queenston's relationship with the various entities its working with; and I think that will continue. In terms of its NI 43-101 numbers, I think the company will continue to plug in more numbers and add more ounces. Given all this, I think Queenston is in a good situation.
TGR: Any final thoughts on the precious metals sector that you'd like to share with our readers?
TK: It's very important to continue following the evolution of gold pricing, performance of equities markets and performance of the overall global economy. There is a clear relationship between equity markets performance and the gold price, as well as the overall economic performance of particular countries, specifically those in North America. We are quite bullish on gold; and, given what's going on, we believe it will continue to be a safe place for investment.
Mr. Tan Khandaker is principal and executive managing director of Khandaker Morgan Group, Inc. and also serves as a head of Global Portfolio Strategies and Risk Management. He has more than 10 years experience as an independent advisor to various funds, PE and investment banks. Prior to founding Khandaker Morgan Group, Inc., he founded and managed Roushan Khandaker Group—a boutique small-cap equities research firm for more than eight years—focusing on the metals and mining, healthcare, oil & gas and cleantech sectors. Mr. Khandaker has interviewed more than 5,000 CEOs of global small-cap companies in Khandaker Specialty Sectors and has overseen an India-based, 20-person analyst team conducting independent valuation research on global small- and micro-cap companies; many of his picks where acquired at a very high premium. Mr. Khandaker developed particular expertise in mining, healthcare and mergers and acquisitions (M&A) and consulted for various investment banks and financial magazines shortly after leaving academic research at Harvard Medical School and affiliated Brigham & Women's and Massachusetts General Hospitals in 2001. From 1999–2000, he was an adjunct faculty at Fisher College, Boston; and from 1997–1998, he had firsthand exposure to clinical trials at Mount Sinai Hospital, New York. An entrepreneur at heart, Mr. Khandaker received his MD, (diploma in medicine) from the distinguished Mitford Medical College, Dhaka, affiliated with Royal College of London. A national board scholar, he graduated with distinction in 1995 and was a practicing physician in internal medicine before he joined academia. As captain of the medical school soccer team, he led his team to victory on numerous occasions.
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1.) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his 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: VG Gold, Goldcorp, Avalon, NovaGold and Queenston.
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