Gold companies cheap to buy but not for long
Fund Manager Adrian Day believes that the U.S. dollar is fundamentally overvalued and we can expect a devaluation at some point. This is good news for the price of gold. In this interview with The Gold Report, Day adds the even-better news for investors in gold equities is that so many good shares now sell for so little, and he discusses several companies that won't remain bargains for long.
The Gold Report: Despite the lack of an economic recovery and the reality of ever-increasing debt, the U.S. dollar and the equity markets remain strong, while gold (as denominated in U.S. funds) remains weak. Do you expect these conditions to change?
Adrian Day: Yes, absolutely. The strong dollar and equity markets are two of the main reasons why gold has been down over the last 18 months. The third reason is anticipated higher interest rates.
Gold will recover because the U.S. dollar is overvalued against most other currencies, by as much as 25–30% against most Asian currencies. We're not expecting an equities crash any time soon, but the risk level in the market has increased, and stocks are no longer fundamentally cheap. So investors will increasingly look to the protection gold affords. As for higher interest rates, the U.S. Federal Reserve has, by its actions if not its words, made clear it is waiting for perfect conditions before raising rates. I'm not quite sure when we're going to see such conditions. In any event, higher rates are already factored into the gold price, and should the Fed approve a quarter-point rise, I would actually expect gold to rise on that news.
TGR: Many people argue that continuing zero-interest rates are the only reason the economy is doing as well as it is. Do you agree?
AD: No question. This has been one of the weakest-ever economic recoveries out of a recession. My greatest concern is the lack of tools remaining to the Fed should the U.S. economy enter even a modest recession.
Interest rates are too low. A strong economy requires capital investment, which comes from savings. Creating wealth by printing money builds a facade. It depreciates the value of the underlying currency, encourages speculation and punishes savers, especially retired people.
TGR: What do you make of the reports that China and Russia, possibly with the aid of Brazil and India, intend to create a rival to the petrodollar?
AD: This is coming. History teaches us that economic dominance is never permanent. States that dominate the world through military and economic power establish a reserve currency. But over time, the baton is passed from one state to another, and in many cases it's clear who the successor will be. Britain was once the dominant power, and the pound was the reserve currency throughout the 19th century. After World War I, however, it became obvious that the U.S. would replace Britain as the leading world power and that the U.S. dollar would become the reserve currency.
America's situation today is similar to what the British faced a century ago. I believe that the U.S. has peaked. It is hugely indebted, with a huge welfare state and an overextended military. So who will replace the U.S.? This is not obvious. That's why we have this attempt by the BRICs to weaken the dominance of the dollar. This is a step along the path to a new reserve currency. If this is to be the Chinese yuan, that's probably 15 years away, because China's capital markets are just not deep enough today. In the meantime, the excess U.S. dollars all over the world will begin to return home, and this process will depreciate the value of the U.S. dollar.
TGR: The current bear market in precious metals equities began in April 2011. Despite all the talk of "creative destruction" among mining equities, are there still too many "zombie" companies?
AD: Far too many. It is too easy to raise mining money in Canada. If you discount a company's stock and give a five-year warrant at a small premium, someone will buy it, even if it's only an existing shareholder who liquidates his current holding to get a more attractive deal in the new round. In addition, there is flow-through financing, which would often not be possible were there no tax benefits.
In 2014, 57% of the financings in the gold sector were for less than $1 million ($1M). We're now seeing financings for as little as $100,000 or even $50,000. This money is spent merely to keep the lights on and pay salaries. It's not spent on actual work in the ground. I've even heard of financings where the entire point was to repay old debt owed to directors and managements. About 45% of TSX-listed gold companies have less than three months cash on hand.
TGR: A higher number of listed companies means more fees for the exchange, but what effect does the continued existence of hundreds of zombie companies have on the gold sector as a whole?
AD: It affects the whole sector negatively because every $1M put into a bad company is $1M that's not going into a better company. Investors burned by investing in zombie companies turn away from gold companies for good.
TGR: Which companies have you been buying lately?
AD: Over the last couple of months, we have been buying a lot of companies. The seniors include Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) and Goldcorp Inc. (G:TSX; GG:NYSE). Smaller producers include Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) andB2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX). We've also bought Pretium Resources Inc. (PVG:TSX; PVG:NYSE), Vista Gold Corp. (VGZ:NYSE.MKT; VGZ:TSX), Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE) and Balmoral Resources Ltd. (BAR:TSX; BAMLF:OTCQX).
TGR: What do you like about Balmoral?
AD: First, it is a prospect generator, and I like this model. Producers are hungry for resources but with few exceptions aren't doing much exploration themselves. And so they rely increasingly on others to find their future reserves. This model doesn't guarantee success, of course, but I would point out that shares of the prospect-generator group have outperformed traditional exploration companies by quite a wide margin over this bear market.
Second, this is a company run by good people with a good balance sheet who are doing good work on the Detour Trend in Quebec, a very prospective area in a great jurisdiction.
Third, Balmoral shares are very cheap right now.
TGR: Balmoral likes to point out that many juniors in its region have been bought out by larger companies. Is this likely to happen to Balmoral?
AD: It's an obvious buyout candidate. But I think the company would prefer to further prove up its properties before it was taken out.
TGR: What other prospect generators do you like in Quebec?
AD: Midland Exploration Inc. (MD:TSX.V) is one of my favorites. The company just raised $14M, primarily from a group of Quebec institutions. So it is extremely well funded for a small company. Midland has 22 projects with 10 active joint ventures (JVs). Its partners include Agnico Eagle Mines Ltd. (AEM:TSX; AEM:NYSE), SOQUEM Inc. and Japan Oil, Gas and Metals National Corp. (JOGMEC). Midland is very active, its management is very disciplined and it has a very low burn rate of about $1M a year.
TGR: Did Midland need to raise this $14M?
AD: No, it didn't, as it had nearly $5M at the time. Typically, I would argue against increasing the number of shares by 50%, but this financing demonstrated the confidence Quebec and its institutions have in Midland. After Virginia Mines, a company with a similar model to Midland, was acquired by Osisko Gold Royalties Ltd. (OR:TSX), the Quebec pension funds were looking for another horse they could back.
Gino Roger, Midland's president and CEO, has certainly demonstrated he knows how to spend money wisely. He has a great exploration team, and I have no doubt the company will get a discovery.
TGR: Which prospect generators do you like in Mexico?
AD: The first would be Riverside Resources Inc. (RRI:TSX.V). The company also has properties in British Columbia (B.C.) and Arizona. This is one of those companies you buy and then put away while waiting for a discovery. It has 16 projects, including five JVs and strategic alliances with Antofagasta Plc (ANTO:LSE) and Hochschild Mining Plc (HOC:LSE). These alliances are interesting because they result in someone else paying much of the money for generating prospects, and if the partner does not move a project to joint-venture status, Riverside retains the prospects generated.
Riverside features a very tight share structure and highly disciplined management under President and CEO John-Mark Staude. The company doesn't waste money. It has a little over $3M in cash now, plus some equities, enough to carry it for the next 12 months.
TGR: And the second prospect generator you like in Mexico is?
AD: That would be Almaden Minerals, but there is some question whether this company is still a prospect generator. However, shareholders have just approved splitting it into two. Almaden will keep the Tuligtic property, which is close to a prefeasibility study.
The spin-off, called Almadex Minerals Ltd., will get about $3M in cash and another $2M in gold bullion, over 20 development properties and over 20 royalties. This new company will mean Almaden is returning to its roots. And this new prospect generator will not have to raise more money anytime soon. I think it's a good time to buy Almaden, because you'll get Almadex as well for only $0.80/share. I should point out that we already own more than 5% of Almaden. And I think Ixtaca will get sold. It's an attractive project in one of the best mining jurisdictions.
TGR: Which prospect generator do you like in Europe?
AD: Reservoir Minerals Inc. (RMC:TSX.V), though not specifically because it's in Europe! It already has a big discovery, the Timok copper-gold project in Serbia, which has an Inferred resource of 65.3 million tons (65.3 Mt) at 2.6% copper and 1.5 grams per ton (1.5 g/t) gold, including 6.8 Mt at 9.6% copper and 5.9 g/t gold. This is a JV with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE). Should Freeport take the project to feasibility, Reservoir will retain 30%. Freeport is drilling Timok extensively now, and if the existence of a large enough deposit is confirmed, it's pretty clear it will buy that remaining 30%.
Reservoir Minerals Inc. has several other JVs in the Balkans and North Africa. The company has about $40M in cash, about 25% of its market cap. This puts it in an excellent position to develop what it has and generate further prospects. And this cash also allows it to take a strong position with Freeport with regard to the sale of Timok. Simon Ingram, Reservoir's president and CEO, is technically very competent and knows how to tell his company's story.
TGR: How have the majors come out of the bear market?
AD: As a group, they bought at the top and sold at the bottom. They bought heavily in 2009–2011, and they've sold heavily ever since then. They've taken over $50 billion in write-offs. For an industry as small as gold mining, that is really quite appalling.
Now we have a situation where many companies with advanced projects are valued so cheaply, but few of the bigger companies have taken advantage. There are some exceptions: Franco-Nevada, Agnico Eagle Mines, Goldcorp. But even today, some of the majors are continuing to try to sell their assets into a weak market.
TGR: Would two of those be Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Newmont Mining Corp. (NEM:NYSE)?
AD: Yes, as they were two of the companies that went a little crazier during the good times. We are beginning to see a pickup in mergers and acquisitions (M&As), and as gold begins to move up on a sustained basis, which I expect by early next year, we should see a sustained increase in M&As.
As I mentioned above, the gold companies need reserves. Barrick Gold went from 104 million ounces (104 Moz) to 93 Moz in reserves, even though it kept the price at which it values its reserves the same. Goldcorp reserves are down 8%, while IAMGOLD Corp.'s (IMG:TSX; IAG:NYSE) are down 15% and Coeur Mining Inc.'s (CDM:TSX; CDE:NYSE) 27%.
TGR: Why have you been buying Goldcorp?
AD: It has shown a strong growth profile. Over the last year, it has brought three new mines on-stream: Éléonore in Quebec, Cochenour in Ontario and Cerro Negro in Argentina. It has a good jurisdictional-risk profile, operating as it does mainly in Canada and the Americas. And it has the lowest net debt to market cap of any major mining company at 24%. The sector average is about 47%.
Goldcorp is a disciplined company. Remember that after its hostile offer for Osisko Mining, Osisko found white knights in Agnico Eagle Mines and Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE). Goldcorp then raised its offer, but after Agnico and Yamana raised theirs in turn, Goldcorp walked away. That's unusual. Most companies let ego get in the way in battles of this sort. Having increased its line of credit and sold off its shares inTahoe Resources Inc. (TAHO:NYSE; THO:TSX), Goldcorp is now poised to make a major acquisition.
TGR: Which companies in the royalty/streaming sector are your favorites?
AD: Franco-Nevada and Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX). There's not much to say about Franco except to say that, if you want only one gold company, buy Franco. It has the best people in the business. It has a great balance sheet, strong cash flow and a diversified asset base with a strong growth profile. It has about 350 mineral royalties, of which about 35 are producing now, so there is plenty of potential. It is a good buy at less than $50/share.
Royal is also a great company, although its balance sheet is not as good, and it is not as diversified as Franco. But it probably has more near-term upside, and with Thompson Creek Metals Co. Inc.'s (TCM:TSX; TC:NYSE) Mt. Milligan mine in B.C. now producing, it will probably see a bigger revenue increase than Franco over the next 12 months.
We also like Altius Minerals Corp. (ALS:TSX.V). This is non-gold, of course, but it is a diversified company with roots as a prospect generator that has consistently sought out royalties.
TGR: Which near-term producers has your company bought?
TGR: Romarco began construction of its Haile gold mine in South Carolina in May. Even so, shares are still under $0.50. Does this surprise you?
AD: Not really, because this is the stage when shares of companies like Romarco languish. There will be little excitement until its first gold pour, which is scheduled for Q4/16. But I expect that over the next 9–12 months, we will see the share price move up steadily, to say $0.70–$0.90. There is now an extremely low downside to Romarco.
Diane Garrett is one of the best CEOs out there. She always does what she says she will. She has demonstrated her competence with local communities, government agencies and the banks. She raised the financing for Haile without any gold hedging, which is impressive.
TGR: Are you confident that Pretium will get the permits for its Brucejack project in B.C.?
AD: Pretium will get the permits, but it's a long process. While it waits, it continues to drill and is coming up with some very good results. I believe that this stock still suffers an overhang from the dispute a couple of years ago about the reserve calculation. Considering its Proven and Probable resources of 6.9 Moz gold, the mine capital expenditure (capex) of $747M is quite reasonable. Pretium is a very good buy right now.
TGR: Is the purpose of Pretium's current drilling to define what it has, expand what it has, or both?
AD: Both. This is a very "nuggety" deposit, so much tighter drilling is required.
TGR: How do you expect the capex will be raised?
AD: I doubt Pretium will have much difficulty financing once it starts getting the building construction permits. The Zijin Mining Group Co. Ltd. already owns 9.6% of the company. I suspect that a Chinese group will come in and take over the company eventually.
TGR: On June 3, West Kirkland published a prefeasibility study of its Hasbrouck project in Nevada. Were you impressed?
AD: Yes. Hasbrouck is a relatively small, relatively unexciting project of 567 Koz gold. The after-tax net present value is $75.3M, with an internal rate of return of 26%. But it's also a simple project with no metallurgical problems, so all-in mining costs will be cheap at $779/oz, and the initial capex is only $54.3M. Permitting in Nevada is more time consuming than it once was, but given Hasbrouck's economics, shares are just ridiculously cheap at $0.06. Part of the problem is that investors are always looking for more excitement, for the big killing, and you won't get that with West Kirkland.
TGR: Will the company have difficulty raising the capex?
AD: Well, $54.3M is not a lot of money in absolute terms, but it is a lot for a company with an $18M market cap. I have faith in Mike Jones, West Kirkland's president and CEO. He's not going to do anything foolish. He will raise the money in the most appropriate way, debt mostly. West Kirkland has little downside and represents a possible triple or quadruple over the next 18 months or so.
TGR: How long do you think that gold equities as a class will remain cheap?
AD: Much depends on the gold price. Investors want a higher price on a sustained basis before they really come back to this sector. Anyone still in the gold market must be patient. That said, the senior gold companies are trading at pretty much their lowest valuation levels ever, and many of the juniors have market caps lower than cash on hand.
Investors can afford to be selective. They need to look at market caps and ask what they are getting for their investment. They need to consider not the number of ounces but their quality. They want companies that have sufficient cash to pursue at least the next stage or two of their business plans. It may take another year or 18 months before we see a general recovery in this sector, but in the meantime, this is just a great time to be buying gold companies. There's an embarrassment of riches.
TGR: Adrian, thank you for your time and your insights.
Adrian Day, London born and a graduate of the London School of Economics, heads the eponymous money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."
Creative Commons image by Christopher Sessums