Gissen and Berol's gold stock tricks and treats
No matter how elaborate an investor's Halloween costume is, the gold space isn't handing out much in the way of treats this year. While Encompass Fund Managers Malcolm Gissen and Marshall Berol don't agree on the timeline for gold's recovery, they have faith that it will come. In the meantime, their focus is on companies that are in production, generate cash flow and have top-notch management teams. They also dig into their treat bag for names in the energy sector and other metals in this interview with The Gold Report.
The Gold Report: It's almost Halloween and we remain in the clutches of a tricky market for junior resource equities. What are your perspectives on how long it's going to take before investors see another treat-filled year like 2010?
Malcolm Gissen: The last couple of years have been frightening for investors, in both gold commodities and gold stocks. Gold prices have been rising the last few weeks, allowing some people hope, but I don't expect an appreciable change in the gold price and the appeal of gold mining companies until 2015.
Marshall Berol: I'm more optimistic than Malcolm. I think the market will change, possibly in as little as five months. The underlying fundamentals that have driven gold up over the last dozen years are still in place: the money printing presses, supply and demand for bullion, bars and coins. Costs are going up, so is the need for higher prices.
I would like to see the market refocus on fundamentals and get away from tracking the hour-to-hour and day-to-day activities of the financial players. What they are doing in the futures markets is driving the price of gold and other commodities up and down incessantly. The dollar is up; the dollar is down. Oil is up, oil is down. Stock prices react to whatever news is coming out of Washington, Europe or Japan. At some point, investors will realize that gold's underlying fundamentals have not changed and that there are reasons to buy it.
MG: We started investing heavily in gold in the accounts of clients of our RIA firm, Malcolm H. Gissen & Associates, in 2002, when gold was under $300 per ounce ($330/oz). We built allocations to precious metals of 15–18% by 2004. When Marshall and I launched the Encompass Fund in mid-2006, gold companies was the largest asset class. We believed that gold was deeply undervalued and with India and China, cultures that value gold and use it as a currency substitute, developing a middle and upper class, demand for gold would increase exponentially. We also knew that many investors would come to realize that the gold price would go up because of inflation and currency devaluation—the historical reasons people buy gold.
That attitude has changed over the last two-and-a-half years. Fundamentals no longer seem to play a role in attracting investors to buy gold or gold stocks. Marshall thinks it would be nice for people to go back to looking at fundamentals; I'm not sure that will happen. The information explosion—gossip, rumors and trying to guess what hedge funds and private equity investors are doing—plays an increasingly larger role in decision-making.
One factor that would cause gold to rise would be the realization that the U.S. government is printing money to deal with its tremendous debt. This is not sound policy. This should scare people, but it doesn't seem to at this time.
The Federal Reserve is doing everything it can to keep interest rates low, which is good for corporations and good for the economy, but it is doing that by buying bonds and mortgages. Eventually, we will have to pay the piper. At that point, hard assets like gold and silver will look a lot more attractive. Until we get to that point, I'm concerned that gold will not break out of the range it has been trading in for the last couple of years.
TGR: Change will require the onset of fear.
MG: Fear is definitely one strong motivator. Unlike Halloween, where children (and many adults!) love going to haunted houses to be frightened, people do not seek fear in their investments. Rather, they avoid fear, often at all costs. If fear returns in the markets, Marshall and I think that gold is likely to be a place where investors will move their money.
Another new development affecting gold and silver prices in the long run could be supply constraints. The world's largest mining companies have realized that they must be more sensitive to escalating costs of building and operating mines, especially with gold and silver at present prices. They can't rely on $1,600–1,900/oz gold prices to pay for $3–7 billion ($3–7B) expansion and construction projects and remain profitable. With gold in the $1,000–1,300/oz range, some companies are not profitable.
I just attended an excellent presentation by Juan Carlos Artigas, head of investment research at the World Gold Council. While arguing that all investors should have a 3–10% allocation to gold because it is an asset with low correlation to almost all other assets, he pointed out that all-in costs for some gold producers were in the $1,200/oz range. As a result, CEOs are less willing to build large projects. We also have seen much less merger and acquisition activity among the majors. I believe that will, over the next few years, threaten the gold and silver supply.
If gold supplies are threatened, it could raise gold prices. I can't say whether that will happen in six months or three years, but I believe that we're headed in that direction.
TGR: Do you expect the trend of up-and-down gold prices with no real pattern and with little consensus to continue until there is a decided move upward?
MB: Although we disagree on timing, we agree that gold will continue trading in the $1,200–1,450/oz range until it breaks out to the upside.
MG: I think there's a floor in the $1,100–1,200/oz range. When gold goes below a certain level, companies will stop producing, there will not be enough gold to meet demand and we'll see higher prices.
Industry executives tell us that if gold should ever get to $1,000 or $900/oz, they expect many of their colleagues to go on care and maintenance, because they can't make any money at that price. They'll go to a skeletal crew and cut back on production.
MB: It's happening. Goldcorp Inc. (G:TSX; GG:NYSE) reported it is delaying work in Argentina due to rising costs and other factors. Its all-in sustaining cost is likely to be $1,050–1,100/oz for 2013. At that level—and this is one of the largest gold miners in the world—management teams cannot continue to produce and lose money.
TGR: Let's look at silver. New York's CPM Group expects silver prices to consolidate for another three years, at an average of $18/oz. Do you support that forecast?
MG: I don't, for a couple of reasons. First, it's very difficult to make forecasts for a specific timeframe. I cannot predict what will happen in three years. It is difficult enough trying to forecast where prices will be in three or six months! Second, because silver has so many more industrial uses than gold, I don't see silver prices declining by an additional 15% after the sharp decline of the past year. I also do not believe that silver prices will break out until factors—similar to what I mentioned for gold—change.
MB: Silver's current price is $21–22/oz, so CPM's forecast implies that the price will decline over the next three years. I don't agree. About half of silver usage is industrial—electronics and medical, for example—all of which are increasing.
Silver tracks the price of gold investment-wise, but I think it could do better than gold percentage-wise over three years. Historically, silver has been more volatile than gold. It goes up or down to a greater percentage than gold.
TGR: Malcolm, we're just a couple of weeks beyond the federal government shutdown in the U.S. What are your thoughts on the long-term health of the American economy and the American political system?
MG: I'm going to stay away from the politics, because my politics and Marshall's politics are almost diametrically opposite.
I believe the U.S. economy is much healthier than a lot of Americans realize. Our entrepreneurial spirit is extraordinary; the number of young people starting companies has never been greater.
Sometimes government can get in the way. We need more reasonable, workable regulation than we have now. If we do that, the sky is the limit for the U.S. economy. I don't think that will change for many years; I'm very bullish on our economy.
TGR: In 25 years, will the U.S. greenback still be the world's reserve currency?
MG: I think it will. Twenty-five years would be too soon for the American dollar to lose its position as the world's basic currency, just as English is the dominant language used around the world.
MB: You also have to ask yourself what the reserve currency would change to. The euro isn't in any position to become a reserve currency. Nor will it be the yen, the ruble or the peso. It may one day be the Chinese currency, but not that soon.
That brings us back to gold. It would not replace the dollar, but central banks are adding gold to their reserves to lessen the impact of the dollar on the percentages held in their reserves.
TGR: Did you make changes to your Encompass Fund (ENCPX:NASDAQ) due to the government shutdown?
MG: We made no changes in either client accounts or in the Encompass Fund. However, we did debate whether to move more to cash in the eventuality of a default on the U.S. debt and the negative impact that would have on the market. We concluded Congress would likely go right to the wire, when the more moderate Republicans would prevail and strike a deal.
MB: The client accounts are managed to each client's individual goals and objectives. The objective of the Encompass Fund is long-term capital appreciation. We are not a trading fund. The turnover rate for the Encompass Fund runs around 25%. We don't focus on day-to-day, week-to-week or even month-to-month news developments. We look for industries and companies that will do well over time.
TGR: What are your clients telling you these days?
MG: I think clients like less risk and less volatility, and we have moved in that direction over the last 12–15 months. We have invested client accounts in more large-cap, domestic stocks. We like the energy, healthcare and technology sectors. We also have added Real Estate Investment Trusts.
We've done the same thing in the Encompass Fund. It was more heavily invested in resource companies, particularly metals. Over the last six months, we've kept the best of the resource companies, but energy is now the largest component represented in the Encompass Fund.
TGR: Your website describes the Encompass Fund as a "go anywhere fund." Geographically, where has the fund gone in the last year that it had not gone previously?
MB: It's more a factor of where we've pulled back than where we've gone for the first time. The fund has a number of resource sector investments in Canada, the U.S., Mexico, South America, Africa and a couple of companies in Europe. We are more wary of jurisdictions that have experienced geopolitical problems, such as Argentina, Bolivia, Ecuador, areas where the governments appear less friendly toward resource operations.
TGR: Marshall, you've invested in resource companies based, in part, on your relationships with company management. How has the downturn in the junior resource space changed those relationships?
MB: It hasn't changed the relationships as much as it has focused us even more on company management.
At the end of 2008, we assessed where all of the companies in the Encompass Fund were relative to their projects, finances and management. We reduced or eliminated a number of the companies that were not making the progress we had hoped for and added to those we thought were stronger. That worked out extremely well for the following couple of years, as the markets improved and some of the companies did likewise.
We did the same thing earlier this year, focusing even more on the management teams. In this very difficult environment, strong, knowledgeable managements with successful track records for bringing projects along and raising money are extremely important.
TGR: But you must have to say no to people when they come to you for more financing.
MB: Yes, almost every day. This year in particular, companies have needed to raise funds just to keep the lights on, much less advance their projects.
We are being far more selective in what we believe justifies funding. Primarily, that translates to companies that are in production and need funding to increase production, or are very, very near production.
TGR: Do the relationships just dry up when you have to turn down funding requests?
MB: I hope not. It's a business decision. Companies are in a position where they need to ask. We're in a position where we can and will say no if it doesn't fit our portfolio objectives. I would hope that the management teams understand our position and our responsibility to our investors.
TGR: What is your current investment thesis for junior mining companies? What do companies you invest in today have to have?
MB: It's very good if they're in production or very near production. That means they're generating revenue and cash flow of some kind and are advancing their projects.
Management and the state of the balance sheet are also factors. Companies with significant cash on their balance sheets are a lot more attractive.
With rare exceptions, it is difficult for us to justify investing in very early-stage companies in this environment.
TGR: This year investors have gotten more tricks than treats in the gold space. What are those rare treats that you're following?
MB: We found a number of treats among the energy companies. We've been invested in Magnum Hunter Resources Corp. (MHR:NYSE.MKT) for some time. It's expanding its operations in the U.S., primarily in oil, some in gas.
TGR: It was up almost 9% on Oct. 24.
MB: Yes. Many of the smaller companies are volatile. Magnum Hunter has doubled in price over the last couple of months. Thus, it's more difficult to buy at these levels. A short while ago, we trimmed the position simply for portfolio management purposes; we still like the company.
We also find industrial metals, such as vanadium and antimony, attractive.
TGR: Which vanadium or antimony plays do you like?
MB: U.S. Antimony Corp. (UAMY:OTCBB) is expanding production in Mexico: mining, milling and processing. A number of strategic metals are currently sourced primarily out of China, and there are a lot of reasons why the users and governments around the world want to move away from China being basically a sole source supplier.
We have an interest in American Vanadium Corp. (AVC:TSX.V). While its project in Nevada is still a ways off, it also has a relationship with a German manufacturer of fuel cells used for energy storage for solar and wind power. That's a very attractive business opportunity for American Vanadium to produce revenues in the short term while it moves ahead on starting production at its vanadium project.
TGR: Is that an offtake deal?
MB: It will be partially an offtake deal when it gets into production. Right now, American Vanadium is a sales agent for these vanadium-based batteries used to store energy produced by the solar and wind industries.
TGR: Returning to gold, which small-cap gold companies in the Encompass Fund portfolio would you like to talk about?
MB: Relative to a good management team able to move the company ahead and raise funds, I would mention Brazil Resources Inc. (BRI:TSX.V; BRIZF:OTCQX). It isn't yet in production, but it recently announced acquisition of another Brazilian gold company. Marketwise, it has done better as a nonproducing junior company stock than many of its peers.
TGR: Earlier you talked about avoiding places like Argentina, Bolivia and Ecuador. Brazil is right in that neighborhood. Why are you comfortable investing in Brazil?
MB: The Brazilian government seems to be more reasonable, and it is a far larger and broader based economy than elsewhere in South America. Argentina, for example, nationalized a Spanish oil company and changed the tax laws, and the monetary situation is challenging.
TGR: Keeping with our trick-or-treat theme, which gold companies were tricky in 2013?
MB: There were a few whose stock prices suffered dramatically and that may be in positions to treat investors well in 2014.
One is Northern Dynasty Minerals Ltd. (NDM:TSX; NAK:NYSE.MKT). Its Pebble project in Alaska is very large and has a lot of gold and other metals. However, it is controversial from an environmental standpoint. Until mid-September, Northern Dynasty had Anglo American Plc (AAUK:NASDAQ) as its 50/50 partner. Then, Anglo American announced that it was withdrawing from the partnership and discontinuing its involvement, after having spent $541 million ($541M) of a projected $1.5B investment to develop the Pebble project. That took the Northern Dynasty price down dramatically, and it has basically stayed there.
Northern Dynasty says the advantage is that it now owns 100% of Pebble. Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) owns 18% of Northern Dynasty. Nobody knows what will happen there.
TGR: Does CEO Ron Thiesssen need another partner to make a go of it?
MB: Yes, although Northern Dynasty claims to have the financial capacity to move forward with permitting and the project.
But investors were tricked, to use our Halloween analogy, because they thought Anglo would be putting another $1B into Pebble. Anglo's announcement changed the project and the perception of Northern Dynasty. If these concerns can be straightened out, a year from now Northern Dynasty stock should be a real treat for those who invested at this level.
Another situation where the market got tricked is Pretium Resources Inc. (PVG:TSX; PVG:NYSE). Pretium has a major gold project in British Columbia. Its Valley of the Kings project is very high grade and very large. It was forecast to be in production in 2016. Earlier this month Strathcona Mineral Services Ltd., one of the two independent consulting firms working on a bulk sample project to delineate the gold resource, resigned. The stock took a hit.
Within the past week, Pretium released more details about why the firm withdrew. That raised even more questions about the nature of the project and how viable it is. The stock took another hit. The market felt tricked by an unexpected event driving the stock price down considerably.
If the consulting firm's withdrawal and the reasons for it turn out to be a tempest in a teapot, Pretium stock will become a real treat for investors over the next few months and into 2014.
TGR: Do you consider Strathcona's resignation an entry point to the stock?
MB: Not necessarily an entry point, but it creates what could be an excellent opportunity to get into the stock at half the price it was a month ago.
TGR: Snowden, another geological consulting firm, continues to oversee the bulk sample. Is having Snowden alone sign off on the bulk sample enough?
MB: It will be enough for some people, not for others. That is the conundrum in assessing Pretium and determining a good entry point price.
Some people will say there's too much smoke and don't want to get near it. Others will assess the situation as it develops and as the bulk sample results come out—Pretium has announced results from about one-quarter of the 10,000-ton bulk study—and will decide they want to invest.
TGR: Any other names you'd like to mention?
MB: We like Primero Mining Corp. (PPP:NYSE; P:TSX), which is making good progress at its San Dimas mine and Cerro del Gallo project in Mexico. It is producing cash flow, is growing and expanding and has a very accomplished, experienced management team. Despite recent questions about Mexico instituting a new tax and royalty structure, Mexico remains an attractive mining jurisdiction.
I recently visited Comstock Mining Inc. (LODE:NYSE.MKT). It has put together a major land package in the Comstock Lode area south of Virginia City, Nevada. It has been in production for about one year, and projects doubling its production to 40,000 oz gold equivalent in 2014, from 20,000 oz gold equivalent in 2013. The key for Comstock will be continued production expansion, which should lead to a lower cost of production per ounce and increased cash flow and operating margins. Increased exploration, which is ongoing, is likely to increase production and cash flow over time.
TGR: What tricks should investors avoid in today's economic environment?
MB: Unfortunately, tricks are most noticeable with hindsight. I think the trick to success is to avoid assuming that when gold or silver prices rise that it will raise all the boats. While we remain optimistic on the price of gold and silver, just having an inexpensive stock doesn't mean it will go up if the price of gold goes up. You have to dig deeper and look at the management, the projects, the location and the finances.
TGR: Indeed. That trick is a real treat. Thanks for your time and insights.
Malcolm Gissen founded Malcolm H. Gissen & Associates Inc., an investment advisory services firm, in 1985. His management experience has focused primarily on investments in publicly traded companies. He holds a Bachelor of Science degree from Case Western Reserve University and a Juris Doctor (J.D.) degree from the University of Wisconsin.
Since 2000, Marshall Berol has been the chief investment officer of Malcolm H. Gissen & Associates Inc. In addition, for more than 20 years, he has owned the investment firm BL/SH Financial. His investment management experience has focused primarily on investments in publicly traded companies. Berol did his undergraduate work at the University of California at Berkeley, and has a Juris Doctor (J.D.) degree from the University of San Francisco School of Law. Prior to entering the financial services industry, Berol was a partner in a San Francisco law firm.
Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.