Undervalued companies for the precious metal portfolio
The Gold Report: Ralph, thank you for joining us today. Let’s talk about royalty and streaming companies. What factors are making them attractive investment vehicles right now?
Ralph Aldis: There are several aspects. We look at factors like return on invested capital. It doesn’t necessarily have to be extremely high; we just want to see that there’s low volatility in those returns. The royalty companies do that very well.
The royalty companies are highly diversified, and thus, the geologic risk of any particular deposit really has been diversified away.
Additionally, royalty companies essentially get paid off the revenue line of other mining companies. They’re getting paid first, and those cash flows have a high certainty to them because they’re coming off the topline versus coming off the bottom line.
TGR: What royalty and streaming companies are at the top of your list?
RA: The three biggest and most successful ones have been Franco-Nevada Corp. (FNV:TSX; FNV:NYSE), what’s now called Wheaton Precious Metals Corp. (WPM:TSX; WPM:NYSE) and used to be Silver Wheaton, and Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX).
The last three to five years, Franco has outperformed the other two companies by a pretty good margin. That’s because the other two names have had some minor issues. But the issues are solvable, and actually some of them are being solved right now.
When we had that downturn in the metal prices in 2015 and 2016, Silver Wheaton and Franco both did very large royalties with some of the major miners that were producing gold as a byproduct. Those streams were in production and paying right then and there, so they immediately started getting returns on that.
Wheaton Precious Metals has an issue with the Canadian Revenue Authority (CRA), which is trying to assess taxes on some of its offshore earnings. So, the company has somewhat been under a cloud.
Looking at three-year numbers, Franco-Nevada is up 55%. Wheaton Precious Metals is actually negative, -20%. And Royal Gold is up 28%. That’s reflected in what’s going on. Franco hasn’t had any issues. Silver Wheaton has been challenged by the CRA. It has been in negotiation, and discovery, I believe, is finished now. But if the matter can get resolved favorably, and case law points to it might, Wheaton Precious Metals could have a very significant pop. I could see 20% in any single day if it gets this thing put to bed.
The last big royalty stream that Royal Gold did was on Mount Milligan. The operator did have some problems. Mount Milligan has since been taken over by Centerra Gold Inc. (CG:TSX; CADGF:OTCPK). Centerra has a lot of cash in the bank, so it has the deeper pockets to make sure that Mount Milligan continues to work. I think that’s why Royal Gold has lagged somewhat relative to Franco.
TGR: The GDXJ (VanEck Vectors Junior Gold Miners ETF) rebalancing occurred in June, and it created some buying opportunities. Can you give us a quick overview of what happened at the GDXJ and why?
RA: Between the GDXJ for juniors and the GDX (VanEck Vectors Gold Miners ETF) for seniors, the combined ownership was hitting up against owning 20% of shares outstanding for some companies and actually went over 20% for some. There’s a Toronto Stock Exchange rule where once you own over 20%, you’re obliged to make a compulsory takeover offer. And obviously, that’s not the goal of the ETF. Part of those flows going into it were driven by some of the leveraged products—DUST (Direxion Daily Gold Miners Bear 3X ETF), JNUG (Direxion Daily Junior Gold Miners Bull 3X ETF) and NUGT (Direxion Daily Gold Miners Bull 3X ETF). These funds actually buy the GDX and GDXJ and leverage it up. That’s why they grew so fast, because a lot of people wanted that 3X product earlier in the year.
With the amount of assets coming into the fund, the GDXJ could no longer be in those smaller companies where it could go over 20%. The GDXJ had more than $5 billion in assets at the time when it announced that it was going to liquidate or downweight half of those names in the fund and shift that money into larger-capitalization names, which are really in the midtier spectrum. It announced this with an eight-week window.
Over those ensuing eight weeks, everybody started frontrunning those names, selling the ones that were going to be kicked out and adding to the names that were going to be bought, even though there was nothing fundamentally wrong with any of those names. It was just that the GDXJ had showed its cards, and people will game that to try to make money.
That knocked down the share prices of some companies where there’s no fundamental reason why they should have been knocked down 20 to 30%, depending on the name.
TGR: Let’s talk about a couple of those names that have been affected and might offer buying opportunities.
RA: Some of the names are tightly held, such as Wesdome Gold Mines Ltd. (WDO:TSX); Resolute Funds Ltd. owns just under 20% of the stock. There are three or four other players, including us. We own a substantial amount of that stock.
TGR: Wesdome recently released drill results from the Kiena mine complex and gave details on the ramp at Kiena Deep that’s going to take about nine months or so to build.
RA: Yes, it is going to take about nine months or so to get that ramp fully put in. But the company said by September/October it’ll be down in the ramp, not complete, but it will have some new drilling stations. In the press release recently, it alluded it had run out of the ability to drill that deep discovery that has the market so excited about Wesdome. The news flow could be a little slow, but by September/October we should start to see more drilling taking place. Wesdome did put out a few holes with this last press release, and there were some impressive results, like 12.8 grams over 8 meters. But again, we’re probably not going to see any results for another two or three months as it ramps down.
But I think it’s positive; Wesdome will get a new mine into production that’s been on care and maintenance for a couple of years. This provides a good growth profile.
TGR: What’s another company affected by the GDXJ rebalance?
RA: Klondex Mines Ltd. (KDX:TSX; KLDX:NYSE.MKT), which is another name where three or four big players own a substantial amount of the stock. We are one of those names, too. What also happened with Klondex is because the majority of its shareholder base are U.S. residents, it had to change from International Funds Control Reporting System accounting to U.S. Generally Accepted Accounting Principles (GAAP).
That made Klondex look as if it had reported a miss on the quarter because U.S. GAAP requires you to write off everything once you have one ounce of gold production coming out of the mill. And that’s what it had at True North, which was an acquisition it had done the prior year. It was running some of the tailings through the mill just for testing it, and it produced some gold. But it was really more of a situation where it was pre-commercial production, which U.S. GAAP does not recognize. So Klondex had to report the cost at True North at something around $1,600/ounce gold. But it was just an accounting change. And if you looked at the earnings based on the previous way it was reporting it, it actually was an earnings beat.
But the algorithms out there don’t care. They just scan and look for earnings misses and start shorting that stock. Plus, they also see that this name is being downweighted in the index, so maybe that’s a reason to short it also.
Another name that got knocked down about 22% is Golden Star Resources Ltd. (GSS:NYSE; GSC:TSX). On that one, it was the number of days of trading volume that spooked people. Golden Star has actually had a pretty good turnaround. Its CEO has done a great job with the company. Royal Gold actually gave it a royalty to help get the development done that it needed.
TGR: Are there other companies that investors should be looking at?
RA: One of them is still in the exploration stage, TriStar Gold Inc. (TSG:TSX.V). The company recently did a small raise, $5.1 million. It has a gold alluvial conglomerate deposit in Brazil that outcrops at surface. It’s very much like Tarkwa in Ghana, where Gold Fields Ltd. (GFI:NYSE) has been mining for a number of years or like Yamana Gold Inc.’s (YRI:TSX; AUY:NYSE; YAU:LSE) deposit in Brazil, Gualcamayo.
Now that TriStar has raised money, it’s going to be doing some infill and stepout drilling. It has about 16 kilometers (16 km) of trace of this outcrop, and the current resource is only on about 2–3 km kilometers of it. So, we should see some resource updates that grow the resource, and I think the market will be pleased to see that.
TGR: Are there other companies you want to talk about?
RA: Sandstorm Metals & Energy Ltd. (SND:TSX.V) has been punished recently by being downweighted in the GDXJ. It also did a transaction where it bought a piece of Mariana Resources Ltd. (MARL:TSX.V; MARL:AIM) to get partial ownership over the Hot Maden deposit.
Sandstorm eventually wants to create a royalty out of that, but is willing to take the risk of equity ownership and then see if it can transition it into a royalty because the royalty space has become fairly competitive. This is one way where it thinks it can get an advantage to getting a royalty that has a little better economics to it.
One other company is AuRico Metals Inc. (AMI:TSX); the company has royalties on the Fosterville deposit, which Kirkland Lake Gold Inc. (KL:TSX; KLGDF:OTCQX) owns in Australia. Fosterville has just been knocking it out of the park with some great resource additions at higher grades. AuRico is benefitting from that. But it also has the Kemess development project, which was the original Northgate Minerals Corp. (NGX:TSX, NGX:NYSE.MKT) Kemess mine. All the infrastructure is there; it’s been on care and maintenance. It may be now that that deposit is going to become economic again at the metal prices that we’re seeing today. AuRico has an opportunity to redevelop it. It’s been adding to its team. AuRico may end up being a royalty company. It may end up being a development company. It may end up having a partner come in. There’s more than one way that it can make some money and create some wealth with its asset base. I’m very positive on AuRico Metals, too.
TGR: Any other parting thoughts?
RA: Investors need to keep their wits. Sometimes, you get hot markets and you want to invest as much as you can. But you have to remember to keep a diversified portfolio, with 5 to 10% of your assets in the precious metals space. The rest should be in another type of asset that is uncorrelated, just as the gold space is largely uncorrelated with the broader market. That gives you diversification and helps you weather the highs and lows in the respective markets as they oscillate. Stay diversified, and rebalance once a year at minimum.
TGR: Thanks for your insights.
Ralph Aldis, CFA, portfolio manager of U.S. Global Investors, is responsible for analyzing gold and precious metals stocks for the World Precious Minerals Fund (UNWPX) and the Gold and Precious Metals Fund (USERX). In addition, Aldis serves as co-portfolio manager for the Global Resources Fund (PSPFX), Holmes Macro Trends Fund (MEGAX), All American Equity Fund (GBTFX), Emerging Europe Fund (EUROX), Near-Term Tax Free Fund (NEARX), U.S. Government Securities Ultra-Short Bond Fund (UGSDX), the China Region Fund (USCOX), and the U.S. Global Jets ETF (JETS). In 2011, and again in 2015, Aldis was named a U.S. Metals and Mining “TopGun” by Brendan Wood International. In 2016, he and Frank Holmes were named Best Americas-Based Fund Manager by the Mining Journal. 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.
1) Patrice Fusillo conducted this interview for Streetwise Reports LLC and provides services to Streetwise Reports as an employee. She owns, or members of her immediate household or family own, shares of the following companies mentioned in this article: None. She is, or members of her immediate household or family are, paid by the following companies mentioned in this article: None.
2) The following companies mentioned in this interview are billboard sponsors of Streetwise Reports: Wheaton Precious Metals Corp. Streetwise Reports does not accept stock in exchange for its services. Click here for important disclosures about sponsor fees. The information provided above is for informational purposes only and is not a recommendation to buy or sell any security.
3) Ralph Aldis: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: None. I, or members of my immediate household or family, are paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this interview: None. Funds controlled by U.S. Global Investors hold shares of the following companies mentioned in this article, as of 03/31/2017: Franco-Nevada Corp, Wheaton Precious Metals, Royal Gold Inc., Centerra Gold Inc., VanEck Vectors Gold Miners ETF, VanEck Vectors Junior Gold Miners ETF, Direxion Daily Gold Miners, Direxion Daily Junior Gold Miners, Wesdome Gold Mines, Klondex Mines Ltd, Golden Star Resources Ltd, TriStar Gold Inc., Gold Fields Ltd, AuRico Metals Inc., Kirkland Lake Gold. I determined which companies would be included in this article based on my research and understanding of the sector. 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.
5) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their immediate families are prohibited from making purchases and/or sales of those securities in the open market or otherwise from the time of the interview or the decision to write an article, until one week after the publication of the interview or article. As of the date of this interview, officers and/or employees of Streetwise Reports LLC (including members of their household) own securities of Wheaton Precious Metals Corp., a company mentioned in this article.
Source: Streetwise Reports (7/11/17)