Gold mining executives: “You have to be able to survive the lows in order to reap the benefit of the highs”
During a time of stagnating gold prices and non-existent capital market funding for junior resource companies, Bill Reid, Chairman; and Jason Reid, CEO and President of Gold Resource Corporation, were kind enough to share comments.
Despite following gold down over the last two years in terms of share-pricing, Gold Resource Corp. has avoided most internal pains suffered by mining companies during this ongoing resource bear market. That may be attributed to a philosophy of a “one year payback time[or less]” on all capex development, as indicated by Chairman Bill Reid during an interview with BullMarketThinking’s Tekoa Da Silva.
Here is that conversation in its entirety:
Tekoa Da Silva: Bill—you spent most of your career in the trenches of a multi-decade bear market in natural resources. We’re seeing a bit of that today. How tough of a time was it for you to earn your education in that environment during those years?
Bill Reid: Well, the commodities business is a cyclical business and I’ve seen numerous cycles. When we’re in an up-cycle, people can never see a reason why it’s going to go down but it always does. When we’re in a down-cycle, people can never see a reason why it will go up, but it does.
So you have to understand from the beginning that this is a cyclical business. Now actually this last cycle has been a good one. It’s been basically an up-cycle for the last decade. The gold price on January 1stversus the gold price on December 31st has been up the last 11 years.
So this has been a good cycle. 2013 is the first year in a while that we’ve had a down-cycle in the gold price and of course, people are ready to bail out. We’ve had a pretty good run [but] I don’t think it’s over yet.
I can remember back, I think it was in 2000, when gold hit $250 oz. That was a very difficult time. Once again, nobody was interested in the gold mining business and the prices were very low. But we’ve always understood that you have to be able to survive the lows in order to reap the benefit of the highs. It’s a cyclical business and that’s not going to change.
So as of today with the business in a lull or certainly out of favor in most quarters, and the prices [having] pulled back a little bit, you’re finding that a lot of juniors are probably going to go out of business. We’re fortunate that our philosophy was such that, “Hey, let’s get into production as quickly and as cheaply as we can.” We did that and it’s nice that during these tough times we’re in a position where we’re generating cash flow.
So I would say actually you really do learn more in the tough times than you do in the good times because when things are frothy, everybody can be successful. But when times are tough, not everybody can. So that’s just kind of a quick overview that the commodities business is cyclical and you better be able to handle both [sides] .
TD: In some of the writings that you published Bill as CEO during 2006-2009 following the IPO of Gold Resource Corp., you were talking about a set of values and philosophies that now the CEOs of the majors are starting to talk about. Was it experiencing those cycle bottoms that gave you the foresight to choose the hard pathway in terms of those philosophies and values?
BR: Yes, it certainly played a big role. One of the things I was always frustrated about, was that we had a decade or more where this industry was all about resource ounces in the ground. That’s all they would talk about and they never told you how economic [the deposits were] and if they were economic at all. They didn’t even like to tell you the grade because what they would do in that environment is just keep lowering the cut-off grade, which lowers the average grade and adds more ounces to your resource. But the project may not be economic and in fact, a lot of times they’re not economic.
So it was very frustrating for me because it was like a game they were playing but it was what the investor wanted, which was, “How many ounces you got in the ground? What’s the potential of your production growth, etc.?”
That timeframe was when there were a lot of bad decisions made because some of these really lower grade deposits were put into production and as you said, today—we kind of smile because the industry has come around to what we have said from the beginning.
We looked at this [business] from the beginning as “We’re here to make money and share that money with the owners of the company.” It’s that simple. I mean that’s our philosophy. We’re here to make money and share a portion of that money with the owners of the company.
Now there’s a strategy that goes along with that. I mean number one you have to be disciplined in your capital structure. I remember so many Canadian companies, every time their stock would go up, they would just sell more stock. They loved to say, “Oh, we’re topping up our bank account.” Well, that isn’t the reason why you should be in this business. The main reason is to make money and in our opinion distribute a significant portion of that (or as much as you can anyway) back to the owners of the company.
So you have to have a disciplined capital structure. We did that. We [also] had to look for high-margin properties, which generally meant higher-grade properties. You [also] had to look at the payback. So these were all parameters or metrics that we focused on which in the past the industry did not, but it has come around to that today.
TD: Bill, how did you narrow down to the concept of a one-year payback time or less? Did you see someone else that was very successful that went down that path?
BR: I think maybe we were the only ones that ever had that philosophy because everybody rolls their eyes when they hear that. But let me be clear: you want to boil things down to the simplest concept, and the industry will throw out all these things; internal rate of return, net asset value, even discounted cash flow. All these different things. What does that mean to the average investor? It doesn’t mean anything.
So let me be very specific and very simple. Just ask them or look at how many years does it take to pay back the capital that you’re investing in that project. You might be surprised with the numbers that come back. That’s what I listen to when I listen to people’s presentations. I heard one the other day. Somebody was talking about a project they were going to do and they finally got around to saying it had an eight-year payback and I rolled my eyes. I mean an eight-year payback is terrible. That is not a good project. A five-year payback is probably not good especially in this business, when you don’t know what the price of metal is going to be five years from now.
So what that did was give us the discipline to not get sidetracked by a lot of these lower-grade ‘ounces in the ground’ concepts. When you look at it you should think, “We’re going to have to have a one-year payback of our capital that we’re going to put into this project.” Allocation of capital is one of the most important things a CEO and his top people do. The board of directors look at the allocation of capital and one of the reasons most of these major companies are having difficulties today in this price environment is that they really didn’t focus on that. Again, [they said] let’s just give it more ounces.
So that concept is a good one. Every investor should know about it. A two to three-year payback, that’s fine if you’ve got a significant life. We always wanted a one-year payback so we could put a project into production even if it only had a three to four-year life, because a lot of times especially in underground high-grade mines, you can’t drill it out like an open pit and say you have 15 years.
There are many underground mines that have operated that only have say four years of reserves but they operate for 20 years. It’s just the nature of the business, [because] it takes too much to drill out ahead of time.
So my point, is that that’s a very good concept [to have] to maintain the discipline… I think all investors should be aware of it and when they’re looking at a company and its new project, [always ask] “How many years of payback is involved in that allocation of capital?”
TD: We’re seeing a flush out of so many projects, companies that were assessed by the market as a billion dollar market cap back in 2011 are now for example trading at $30mm or $40mm—because of the reasons you just stated. They won’t be profitable until $1500 oz. or $2000 oz. gold because of the low grades. So things are going on sale all over the place.
Jason—is that something you could talk to in terms of things being flushed out right now, companies looking to sell themselves, or projects coming onto the auction block? What are you guys seeing there?
Jason Reid: Yeah, we’ve seen a couple companies come through our front door, looking to sell themselves. I mentioned this in the conference call and I think it’s worth repeating here that Citibank came out with an analysis, that I think 98% of gold producers are not profitable at $1320 gold. Regardless of whether those exact numbers are correct or not, the point is very valid that all mining companies are struggling right now and you might see some producers go under, let alone a decimation of the juniors which could play a major role going forward [in terms of] the supply and demand.
So are we seeing that? Absolutely…
TD: If I can ask you both now about gold as an asset—what are your fundamental views and where did you come to believe them?
BR: Well, gold has had value for 5,000 years, and it comes and goes with popularity but I think in today’s world where you’re talking about the difference between something that everybody will accept that has value, versus somebody’s paper, that it’s still – gold still holds the value that it has had throughout history.
So today’s countries and governments are printing as much money as possible even though it doesn’t show in inflation [right] now. At some point, you can’t do away with axiomatic things in economics and I don’t think that – if you just say to yourself, “Boy, we can create great societies by just taking paper, putting ink on it, calling it money and printing all we can.” If that were true, the world would be a much richer place, but that hasn’t happened. So I’ve seen gold – actually I remember when Nixon took us off the gold standard basically and it was $35 oz. I’ve seen it go all the way now to $1900 oz.
The way I look at it, is that it’s not gold changing its value. It’s the paper money that’s losing its value and it’s being reflected in gold. I’ve always been focused on the fact that we produce a commodity that the world needs [in order] to show basically how badly governments are running their countries. So anyway, that’s just kind of my overview.
JR: Expanding on what Bill was saying—there’s a great book called The History of Money and they go back into when the Lydians were minting their first coins all the way through [to today’s] history.
Over and over it’s repeated where governments or kings take perfectly pure gold and silver rounds and when they want to engineer their currency, they dilute the rounds whether it be with copper or some other base metal. When they dilute the currency too much, eventually the society abandons it, and that requires the government or the king to then go back and invent a new one that’s pure—effectively taking it back to the gold standard.
This has happened over and over in history. Very few people look at or look into the history of money but that’s exactly what’s happening today. You see our fiat, our paper currency, is being devalued tremendously every month by $85 billion which is almost incomprehensible.
I was just in a conference where I had to speak on this concept. I was also presenting the company as well. One of the speakers before me was talking about our current currency, the coins, and how there’s really no valuable metal in our current coin. So the same thing is happening today whether it be in our coins or our fiat money. At some point, like Bill mentioned, it’s not hard to imagine inflation is going to be very difficult to handle and the big question will be, “[Will] this society return to a gold standard in some form or fashion whether it be another basket of currencies backed by percentage of gold?”
But tying this all back to where we are today—your thesis to own gold and silver two years ago, I would argue is not only as intact as it was then; but given all the additional monetary devaluation, it should be even more so.
So I feel very fortunate that we’re in a unique business. We’re in the only business where we get to produce true wealth, and as Bill mentioned, not just ink on paper but we’re talking gold and silver that have been around for thousands of years.
So we’re in a very unique business and we’re fortunate to be in this business and timing is everything. I think we’re in a great time. We’ve been having this pullback over the last two years, but prior to that, we had a 12-year bull market and…when we finally turn back around, it’s going to be very exciting.
TD: All right. Well, Bill and Jason, before we wind down, are there any items that you think that we may have missed?
JR: No, but I think the biggest one we touched on early on, [is] that this market for the metals equities is in turmoil and we just need to make sure that we are [among] the ones remaining standing, and I think the opportunity out there once the dust settles will be tremendous.
TD: Bill Reid, Chairman; Jason Reid, CEO and President of Gold Resource Corporation, thanks for sharing your comments.
JR: Thank you very much.
BR: Thank you.
Disclosures: The author carries a long position in the company mentioned. Always seek the advice of a qualified investment professional before making any financial decisions.
By Tekoa Da Silva