Adrian
Day likes to think long term, and historical trends persuade him that the bull
market in gold should continue for years to come. In this interview with The Gold Report, the founder of Adrian
Day Asset Management explains why he expects a significant gold price recovery
in the near future. In the short term, he counsels investors to choose
companies that minimize risk through royalty agreements, joint ventures and
robust balance sheets. In other words, companies with the means to seize
profit-making opportunities, and Day shares the names of a handful that fit the
bill
The Gold Report: John Makin of the American Enterprise
Institute noted on Dec. 20, "In 2013, the Federal Reserve's
actual monthly purchase of bonds—the size of quantitative easing (QE)—has
averaged $94 billion ($94B), or $9B above the advertised pace of
$85B/month." So is all this talk of tapering a shell game?
Adrian Day: Even if the Fed had stuck to the
$85B/month as advertised, tapering is a sham. The Fed reduced QE to $75B/month
in January and now has announced a further $10B/month reduction. But $65B/month
is still an enormous amount of stimulus. Very shortly, the Fed's balance sheet
will exceed $4 trillion. We're focused on the wrong thing here.
TGR: Considering all this talk of recovery,
the Jan. 10 jobs report was dismal, was it not?
AD: Absolutely. The employment situation in
the U.S. is a long way from what one would expect from a decent recovery, let
alone a robust recovery.
TGR: U.S. job creation since 2008 has been
mostly part-time jobs, temporary jobs and low-paying jobs. How does this lead
to increased consumer spending, which is, we are told, the basis of a robust recovery?
AD: Consumer spending is
being fuelled by debt. Since 2007, it has increased 23% for the lower 40% of
earners. The Fed reports that net household income and net household wealth
have now exceeded the 2007 highs. If we break down the numbers, however, we see
that net worth is actually down for 90% of U.S. households. For the bottom 50%
of households, net worth is down an astonishing 44%.
TGR: We can't have a recovery based on the purchase of yachts and multimillion-dollar New York City condos, can we?
AD: Of course not. We can't have a strong
economy based on just 10% of the population getting richer. Frankly, I don't
mind whether there's a gap between the rich and the poor—so long as the rich
are getting their wealth honestly and not from government handouts. And so long
as the middle class is getting richer also.
TGR: President Kennedy said famously that a
rising tide lifts all boats. Do we still believe that?
AD: Since 2008, the Fed's stimulus has gone
mostly to Wall Street, not to Main Street. That is a fundamental problem for
the economy but also for the polis, for the public social good.
It's not that I want
the government to do things specifically for the middle class; I just want it
to get out of the way. If small businesses are created and can expand and hire
people, then we will have a rising tide lifting all boats.
TGR: The International Monetary Fund last
month cautioned that debt levels have become so perilous that
recovery, as Ambrose Evans-Pritchard of The Daily Telegraph wrote, "will require defaults, a savings tax and higher
inflation." Do you agree?
AD: Debt has become unmanageable. Now, there
is nothing wrong with debt per se. When I argue against high government debt,
people often respond that in the 19th century the U.S. debt to GDP ratio was
higher than today. But that debt was used for capital investment (canals,
railroads, etc.), which led to higher economic growth. Today, debt is being
used to fund wars and welfare, not investments in the future.
Defaults? Perhaps.
Taxes will never deal with the debt problem. You could tax 100% of income above
$100,000, and you would fix the U.S. deficit only for a few months. Higher
inflation? Perhaps. The one thing Evans-Pritchard didn't mention was currency
devaluation. Because the vast majority of U.S. debt is issued in U.S. dollars,
the easiest way to liquidate it is to devalue the dollar.
TGR: In a speech last month in Shanghai, you said,
"Gold moves in long cycles." Do all commodities move in cycles?
AD: Most do because producers get price
signals from the market with a delay. Take the retailer that sells TVs. If
sales go down three weeks in a row, the retailer will order fewer units the
next month. He gets an immediate price signal. The wholesaler gets signals with
a bit of a lag but still relatively early.
But the producer of a
rare earth that goes into TVs gets the signal from the market with a much
longer lag than the retailer, the wholesaler and the manufacturer. So, metals
cycles tend to be very long. And it's far more difficult for miners to cut back
or increase production than for retailers to adjust orders.
TGR: Where are we in the current gold cycle?
AD: Over the last 250 years, the shortest
cycle on record was the 1970s, just over 10 years. Typically, gold upcycles
have lasted close to 40 years. On that basis, we aren't even halfway through
the current gold upcycle.
TGR: So last year's price collapse did not
indicate the end of the gold upcycle?
AD: Significant corrections in long, secular
bull markets are typical. Gold, from top to bottom, has declined 37% in this
particular cycle. If you look back to the upcycle of the 1970s, 1975–1976 saw a
midcycle correction of 47%. But that was right before gold went up eightfold to
more than $800/ounce ($800/oz).
Where are we now? It
would be optimistic to assume a V-shaped recovery, but gold has bottomed, and
over the next 12 months we are likely to see a slow, if uneven, recovery. The
typical recovery comes from a long midcycle correction. We should reach
$1,550–1,650/oz in 2014 or early next year, and then gold will start to
accelerate. Some gold stocks could recover a lot quicker in expectation of
higher prices.
TGR: You noted in Shanghai that gold stocks
have lagged behind the gold price in an extraordinary manner. Why?
AD: First, costs have gone up, in some cases
more dramatically the price of gold. Second, companies grossly overpaid for
acquisitions with no synergies. Barrick Gold Corp. (ABX:TSX; ABX:NYSE) comes to
mind in this regard.
For these reasons, we've
seen a great deal of new equity dilution. If we look at all-in costs—and not
just mining costs— it's been estimated that about half of all mines are losing
money. So it's no surprise that gold stocks have done badly, particularly in
light of the attractive and simple alternative: gold exchange-traded funds.
TGR: When can we expect gold stocks to
recover?
AD: As you know, many gold companies have made big
mea culpas. They've fired CEOs and committed to not making the same mistakes.
The irony is that with companies and individual mines so cheap now, when it's
so difficult for companies to raise capital, this is precisely when the big
companies should be making acquisitions.
That's why I
applaud Goldcorp Inc.'s
(G:TSX; GG:NYSE) bid for Osisko Mining Corp. (OSK:TSX). I think
a few more mergers and acquisitions (M&A) like this will get the market
excited again.
TGR: Assuming a general recovery in gold
stocks, which sector do you think will do best—majors, mid-caps or micro-caps?
AD: Broadly, the seniors will probably move
first because when generalist investors move into the gold sector, that's
typically where they first put their money.
But I don't look at
the gold sector that way. Today, the most important criterion is the balance
sheet. Does the company have the cash to carry out its plans? If it must raise
cash, can it do so in a nondilutive manner? Some seniors will be able to answer
affirmatively, and so will some explorers. That's the test.
TGR: It's said that some companies are too
big to fail. Are some gold companies, like Barrick, too big to succeed?
AD: There's no systemic reason why Barrick
is too big to succeed. It has a complex and far-flung structure, but so does
Nestlé S.A., which buys from more than 100 countries and sells to more than
200. Nobody says that Nestlé is too big to succeed. Barrick's problem is that
it probably grew too big too fast.
Successful exploration
entails risks and the understanding most risks will fail. It's natural that
lower-level managers in large companies become much more risk averse. The
solution is for the majors to use the juniors as their exploration arm, as
companies like Newmont Mining Corp. (NEM:NYSE) have done. Newmont does
joint ventures (JVs) with other companies and then, if appropriate, buys the
properties or buys its partners outright.
TGR: How long until Barrick's new management
can put its stamp on the company and tell investors: That was then, and this is
now?
AD: The first thing Barrick must do is make
it very clear exactly what kind of company it is: does it want to be a gold
company or a diversified mining company? Will it hedge? Considering the way the
management transition has been handled—the $11.9 million ($11.9M) signing bonus
for new Co-chairman John Thornton and the two independent directors resigning
because they think the "independent" directors are still too close to
Peter Munk—I think it's going to be a while before Barrick can draw a line
under the past.
TGR: Why do you favor the royalty/streaming
model?
AD: When a company acquires or creates a
royalty on another company, that first dollar in is typically the last dollar
in, meaning that the royalty company is not responsible for setbacks. If there
are cost overruns, if the shaft floods, if taxes are raised, the company with
the royalty is not responsible.
The worst that can
happen is that royalty payments are reduced or delayed. For instance, the
original capital expenditure (capex) of Pascua Lama, Barrick's project that
straddles Chile and Argentina, was $2.25B. By the time it was shelved, the
capex had reached $10B.Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX), which had a royalty on
Pascua Lama, was not responsible for this huge increase. Of course, Royal still
doesn't have any revenue from that project, but at least it didn't have to
front any more money.
TGR: What are the advantages for royalty
companies besides risk mitigation?
AD: Staffs tend to be small, so profit
margins tend to be high. And royalty companies have exposure to exploration
upside. If a company has a royalty on a particular mine, it will typically have
a royalty on at least some of the exploration ground around that mine. If there
is a discovery on that ground, the royalty owner benefits just as much as if it
were the company making the discovery. Royalty companies get most of the upside
and very little of the downside.
TGR: Which royalty companies do you like?
AD: I like most of them. Having said
that, Franco-Nevada Corp.
(FNV:TSX; FNV:NYSE) is, in my view, far and away the best. It
has great management, a great balance sheet, about $900M in cash and no debt.
It has a very broad portfolio of properties. It has royalties on 37 producing
mines and more than 300 other, nonproducing royalties.
TGR: Which of the smaller royalty companies
do you like?
AD: It's not in the gold business, but Altius Minerals
Corp. (ALS:TSX.V) has morphed into a royalty company. It began
as a low-risk operation, partnering on JVs. It then innovated by spinning off
projects but retaining shares and royalties.
Altius has just
acquired a package of royalties on coal and potash. Add that to its royalties
on Vale S.A.'s (VALE:NYSE) Voisey's Bay nickel mine and Alderon Iron Ore
Corp.'s (ADV:TSX; AXX:NYSE.MKT) developmental Kami iron ore project in
Newfoundland and you have a very attractive company.
I also like Virginia Mines
Inc. (VGQ:TSX), which, like Altius, has grown largely with JVs. It
has a royalty on Éléonore in Quebec, which is Goldcorp's next major mine to
come onstream, in Q4/14. Production is estimated at 600,000 oz annually after
ramp up.
TGR: Your January portfolio review noted that
Altius was up 24% for 2013, and Virginia Mines was up 16%.
AD: Most of the mining companies that did
well last year had very good balance sheets and weren't associated with high
risk. That's certainly true of Altius and Virginia.
It amazed me that
Virginia was still so inexpensive even as Éléonore's net present value
continued to grow and Virginia's royalty came ever closer to fruition. The
explanation is that investors are short-term oriented. Virginia is arguably a
little ahead of itself after the recent run, given today's gold price, but it
is still one of the top companies I would want to hold long term.
TGR: Any other royalty companies you'd care
to mention?
AD: Callinan
Royalties Corp. (CAA:TSX.V). Again, it's not gold. Callinan actually
pays a dividend, about 4.6%. It's quite nice to get a decent dividend on a
resource-related company. Callinan has a good balance sheet and is continuing
to make investments in other companies where it retains royalties. Over the
next few years, investors will see Callinan expand from basically one producing
royalty to several. In the meantime, investors get paid.
TGR: Reservoir
Minerals Inc. (RMC:TSX.V) was up 21% last year. What's its
story?
AD: Reservoir has a JV with Freeport-McMoRan
Copper & Gold Inc. (FCX:NYSE) on the Timok copper-gold project in Serbia.
This proves again the worth of the JV model. Reservoir had to give up 75% of
Timok, but with Freeport paying for the exploration, Reservoir can maintain its
balance sheet.
Reservoir has about
$18M in cash right now, which is a lot, considering what its expenditures are.
It has had continually spectacular results from Timok. I think that Freeport is
going to buy Reservoir or, at least, buy Timok. This could mean a very
significant premium over the current stock price. Most shareholders are waiting
for the endgame, so there aren't a lot of shares available. So it's important
to look for any setback to buy, and to use a limit.
TGR: Moving to British Columbia's biggest
exploration story, could you explain the "battle of the consultants"
over the quality of Pretium Resources Inc.'s (PVG:TSX; PVG:NYSE) Brucejack
deposit?
AD: That was unfortunate. Pretium had two
independent consultants, Strathcona and Snowden. Strathcona is the company that
blew the whistle on Bre-X, so it has credibility. Pretium was doing a bulk
sample to assess the value of Brucejack because the deposit is high-grade but
spotty. The two companies had different methodologies for conducting and
assessing this sample. These were technical differences, and I don't know why
Strathcona believed it had to resign from the project so publicly.
TGR: You sold Pretium, but now you're bullish
on it again.
AD: We sold because I was in a risk-averse
mode at the time. I know Pretium's CEO, Bob Quartermain, and his integrity is
unquestioned. Nonetheless, I knew that a very public controversy like this
would cause the stock to decline for quite some time, which it did.
Then the initial bulk
sample results were released, and they were excellent. So I thought it was time
to jump back in. I feel very positive about the deposit, and the bulk sample
results have only gone to support that confidence. I think Pretium is a good
buy at this point.
TGR: You have stressed the correlation of
success with cash and/or cash flow. Name a company that demonstrates these
attributes.
AD: Almaden Minerals
Ltd. (AMM:TSX; AAU:NYSE) has great management, about $16M in
cash plus a couple of million in gold bullion. The beauty of having cash means
that a company can raise money or sell assets only when it wants to.
Almaden owns the
Tuligtic gold-silver property in Puebla, Mexico. The company continues to drill
the Ixtaca zone aggressively, and the results continue to be strong. A
just-released updated resource estimate on the Ixtaca zone on this project
shows an increase in total resource of about 20% and a Measured and Indicated
resource of 3.5 million ounces; the deposit continues to grow. A preliminary
economic assessment is scheduled for early March and I am expecting it to be
positive. This stock is a bargain.
TGR: Any other bargains come to mind?
AD: Midland
Exploration Inc. (MD:TSX.V), another prospect generator. It has 10
main projects in Quebec, five of which are currently under joint venture. Key
projects are the Maritime-Cadillac gold project with Agnico-Eagle Mines Ltd.
(AEM:TSX; AEM:NYSE), the Patris gold project with Teck Resources Ltd. (TCK:TSX;
TCK:NYSE) and the Ytterby rare earth project with Japan Oil, Gas and Metals
National Corp. (JOGMEC). These partners have already re-upped, which
demonstrates confidence in the projects, and the company is working on finding
partners for more of its projects. Midland has $4.5M in cash, more than enough,
considering the money its partners are spending.
Midland's stock is at
$0.97/share. It's a very thinly traded company, so I would urge investors to
use a limit price when they buy, otherwise they'll just push the price up on
themselves. (Our clients actually own more than 10% of Midland, and we're
considered an insider.)
TGR: Could you rate the balance sheets of
some other gold companies?
AD: We own Detour Gold
Corp. (DGC:TSX). It does have cash, but it also has ongoing capital
expenditures on its Detour Lake mine in Ontario. It's more leveraged on the
gold price than some of the other companies I've mentioned. If gold goes from
$1,200 to $900/oz, it's not going to be a great investment. But if gold goes
from $1,200 to $1,500 or $1,600/oz, Detour will be one of the better
performers. It is also a potential takeover candidate.
We also own quite a
bit of New Gold Inc.
(NGD:TSX; NGD:NYSE.MKT). It has four producing mines: Cerro San
Pedro in Mexico, Mesquite in California, New Afton in British Columbia and Peak
in Australia. It also has very strong management. Randall Oliphant, the
executive chairman, is a former Barrick CEO, and board member Pierre Lassonde
is chairman of Franco-Nevada.
New Gold has a good
balance sheet and a good pipeline of projects. It is one of the most
undervalued of the senior gold companies. So I would definitely be a buyer
there.
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 (www.adriandayassetmanagement.com;
410-224-2037), where he manages discretionary accounts in both global and
resource areas. Day is also sub-adviser to the new EuroPacific Gold Fund
(EPGFX). His latest book is "Investing in Resources: How to Profit from
the Outsized Potential and Avoid the Risks."
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DISCLOSURE:
1) Kevin Michael Grace conducted this interview for The Gold Report and
provides services to The Gold Report as an independent
contractor. He 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: Virginia Mines Inc., Pretium Resources Inc., Almaden
Minerals Ltd. and Midland Exploration Inc. Goldcorp Inc. and Franco-Nevada
Corp. are not affiliated with The Gold Report. Streetwise
Reports does not accept stock in exchange for its services or as sponsorship
payment.
3) Adrian Day: I or my family own shares of the following companies mentioned
in this interview: Almaden Minerals Ltd., Altius Minerals Corp., Franco-Nevada
Corp., Freeport-McMoRan Copper & Gold Inc., Goldcorp Inc., Midland
Exploration Inc., Reservoir Minerals Inc., Royal Gold Inc. and Virginia Mines
Inc. I personally am or my family is paid by the following companies mentioned
in this interview: None. My company has a financial relationship with the
following companies mentioned in this interview: None. I was not paid by
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