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07/13/2015 10:00 am EST
Resource expert Adrian Day suggests that relative to gold itself, gold mining stocks are trading at the lowest valuations in decades. Here, the editor of Global Investing discusses the state of the gold market as well as his favorite miners and royalty streaming stocks.
Steven Halpern: Our guest today is Adrian Day, editor of Global Investing newsletter and manager of Adrian Day Asset Management. How are you doing today, Adrian?
Adrian Day: Oh fine, thank you, Steven. Fine.
Steven Halpern: Well, thank you for joining us. Now gold has continued to slide in price but you see some reasons to be optimistic. First you note that seasonally, the seasonally weak period for gold is coming to an end soon. Could you explain this seasonality factor?
Adrian Day: Yeah. Very briefly, there is a pattern, a seasonal pattern that you know has some logical basis to it. Gold is bought for many, many reasons, as you know. We can sort of divide the reasons maybe into two.
Frank Holmes likes to talk about the fair trade and the love trade. Well, the love trade, by that he means people giving gold as jewelry, as gifts, and so on. Around the world, that tends to be concentrated on various holidays.
In the US, of course, Christmas and Valentine's are big days for giving gold jewelry. Around the world, there are different holidays.
If you look at the seasonal patterns based on those holidays, we sort of finished with the Muslim and Indian holidays and now we are in a quiet period, but come—normally the end of August, September—you get a pick up because of the jewelry buying ahead of, predominantly, Christmas. It is a seasonal pattern based on holidays basically.
Steven Halpern: Now, you also note that fears of a rate hike have been acting like a Sword of Damocles sitting over the gold market. But you don’t necessarily see a rate hike as a negative. Could you expand on that?
Adrian Day: Yeah, it’s a good question because I’ve often said—and many analysts have said—that if there is one major negative for gold, it would be increasing interest rates.
Now, I always qualify that with the important qualification. We are talking about increasing real interest rates. If the Federal Reserve raises interest rates but inflation is rising faster, that’s not negative for gold at all. In fact, it’s a positive.
Now, in this particular case, two things, I would say; first of all, when the Federal Reserve changes direction on rates, after a series of hikes they counter, after a series of cuts they raise, it normally signals a series of rapid increases, in this case increases in rates. That’s the normal pattern.
In this particular scenario where we are right now, I don’t think, I honestly don’t think that a quarter rate increase in the Fed funds rate is going to signal the start of a rapid series of interest rates and I don’t think any analyst thinks that.
First of all, we are not going to get that series of rate hikes, and secondly, this rate hike must be about the most telegraphed in history. If anyone owning gold doesn’t know it’s coming and then dumps his gold when it goes up, he’s just not paying attention.
I think we are going to see one quarter rate hike probably by the end of the year, and frankly, if I can be a little bit snide if you like, I think this is just so the Fed can show they have what it takes to preserve some sort of credibility. But I don’t think it’s going to signal a turn in the direction of rates.
Steven Halpern: Now, interestingly, you point out that gold stocks are now at their lowest evaluation in decades, relative to gold itself. What’s the overall situation with gold mining companies?
Adrian Day: Yeah, it’s a good question. If you look at the indices like the XAU index, or the others, HUI, and so on, any of the gold mining indices are now basically at 12-year lows. The XAU has not been at this level since the middle of 2003.
That’s in price, but when you look at the companies, the companies are generally much larger, they are larger but producing more gold, and of course, the price of gold is significantly higher than it was back in 2003.
If the price is at a 12-year low, the level of the index relative to gold, which you can track is at about a 20-, a little more than a 20-year low. If you look at the gold mining stocks in terms of evaluation, price to book value, price to ounces of reserves, price to free cash flow, and so on, by many metrics they are now at 70-year lows.
Whichever way you want to look at it, the gold stocks are incredibly inexpensive right now. We don’t have time to go—I mean, there are some reasons why perhaps they are cheap—but I think this is just over doing it.
Adrian Day: Yeah. Let me start by saying, if I may, that when I look at gold stocks, you can buy major mining companies, diversified mining companies. You can buy junior minors that are growing or you can buy expiration companies that are looking for it, and of course, it’s a continuum, some companies fall between those gaps.
I think you have to be extremely careful with the big major mining companies just because of the inherent difficulties and problems the mining companies have, not the least is replacing 5 million, 6 million ounces of gold each and every year. That’s a daunting task.
If you are looking at the majors, some investors—and I understand this—don’t like to go for juniors and exploration companies because of the volatility, because, you know, you have to follow them so closely and so on.
If you are looking for major mining companies, I would say Goldcorp and Agnico are by far the best run of the mining companies.
Goldcorp has over a billion dollars in cash. It’s got a good history of growing production. It’s in politically safe jurisdictions and all of that can also be said about Agnico.
The other thing I like about both of these companies is that they, to a large extent, avoided the mania of overpaying for acquisitions in 2010-2011—which some of the other companies were doing—and they are now taking advantage of the low prices by making acquisitions at these low prices, so I like those two.
Steven Halpern: Now, you mentioned that the types of gold investments available range on this spectrum and one area where you are a noted expert is the royalty streaming firms and two that you like are Franco-Nevada (FNV) and Altius Minerals (TSX: ALS). Could you give our listeners a little background on this sector and these two companies in particular?
Adrian Day: I think the royalty companies basically are the best way for more conservative investors and investors who don’t want to follow the sector on a day-by-day, week-by-week basis. It doesn’t mean the stocks won’t be volatile, but they are a lot more safe, a lot safer and less volatile then the mining companies.
Franco-Nevada is the largest of the gold royalty companies and a royalty company is essentially the same as a royalty company in any other business.
Instead of actually mining and producing gold, they will go out and acquire royalties on other people’s mines—and sometimes—in the case of Franco and Altius for that matter—sometimes they will buy existing royalties on producing lines.
Sometimes they will buy royalties on exploration grounds. And sometimes they will go out—both of these companies have been active in this area—they’ll go out and they will create royalties by going to a junior company that has a discovery, doesn’t want to raise money in the market at these depressed levels, and says, "Look, we’ll give you $25 million to develop this project, or $50, or whatever it is and in return will get 1%, 2% royalty on your future production."
They have done a lot of that, in the case of Franco. I’ve often said that if you only want to buy one gold stock and forget about it, this is the one to buy and it’s quite cheap right now. These stocks have never been great value investments but Franco—in terms of price—is quite cheap right now.
It’s got $1.2 billion in cash, it’s got the best management in the business, no debt. They have about 360 royalties, right now only 34 of them are producing, so they’ve got a lot of upside if gold moves up. I'd buy Franco, it trades on the New York.
Altius is another royalty company. I won’t go on about it, but it’s basically it is in non-gold areas, so it has a royalty on Voisey’s Bay nickel, which essentially pays its overhead.
It has two large royalties on a package in Saskatchewan on coal and on potash. And then it also has some royalties on iron ore developmental projects. It’s pretty well diversified, but non-gold. So I like those two a lot.
Steven Halpern: Again, our guest is resources expert Adrian Day. Thank you so much for your time today.
Adrian Day: Thank you, Steven.
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