Mid-Year Top Performers: Adrian Day

06/29/2016 11:13 am EST

Focus: COMMODITIES

Adrian Day

Chairman and CEO, Adrian Day Asset Management

At the start of the year, MoneyShow featured its annual Top Picks report asking the leading advisors for their favorite investment ideas for 2016. In the report 85 stocks and funds were recommended. This interview is part of our series highlighting the top performing advisors as of mid-year.

Steve Halpern:  Our very special guest today is Adrian Day, money manager, resource sector expert and editor of the industry-leading Global Analyst.  How are you doing today, Adrian?

Adrian Day:  Well I'm fine thank you, Steven, and you?

Steve Halpern: Very good.  Thank you so much for taking the time.  First congratulations are in order; in our 2016 annual Top Picks report, you chose Royal Gold (RGLD) as your favorite stock for the coming year.  The shares are pretty astounding, 89% as of now.  Could you first share an overview of Royal Gold and review your original rationale for recommending the stock at the start of this year.

 

Adrian Day:  Sure, Royal Gold is one of what we call a “royalty”.  There's a group of gold companies called royalty or streaming companies.  They are essentially companies but rather than mining the metal itself, which is very capital intensive and risky, they acquire royalties or streams.  They acquire royalties on operating or developmental mines.

 

The royalty model has been around in the oil business, of course, a 100 years but in the publicly-traded companies, really only started in the mid-80s.

There are a few large ones like Franco-Nevada (FNV), Silver Wheaton (SLW), which is primarily silver as well as gold -- and Royal Gold.  Royal Gold is now the second largest of the gold royalty companies.

 

The beauty of a royalty model is that the company makes an acquisition of buying a royalty and then they get a piece of whatever it is, 1.5% for example, of the net returns; so everything the company produces, they get 1.5% of it.

They're not responsible for putting up any more money.  They're not responsible for fixing problems, etc.  It's a low risk way of getting exposure to the gold mining business.

Steve Halpern:  Could you review the developments over the past six months that led to the stock’s strong gains and perhaps touch on both the gold sector in general as well as any company specific developments that impacted the stock.

 

Adrian Day:  Sure, well the reason we picked Royal Gold at the beginning of the year was really threefold.  One is that it is, in and of itself, a good quality company and we like the business model.  The second reason and this is what we look for when we buy stocks -- three things all coming together.

The second sort of criterion is that the stock is weak for some particular reason and that might be what we consider an overreaction or might be a temporary reason but we're getting the stock at a good price.

The third criterion we look for is that the major trend in the industry or market is on their side.

We thought the gold stocks generally were incredibly undervalued at thea end of the year.  They were selling on valuation basis.  They were selling a 10 and 20-year lows on many valuation criterions.  They were actually selling lower than they were back in 2001 before the bull market even started.  We had all three of those come together with Royal Gold.

The stock was particularly weak so it's a good quality company and we thought the trend was going to be on their side.  It was good quality.  The stock was particularly weak because of concern about the company that was operating the mine on which Royal Gold owns its largest royalty and that's Thompson Creek.

There was a lot of misunderstanding.  The mine itself is a very, very good mine.  It's one of the three lowest cost copper mines in the entire world. Royal Gold was getting the gold by-product so the mine itself was very, very good but the company operating had financial problems because of their other mines.

The market punished Royal Gold not realizing that the mine itself was good and that Royal Gold's interest was on the mine, not on the company.  Yes, if the company were to go bankrupt in the extreme case and the mine closed for a few months, that would hurt Royal Gold's earnings but it wouldn't hurt the company fundamentally.

 

I think the change that has happened is with the pickup in the price of gold. Royal Gold has been able to report first quarter earnings that were very, very strong and I think the market has just slowly come to realization that even if the worst happened to the mine operator, it wouldn't affect Royal Gold's royalty.

 

Steve Halpern:  Looking ahead to the second half of 2016, do you still remain optimistic on both gold in general and on Royal Gold specifically?

Adrian Day:  Yes, very positive.  I think in the immediate future there are a lot of factors that could affect gold up or down.  If we look ahead 3, 6, 12 months, we are extremely bullish on gold primarily because of the global monetary situation.

 

Interest rates are so weak but the European Central Bank and the Federal Reserve are obviously having great reluctance to raise interest rates.  These low and in many cases negative real interest rates are very, very bullish for gold.  

Royal Gold itself remains cheap if you look at Royal Gold's 10-year average valuation, the stock should be a $90 stock instead of a $65 stock.  On a valuation basis, Royal Gold remains undervalued.  I think if you get a couple more quarters, which show that in fact it is generating the revenue, I think Royal Gold will recover nicely.  

Steve Halpern:  We've only got a minute left but perhaps before we go, you'd be kind enough to highlight another name or two that investors could look out for over the balance of the year.  

Adrian Day:  Okay, one is not a gold stock and that is Ares Capital (ARCC).  The stock is a business development company that pays a dividend.  It is in the process of acquiring American Capital and again, we have a stock specific reason that the stock is weak.  

Every time a company acquires another one, the acquiring company stock typically goes down so under 14.50, you're earning 10.5% on Ares Capital. It's a $4.5 billion company. Good quality and they earn a dividend.  You're getting 10.5%.  

The other one very briefly, Midland Exploration (MD), which is a junior -- or an exploration company, I should say.  At $0.90, this is one of the highest quality exploration companies around, Midland Exploration.  

Steve Halpern:  Again, our guest is Adrian Day of the Global Analyst.  Congratulations again and thank you so much for your time today.  

Adrian Day:  Well thank you, Steven.

 

By Adrian Day, Editor of the Global Analyst

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