Adrian Day: Long Term Looks Attractive


A pioneer in global investing, with a reputation for discovering big winners, Adrian Day, President of Adrian Day Asset Management, which manages portfolios in resource and global equities, and the editor of Adrian Day's Global Analyst, gives us his insight on gold's future prospects.

A pioneer in global investing, with a reputation for discovering big winners, Adrian Day, President of Adrian Day Asset Management, which manages portfolios in resource and global equities, and the editor of Adrian Day's Global Analyst, gives us his insight on gold's future prospects.

GR: What's your take on the Fed's rate cut last week, and its effect on the gold price?

The Federal Reserve's actions, both in pumping liquidity into the system in August and more particularly in cutting rates last week, clearly send the message that the Fed is finished with tightening (such as it was) and raising rates. Although lip-service continues to be paid to fighting inflation — and I believe FedHead Bernanke understands how Greenspan's loose monetary policies have contributed to the crisis — nonetheless, the tide has turned and, going forward, the Fed will err on the side of preventing the economy from sliding into too deep a recession. Inflation will take a back seat, and the dollar be damned. This is clearly positive for gold, and the market's reaction since mid-August clearly shows this, with gold up $80.

The markets are now due for a pause, the dollar on the downside and gold on the upside; the metal could come off $30-$40, but the fundamental direction is clear. We would expect gold to continue to react very positively to further credit problems, weak economic news, and interest rate cuts.

GR: Can you give us an idea where you think gold will be headed for the balance of the year?

DAY: First of all, I always take a step back and look at the longer-term perspective. If I'm bullish in the longer term that means that I want to be looking for opportunities to buy. I don't buy because the short term looks good if the long term is weak. That said, the longer term looks attractive for gold. Right now we have a positive macroeconomic environment with good growth around the world-the U.S. is slowing — but the world economy is doing well. The most important global factor is the dollar decline.

The supply and demand situation is very positive as well. Despite the fact that gold has jumped up from $250 to over $700 in five years, we haven't increased new mine production. That tells you something because everyone's looking, and everyone would like to boost production. On the demand side, the ETFs have experienced tremendous growth. These funds have had a great impact on the demand for gold because they have enabled investors to buy and trade gold in the same way they would buy and trade any other stock. ETFs have also made it possible for some of the pension funds and other tax-exempt funds to get a position in gold.

GR: You mentioned that you see the weakness in the dollar as the main reason for gold's strength?

DAY: Absolutely. Going forward, the continued weakness of the U.S. dollar is going to have the biggest impact on gold. That's really what's been driving gold for most of the last couple of years and that's going to continue to be the main factor. There's little doubt that the dollar is going to turn downwards, rather than strengthen.

If you look at gold on a fundamental basis, despite the fact the price has moved up a lot, it's still cheap relative to the dollar. In fact, gold is cheap relative to the money supply. It's cheap relative to stocks and financial assets as well as to oil and other commodities. So, gold remains fundamentally cheap.

There's also a seasonal influence at play. Gold typically peaks in May, drifts down during the summer, then rallies again at the end of August and September. That's because there's a gap in demand at the end of the Indian wedding season before the onset of the European Christmas buying season. This causes the price to slide or soften. We've been seeing the effects of seasonal fluctuation in demand over the past couple of months, fed by dollar weakness, increased geopolitical concerns, and more recently by expectations of easier money following the mortgage crisis. Now it's September and the gold price has moved up [$730.90 on 9/24/07].

A lot of investors think the stocks are expensive because they just look at the earnings multiple, but in fact the producing gold stocks are pretty much selling close to their low valuation levels. And these are lows that go back over the last two decades. Even though on an absolute level sometimes the multiples look expensive relative to other equities, today they tend to be on the low side by historical standards.

Gold stocks have lagged in part because they ran way ahead of themselves at the beginning of the year, ahead of bullion, then came down harder than bullion. Gold stocks also have felt the impact of rising costs – labor and oil costs have been rising faster than inflation, even the price of gold itself – and exploration problems. Political, social and environmental problems are making it more difficult, more time consuming and more costly to explore for gold and develop mines.

If the price of bullion is going to move up over the next several months and years, companies that actually have reserves in the ground, whether they're in politically friendly jurisdictions or they're diversified, will do well.

GR: You have also talked about how diversification away from the dollar among developing countries might begin to affect the price of gold.

DAY: One of the biggest concerns in the global economy is the rise of protectionism. If we see that worsening, that will have a serious impact on the economy. That would have two effects on gold, and they would be somewhat offsetting.

On the one hand, foreign central banks are going to start diversifying their reserves from the dollar and into other assets. This diversification would include other currencies but also, to a small extent, gold. If you factor in a political sensitivity that you don't want be holding your reserves in U.S. currency, then small moves at the margin could have significant effects on the price of gold. A lot of the newly developing countries with huge foreign currency reserves-like Russia, and more importantly, Japan, China, Great Britain, India-are very underweight in their gold reserves, with far fewer gold reserves than the European legacy banks. As these countries start to diversify, very small moves – just 1 or 2 percentage points – into gold will have a huge impact on the price of gold.

If the world economy slows down, that is a negative for gold because the demand for jewelry goes down, but gold tends to do well in a crisis atmosphere. So, by and large, the positive effect of the central banks diversifying out of the dollar to other foreign currencies, including gold, will offset any decline in demand that we see from jewelry. So, I am very, very bullish – I am bullish on gold and gold stocks. It seems to me that many senior and junior companies – those that have the reserves-are excellent buys right now.

GR: Would you say the same thing for silver?

DAY: Well, I am very bullish on silver. Silver is much more of an industrial metal, and it's also a by-product. When the economy is doing well, we tend to produce a lot more silver than we use, because silver is a by-product of copper, lead, and zinc. The companies that produce it tend to just sell it at any price and hedge it because they're not primary silver producers. But having said that, I think that if the global economy remains relatively strong – and I think it will – silver has the potential to outperform gold on a percentage basis partly because there's so much less of it. Silver doesn't have the huge stockpiles that gold has through the central banks, the IMF, and so on. With gold there is always the potential of some kind of overhang that we don't have with silver.

When I am looking at the balance between the two investments, I think that gold is probably a much surer thing. It has less of a downside, whereas silver, although it has much more upside, is less certain. So, I would definitely balance it between silver and gold.

GR: At this point in the cycle of the bull market in the commodities – that is, silver and gold – are you looking at seniors, juniors?

DAY: At this stage of the cycle, one would normally expect seniors to be relatively expensive and start looking further down the food chain. But the plain fact is, the senior stocks in gold are not expensive right now relative to their historic valuations. If you look at the group of senior producers, they're selling on a cash flow at 13 times cash flow multiple. I go back 20 years, and it's never been less than 13. It's been twice that in previous periods, such as 1966-67, when gold was high. In 1996, again, we were in a strong period for gold and we had 22 times cash flow. So these stocks today, given the price of gold and given where we are in the cycle, are, in my view, very inexpensive. So if you look at companies that have reserves, good balance sheets and are in politically friendly jurisdictions, buying seniors is still a good bet. The juniors as a whole really have not moved an awful lot in the last year, particularly in the last few months. The juniors are selling at very attractive multiples.

GR: You want to give us a few names?

DAY: I like Vista Gold Corp (VGZ: AMEX) a lot. Vista is an unusual company because their game plan was to buy proven ounces in the ground but that was simply uneconomic. It's selling around US$4.54 (9/24/07) right now, and it has about 40% of an ounce of gold per share in the ground upon reserve. That makes it pretty cheap. Vista has 12 different properties around the world, so everything is not concentrated in one property. Some of these are high-cost ounces, but the risk is price risk, not geological risk or a metallurgy risk. That makes it extremely sensitive to the price of gold. We were buying Vista over the summer under $4—which was a ridiculous price—so I’d wait for a pullback before buying.

For a more traditional sort of exploration company, I like Virginia Mines Inc (VGQ:TSX). Sure, the stock has been lower, but this one has it all-top management, a solid balance sheet, a low-risk business model, and multiple joint venture projects. The Coffin brothers [Hard Rock Analyst] call it "the simplest and safest speculation around" and I concur. High-priority projects include a base metals property (Coulon) in joint venture with Breakwater, where the company is "extremely encouraged" by recent results. With $45 million in cash; a royalty valued at approximately $40 million; gold resources valued at approximately $25 million (total $110 million); and a market cap of C$198 million (at today C$7.50), Virginia's other assets are very inexpensive.

We also like Canadian Gold Hunter (CGH:TSX). It is part of the global Lundin group and has excellent management. It is in a joint venture company with Almaden Minerals LTD (AMM: TSX)(AAU:AMEX) in the Caballo Blanco property in Mexico. This property is still early stage, and has very high potential.

Gold Fields (GFI: NYSE) is on my buy list. It has a strong balance sheet and long-term reserves, down as would-be acquirer Harmony sells shares.

Goldcorp Inc (GG: NYSE) has a strong balance sheet, one of the highest growth outlooks and more favorable country risk profiles among the senior miners. It is currently down because of one quarter's weak results (lower production and higher costs). But the profile should improve and the longer term outlook is strong. Goldcorp's big Penasquito mine looks very robust, with growth of 31% in reserves and another 10 years of mine life in a recent study. (An initial resource estimate on the Eleonore property, acquired from Virginia and on which the latter holds a royalty, was released. At 1.83 million indicated ounces, Goldcorp admits this is conservative, with every expectation it will grow.)

I think a lot depends on how much work people want to put into these stocks, how much they want to follow them and trade them, and so on. All of the stocks mentioned have moved up significantly since early August, so I would wait for pullbacks, though Canadian Gold, Almaden and Virginia are good buys now. (9/24/07)

Contact: Adrian Day Asset Management
410-224-2037- Phone/ 410-224-8229- Fax
Contact Adrian Day Asset Management

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