Adrian Day: Long-Term Fundamentals Still Good For Gold
Source: The Gold Report††(9/2/08)
A pioneer in global investing, with a reputation for discovering big winners, Adrian Day (Adrian Day Asset Management) gives us his insight on whether he thinks gold has hit the bottom, and what it's going to take to get the juniors going again. He also tells us which juniors he thinks are positioned to weather the slowdown.
The Gold Report: So what's your take on where we are with the markets. . .you think weíll see a change soon?
Adrian Day: People are still very, very concerned about the dollar and inflation, and rightly so. The core CPI numbers were up .7% in one month. Thatís a high number and the precise number may be a monthly anomaly, but itís very clear that the trend in prices is up.
We are seeing a pickup in inflation, not just in the United Statesó and this is whatís important ó but all around the world. I realize, of course, that rising prices are not the same as inflation. But we are seeing rising prices in pretty much all areas of the world, and they are going up faster than the central banks themselves have targeted. With all the credit problems weíve seen over the last 18 months and all the money thatís been put into the system, I donít think thatís going to change in the near term. So thatís a bullish sign for gold. Inflation is a factor we havenít had in the gold market for quite some time.
The dollar is even more important, certainly for the next six to twelve months. And, again, in terms of the long-term fundamentals, I donít see that anything has changed. All weíre seeing in the dollar is a very overdue correction to the long-term trend.
To me itís much more a correction in the strength of the Euro than a correction in the weakness of the dollar. I donít think anyoneís rushing into the dollar because they think our economy is strong and getting stronger. They are perhaps cautious on some of the foreign currencies, which have simply moved too far, too fast. It was an overdue correction, which came a lot later than I thought it would. And it would be a mistake to expect it to turn around after just a couple of weeks.
But if we look at the long-term fundamentals, the U.S. economy is still fundamentally weak and it seems like with every passing week thereís more bad news thatís worse than the news before. We are a long way from the bottom in both the economic decline and the credit crisis in the U.S., and thereís no particular end in sight.
The dollar has to go down over the next 12 months and thatís going to be positive for gold, no question. The low interest rates and the higher inflation numbers mean that at the short end we have negative rates right now. There might be a bit of a lag, but negative rates are always bullish for gold.
TGR: September is here. The Canadians are going to be returning from summer holiday. Do you think this year is going to be similar to past cycles, where in the fall we see increases in gold purchases and the juniors, or do you think thereís going to be a disconnect this time?
AD: Thatís a good question and a bit imponderable. Usually itís very strong in the fall, and we should have already bottomed. Whatís happened this time thatís different is weíve got the dollar correction and, a correction in the strong Canadian dollar as well.
And thatís come at the time when you would otherwise expect gold and gold stocks to be seasonally strong. Canada has housing problems and credit problems like the U.S., although not to the same extent. There might be a different mood this time and thereís no evidence so far that weíre seeing buying returning to the junior sector. And, remember, itís not as though the juniors were strong before the summer started, so Iím a bit concerned that we may not see that increase in the junior market.
With gold itself, the weaker dollar does actually have one huge benefit ó an obvious one ó which is that it makes physical buying of gold actually cheaper. The Indian market especially tends to be fairly price sensitive. When gold went over the $950 level on the way to over $1,000, there was very strong evidence that the Indians started holding back purchasing. Now that gold has fallen under $850 again in the last few weeks, thereís evidence that the Indians have started buying again in heavy numbers. So a stronger dollar will actually help the gold market, but it may not help the gold stocks.
TGR: So youíre saying the stronger dollar would help ETFs, coins or actual bullion?
AD: It would help those because of foreign buying. I donít know about gold coins, but it would certainly help the ETF, of course, which simply reflects physical gold.
TGR: Do you own, in your portfolios, any ETFs?
AD: The one we buy is GLD, which is the largest and most liquid. We also own Central Fund of Canada (CEF:AMEX), which is not an ETF, of course, but itís similar. Not in huge amounts, but we do. It depends on the client and it also depends on the time. We are buying.
TGR: So we've got political crises, major deficits, and central banks printing money. You would think gold would be at an all-time high. What type of event has to occur to change this? It seems like weíre in a perfect storm.
AD: It's important to give it some historical perspective. There have been a lot of graphs appearing recently showing how gold broke through its 50-day moving-average, then its 100-day moving, and finally its 200-day moving-average. I looked back to the middle of 2000, however, and what really stood out on that graph was that for four or five years gold moved up and down, but very close to a basic straight line, a trend line that was moving steadily upward.
And then at the end of í05, it started moving above that trend line, until in the middle fall of í07, it just shot up. What is happening right now is reversion to the mean. Gold simply overshot Ė it wasnít necessarily completely clear to all of us in the gold market, watching it day-by-day, week-by-week, month-by-month.
Taking a longer-term look, it becomes abundantly clear the gold way overshot and went parabolic. Now itís simply coming back to that long-term trend line. So Iím not overly concerned about gold.
The seasonal thing has thrown all this for a loop. If this had all happened three or four months ago, Iíd have been firmer in what I was saying. I donít think we can necessarily expect it to turn around suddenly after the kind of damage that has been done. I donít think a particular eventís going to do it.
Going back to the long-term graph, if gold just does some time between, say, $750 and $870 or so, whether itís three to five weeks or maybe two or three months, gold will be ready to move back up again because all the fundamentals favor gold. The bigger concern for us is the gold stocks. And you have to look at the seniors separately than the juniors.
Itís a little easier to see all the reasons why the senior gold stocks as a group, with some exceptions, of course, have not really kept up with gold. The gold miners have not had such an easy time of it of late.
Itís been more difficult to raise money and get permits. Permits have been delayed, mines have been expropriated. Mining is a much more difficult business than it was and itís much more costly. So as gold moved up, so too did all of the input costs; primarily, energy, which is the number one input, and number two, the costs in local currencies: the Australian dollar, Brazilian Real, Canadian dollar ó all of those are very strong currencies in big gold mining countries. So the margins were not expanding the way that you would think they were.
And thatís only talking about the cash cost of producing an ounce of gold out of a producing mine. There's also keeping a sustaining business going, finding a new deposit, etc.
The juniors are the more problematic because, in most cases, there simply isn't volume in these stocks. The occasional stock will do well based on some particular exciting prospect, but they are becoming increasingly few and far between.
As we all know, the irony is that sometimes companies will release relatively good news and the stock goes down. It just reminds people that they own the thing. And then there are other companies, of course, that donít have particularly good news to put out. There just isn't any volume; the only volume I see are in stocks that are going down.
So the question really is when that is going to change and what we do about it. Certainly, if gold goes back over $950 or $900 and stays there, weíll see more interest, especially if everything else is still relatively weak. Typically, people are attracted to the gold stocks when gold is strong and other things are not so strong. But if the tech stocks are strong and the Dow is strong, people tend not to invest in junior gold stocks to the same extent. Similarly, if gold is strong, but everything else is very weak and people are worried about the overall environment and looking for liquidity, you canít expect the junior gold stocks to get that liquidity. Thatís fairly obvious.
The other thing thatís going to happen increasingly is larger companies taking over juniors and explorers. We know they are looking; they need the reserves and many of the explorers are very inexpensive. A few takeovers in rapid succession will likely bring interest back to the sector.
The good thing is that investors can buy truly good quality juniors at remarkably cheap prices. If you can focus on companies that you know donít have to raise money and theyíre cheap and youíre patient, you're going to do very, very well indeed. Look at Virginia Gold Mines (TSX: VGQ), with a $116.5 million market cap. Its market cap is more than covered by its cash and its royalty on …lťonore, which is an advanced royalty, so it doesnít depend on Goldcorp putting …lťonore into production. Itís trading at less than the market cap of those two things and Virginia never has to raise another penny. I just canít see how you have a lot of fundamental risk in that.
Rimfire Minerals Corp. (TSX.V: RFM) would be another one. Look at Rimfire, $19 million market cap today, $9 million in cash. Again, difficult to know how a year from now thatís not going to be higherÖ or at least itís not going to be significantly lower. And thereís more like that.
TGR: The company that looks exciting to me is Franco Nevada Corp. (FNV:CA), which is involved with two areas that are the future, gold and energy. What would you say about Franco Nevada?
AD: I agree with you completely. Theyíve got a very strong balance sheet. Equally importantly, they have access to capital. They can raise more money if they need to without heavy dilution and, of course, youíve got some of the smartest people in the business running it.
On their last investor conference call they were talking about how this environment is going to prove good for them. A lot of companies are knocking on their door asking for them to create royalties as financing mechanisms. There are two basic forms of royalties. One is pre-existing royalties, where a company like Franco or Royal Gold might buy a royalty that already exists. But the second way of getting a royalty is to actually create a royalty from a junior thatís looking for financing. And for the junior, selling a royalty can be a less dilutive way of getting financing for a project.
Franco said they are not actually in any hurry, and are looking for the very good deals that are going to come along over the next few months. The point Iím making is that these are really first-class value investors and theyíre prepared to be patient; theyíre going to make very good decisions when they make them. I like Franco a lot. Its price is only 1.2 times book, which is really quite cheap for a gold company and particularly cheap for such a good quality one. We were buying it today, I should disclose.
What Iím looking for in this market are companies where one can have very high level of confidence and the absolute risk of the company is low regardless of what the potential upside might be. That confidence comes from a strong balance sheet as well as good management and a diversity of assets. Franco Nevada fits the bill to a T.
TGR: A company you havenít talked about before, but I know itís one that you also like is Cartier Resources (TSX-V: ECR).
AD: One of the reasons I havenít mentioned it is because theyíre so thinly traded and Iíd like to buy everything I want to buy before I talk about it to other people. We bought more Cartier today. It a $6.5 million market cap; itís very, very thin.
I like Cartier. Itís got a very strong business model, which is the joint venture prospect generator model. Itís got a strong balance sheet. It focuses not exclusively on Quebec, but on Quebec and on the eastern part of Toronto. . .so good jurisdictions, good mining camps. The main Kinojevis is a fairly long property with gold mines on either side of it and it looks as though itís a long trend. They own 100% of it, but theyíre considering partnering parts of the property. Another one thatís similar in many ways is Midland Exploration (TSX.V:MD), which we also own. It has a $12 million market cap, and again, on a 60-cent share, weíre not talking about a lot of volume.
Itís all in Quebec. Itís diversified ó not just gold, but gold-based metals and uranium. They have a gold project with Agnico-Eagle (TSX:AEM); base metals with Breakwater. They have a good balance sheet. Midland is in the position where on their current business plan they would never have to raise another penny. Their overheadís been covered by joint venture payments and theyíre doing the work at the moment, but they will never have to raise anymore money unless they want to, which is a very good position to be in.
TGR: Switching gears, switching to gems, Motapa Diamonds (TSX:MTP). This stock has been going the opposite way of the market lately. Itís had a nice little move since June.
AD: Motapaís clearly speculative. All diamonds are highly speculative because youíre looking for a few big stones. Motapa also has a joint venture model on their properties throughout Africa with large companies and small. They have a project called Mothae, which is near the big diamond deposit near Lesotho. The Mothae deposit is a joint venture with Lucara Diamond Corp. (TSX-V: LUC). Lucara is basically a Lundin company and it has nothing else in it and thereís been a lot of speculation recently that Lundin might simply take over Motapa. Certainly on a risk-reward basis and certainly if Motapa were to ever find economic diamonds, it is just remarkably cheap. As I say, the risk tends to be high in these things, but the potential is also high.
TGR: Going to Nevada, can you talk about Allied Nevada Gold Corp. (TSX:ANV), which was a spinoff from Vista? Whatís the attraction there? Not having to raise money?
AD: They certainly donít have to raise money. Theyíve got something like $51 million right now. They did do a financing earlier in the year, which was largely to raise more money for the Hycroft Mine that theyíre putting into production. The idea is that Hycroft will be put into production by the end of the year and will generate enough cash flow to basically pay for some of the rest of their exploration of the sulphides at Hycroft, and elsewhere.
Theyíve got one of the largest land packages in Nevada. It was a merger of all of Vistaís Nevada properties and a private land package put together by Carl Pescio. The key is that Hycroft is going to enable them to have the cash flow to do all this without more capital raisings unless, again, thereís a particular reason for it. So they have good people, good money, a lot of property. I think theyíre going to succeed and Hycroft should be quite a good cash flow generator. So I like Allied a lot.
One more I likeÖ itís almost an embarrassment of riches. Itís just a question of when they are going to move. I still like Miranda Gold Corp. (MAD:TSX-V). Itís awfully cheap, very thinly traded again, but itís a $21 million market cap. Itís got about $12 million in cash, and several joint ventures. They follow the prospect joint venture model. They donít have to raise any more money, unless they have a particular purpose.
They had a string of bad luck last year with some of their joint venture partners deciding not to renew their joint ventures and a few disappointing results on some of their projects. But, you know, in the last six months, even though the market was going against them, theyíve tied down joint ventures on pretty much all of their properties, most of which are in Nevada, and several of them are drilling.
There are four of them that are going to be drilled for sure before the end of the year. Itís difficult to see how you can go seriously wrong from here. And with various partners, a lot of properties, the odds of them being successful at some point are, letís say, much higher than for most.
TGR: Adrian, this has been great per usual. We appreciate it.
Contact: Adrian Day, 801 Compass Way, Suite 207, Box 6643, Annapolis, MD 21401 Tel: 410-224-2037 Fax: 410-224-8229 Email Adrian Day