Heralded as ďthe best of todayís best,Ē John Doody, author and publisher of the highly regarded Gold Stock Analyst newsletter, brings a unique perspective to gold stock analysis. In this exclusive interview with The Gold Report, Doody ponders the efficacy of the Keynesian approach, makes a case for gold equities and explains how the GSA Top 10 Stocks portfolio has outperformed every other gold investment vehicle since 1994.
The Gold Report: John, you've stated in your newsletter, Gold Stock Analyst: ďItís clear the U.S. is going down a Keynesian approach to get out of this recession/depression." I am curious on your viewpoint. Will the Keynesian approach actually work, or will they need to eventually move over to the Chicago School of Free Markets?
John Doody: A free market approach of letting the crisis resolve itself would work, but would cause too much damage; weíd probably lose our auto industry, and it would take too much time. As Keynes said: ďIn the long run weíre all dead,Ē so the government is trying to get a faster resolution. The Treasury is pursuing his fiscal policy idea of deficit spending. Theyíre borrowing the money to bail out the banks. When Obamaís plan is implemented, which could be another $700 billion in stimulus, it will be funded with more borrowings.
Bernanke and the Fed are pursuing a loose monetary policy with a now 0% interest rate. There's actually no way we can not end up with inflation. This is much bigger than ĎThe New Dealí under Roosevelt. And I think that the market disarray over the last several months has confused investors; but when the markets settle down, itís clear to me that it will be up for gold and gold stocks.
TGR: Is there any economic scenario that you wouldnít see gold going up in?
JD: Basically, weíre pumping money into the system, but itís just sitting there. Itís not being put to work, so there are those who think that we are going to enter a deflationary era. But I canít see that. Some donít like Bernanke, but I think thereís probably nobody better prepared to be in his role.
Bernanke is a student of the Great Depression and knows the mistakes the Fed made then, such as forcing banks to upgrade the quality of loans on their balance sheets. His approach is to buy the banksí low quality loans, enabling them to make new loans. They havenít done much of the latter yet, which is probably a fault of the Fed not requiring the funds received for the junk to be redeployed, but they ultimately will lend more as thatís how banks make money.
He knows in the early 1930s we went into a deflationary period of falling prices. For three or four years prices were down about 10% annually. He fully understands the risks of that, one of which is the increased burden of existing debt payments on falling incomes. The debt burden is lighter in an inflationary environment and thatís his target. Long term, he knows he can cure inflation; Volker showed us how with high interest rates in the 1980s. But thereís no sure way to cure deflation, and so Bernanke's doing everything possible to avoid a falling price level. And I think that, because this is a service-driven economy, companies wonít lower prices to sell more goodsóthey will just lay off more workers, as weíre seeing now. I donít think weíll get the price deflation of the í30s, and Iím sure Bernanke is going to do everything to prevent it.
TGR: But arenít we already in a deflationary period?
JD: Well, we may be to an extent; you can get a better buy on a car. But, to put it in the simplest terms, has your yard guy lowered his price, or your pool guy, or even your webmaster?
TGR: Yes, but people opt to do things themselves versus paying other people to do it.
JD: Maybe, but if they do, it wonít show up in pricesóit will show up in the unemployment statistics. So if the yard guy, pool guy or webmaster donít lower prices and their clients become do-it-yourselfers, the effect will show up in unemployment, not inflation data.
TGR: So if every major country in the world is increasing their monetary supply, we would expect inflation. Will there be any currency that comes out of this to be considered the new base currency, sort of like the U.S. dollar is now?
JD: Well, thatís the $64,000 question. We donít really know and, because thereís no totally obvious currency, that is why the dollar is doing well of late. But the dollar is in a long-term downtrend, in part because interest rates in Europe remain higher than here. Higher interest rates, as you know, act like a magnet in attracting investment money, which first has to be converted to the higher interest currency and that bids up its value versus the dollar.
The Euro represents an economy about the size of the U.S., so there may be some safety there. You could argue for the Swiss Franc maybe, but you know the Swiss banks (Credit Suisse, for example) have had some problems, so weíre not quite sure how thatís going.
So, to me, the only clear money thatís going to survive all this and go up, because everything else is going to go down, is gold.
TGR: Whatís your view of holding physical gold versus gold equities?
JD: I only hold gold equities. Theyíre more readily tradable; when gold goes up, the equities tend to go up by a factor of two or three times. Of course, that works to the reverse, as we know. As gold went down, the equities went down more. But because you hold them in a government-guaranteed SIPC account, it provides ease of tradingóyou donít have the worries of physical gold. . .insurance, storage or whatever. You may want to hold a few coins, but that would be about it in my opinion.
TGR: On your website, your approach to investing in gold equities is to choose a portfolio of 10 companies that have the opportunity to double in an 18- to 24-month period with the current gold price.
JD: Yes. We donít really look forward more than 18 or 24 months; but within that timeframe, say a year from now, we could reassess and raise our targets so that, in the following 18 to 24 months, the stocks, while having gone up, could go up more still. There are lots of opportunities to stay in the same stocks as long as they continue to perform well. We're not a trading newsletter, and as you probably know, the way we define an undervalued stock is based on two metrics.
One is market cap per ounce. The market capitalization of a company is the number of shares times its price. You divide that by its ounces of production and its ounces of proven and probable reserves, and you see how the companyís data compares to the industryís weighted averages.
Second, we look at operating cash flow multiples. Take the difference between the gold price and the cash cost to produce an ounce, multiply that by the companyís production per year, and you get operating cash flow. Divide that into its market capitalization and you get its operating cash flow multiple. We look at that this much the same as one looks at earnings per share multiples in other industries.
For reference, we last calculated the industry averages on December 29, 2008 for the 50+ gold miners we follow, which is everyone of significance. At that time, the average market cap for an ounce of production was $3,634, an ounce of proven and probable reserves was $194, and the average operating cash flow multiple on forecast 2009 production, assuming $900/oz gold, was 7.4X.
We focus companies that are below the averages and try to figure out why. An ounce of gold is an ounce of gold, it doesnít matter who mined it. If youíre going to buy an ounce of gold from a coin dealer, you want to get the cheapest price. Well, if youíre going to buy an ounce of gold in the stock market, you should want to get those at the cheapest price, too. Itís oversimplified, as there are other factors to be considered, but this is a primary screening tool to determine which stocks merit further study. The method works, as the GSA Top 10 Stocks portfolio has outperformed every other gold investment vehicle since we began in 1994.
TGR: Are all the companies in your coverage producers or have 43-101ís??
JD: Yes, all are producing or near-producing. They may be in the money-raising stage to build a mine, but theyíve got an independently determined reserve. And that part of the market has done better than the explorers because it has more data to underpin the stocksí prices.
TGR: And you focus in on having 10 just because, as you point out in your materials, it allows you to maximum upside at minimum risk (i.e., if one of the 10 goes down 50%, you will only lose 5% of your money). Is your portfolio always at 10 or does it ever expand more than that?
JD: No, earlier in 2008 we were 40% cash, so it was six stocks. For a couple of months later in 2008 it was 11 stocks. But 90% of the time itís at 10.
TGR: What prompted you to be 40% in cash?
JD: That was when Bear Stearns was rescued in March and gold went to $1000; we were just uncomfortable with that whole scenario. And actually we put the 40% in the gold ETF; so it wasnít true cash.
TGR: Okay. And as youíre looking at these undervalued companies, are you finding that there are certain qualifications? Are they typically in a certain area, certain size?
JD: While we follow Barrick Gold Corporation (NYSE:ABX) and Newmont Mining Corp. (NYSE:NEM) and theyíve both been Top 10 in the past, neither is now. Weíre currently looking further down the food chain. Thereís one with over two million ounces growing to four million a year. Another has a million growing to two million. So, some are still pretty good sized. And then there are others further down that are either developing mines or are very cheap on a market cap per ounce basis.
Earlier, one of the Top 10 was selling at its "cash in the bank" price. Weíve had a nice little rally since October and this stock has doubled, but itís still cheap. It has 9 million ounces of reserves at three mine sites in European Community nations, and itís not Gabriel in Romania. It has no major troubles with permitting its mines and it was selling at its cash/share. Then the chairman of the board bought 5 million more shares. It was already top 10, but I pointed this out to subscribers as great buy signal. Itís doubled since and will double again, in our opinion.
TGR: Can you share with us some of the ones that are in your top 10?
JD: Well, the astute investor would probably recognize Goldcorp (TSX:G) (NYSE:GG) as the one at two million ounces growing to four million ounces. Their tremendous new mine in Mexico, Penasquito, which I have been to and written about, is going to average half a million ounces of gold and 30 million ounces of silver a year. Itís going to be the biggest producing silver mine in the world, momentarily anyway, and will produce huge quantities of lead and zinc. At current prices, itís going to be a billion-dollar-a-year revenues mine, which is enormous. And because of by-products, and even at current prices, the 500,000 ounces of gold per year will be produced at a negative cash cost per ounce.
TGR: Wow. Because of the credits?
JD: Because of the by-product credits. Another one would be Yamana Gold Inc. (NYSE:AUY), which is growing from a million ounces to two million ounces. Both Yamana and Goldcorp are in politically safe areasóno Bolivia, no Ecuador, no Romaniaónone of the places where you have to take political risk. I think weíve learned enough from the Crystallex International Corp. (KRY) and Gold Reserve Inc. (TSX:GRZ) (NYSE:GRZ) situation in Venezuela, where theyíre both on portions of the same huge deposit that is probably 25 million ounces or more. It looks to me that the government is going to take it away from them. So, I would just as soon not be involved in that kind of political risk scenario. Thereís enough risk in gold just from the mining aspects of it that you donít have to take chances on the politics too, as in some nations thatís impossible to assess.
TGR: Yes, another one that is really doing quite well is Royal Gold Inc. (Nasdaq:RGLD). Can you speak about that company?
JD: Yes. Royal Gold has been GSA Top 10 for 18 months now. We put it on in part because of the Penasquito deposit that I mentioned earlier. Royal has a 2% royalty on that, and 2% of a billion dollars is $20 million a year. Royal is unique in that they havenít prostituted themselves by selling shares on a continuous basis. They only have 34 million shares outstanding and they will have royalty income this year of about $100 million. Penasquito is just coming on line, so its $20 million per year wonít be fully seen until late 2010.
Plus Royal pays a dividend. I think it could pay $1.00/share ($0.32 now). Dividend-paying gold stocks typically trade at a 1% yield. A $1.00/share dividend would make Royal a potential $100 stock. Thatís my crystal ball down-the-road target.
Royal is a great play on gold price because they donít have the aggravation of mining. They have a portfolio of mine royalties, plus a small corporate office. Royal employs 16 people, has $150 million in the bank and over $100 million a year income, which is about $3.00 per share pre-tax. Their biggest cost is taxes.
TGR: I see also that Franco Nevada Corp. (FNV.TO) has had quite a rise, though they have been kind of tumultuous between November and December.
JD: Franco is also a stock we like. About half of its royalties are from oil, so thatís why itís suffered. The original Franco Nevada, as you know, was merged into Newmont for five years, and then they came public again in December '07. I think itís a good way to play gold and oil, and I think everybody agrees that oil is not going to stay in the $40 range for long.
TGR: John, can you give us a few more?
JD: A couple of smaller ones we like are Northgate Minerals Corp. (TSX:NGX) (AMEX:NXG) and Golden Star Resources Ltd. (TSX:GSC). Northgate is a misunderstood producer. Everybody thinks itís going out of business when the Kemess Mine closes after 2011, but itís actually not. It has 200,000 ounces a year from two mines in Australia and has a potential new mine in Ontario where theyíve just announced a 43-101 with over three million ounces. Thatís potentially another 200,000 ounces a year, so we think theyíll remain at 400,000 ounces a year from Canada and Australia, both of which are countries we like. Cheap on our market cap per ounce of production and reserves metrics, itís trading at an operating cash flow multiple under 2.0X.
Golden Star has several nearby mines in Ghana with production targeted at about 500,000 ounces in 2009. Theyíve been ramping up to this rate for the past year and cash costs have run much higher than plan. If costs can be controlled and production goals met, itís a takeover candidate for someone already in the country, such as Newmont or Gold Fields Ltd. (NYSE:GFI)(JSE:GFI).
One thing I think readers should bear in mind is that gold mining will be one of the few industries doing well in 2009. Their key cost is oil, which is about 25% of the cost of running a mine. Oilís price, as we know, is down about 75% in the $147/barrel high last July. At the average $400 cash cost per ounce mine, thatís a cut of about $75/oz off their costs. That result alone is going to give them an uptick in future earnings versus what they showed for third quarter 2008.
Something else people may not recognize is that currencies are also falling; many are down 20% to 40% versus the U.S. dollar. All the commodity nation currenciesóthe Canadian dollar, the Australian dollar, the South African Rand, the Brazilian Real, the Mexican Pesoótheyíre all down 20% to 40%. When your mining costs in those countries are translated back into U.S. dollars, theyíll be 20% to 40% lower.
So, the miners are going to have falling cash costs and even if the gold price remains exactly where it is now profits are going to soar. This will be unique in 2009. I canít think of any other industry in which people are going to be able to point to and say, ďThese guys are making a lot more money.Ē I think the increasing profits will get the gold mining industry recognition that it isnít getting now. Of course Iím a bull on gold because of the macroeconomic picture. When you put falling costs of production together with a rising gold price, youíve got a winning combination for the stocks in 2009.
TGR: I was wondering if you could give us something on Silver Wheaton Corp. (NYSE:SLW) (TSX:SLW).
JD: Well, Silver Wheaton is another royalty company; itís not a producer. It gets its profit royalties by paying a cash sum up front and $4/ounce on an ongoing basis. It captures the difference between the silver price and $4 an ounce; if silver is $10 and it pays $4, it makes a $6 an ounce profit; at $20 silver, its profit would be $16. Aside from no pure silver miner actually producing ounces as low as $4.00, thereís a lot of leverage to silver price. I am not a silver bull, but because Iím a gold bull I think silver will follow gold higher.
Silver Wheaton is one of those companies that doesnít have the issues of actually doing the mining. It has a portfolio of mines that it gets production from, and it owns 25% of the production from Goldcorpís Penasquito mine that it buys at $4 an ounce, and will average about 8 million ounces a year. Itís just starting up now, but it will really get going in 2010. Silver Wheatonís share of the total mineralization at Penasquito is 1 billion ounces. Thereís 4 billion total ounces of silver there and it bought 25%. So, for a long timeóthe mine life of Penasquito is over 30 yearsóitís going to be a big producing mine for Silver Wheaton.
TGR: Isnít there a twin sister to Silver Wheaton in the gold area?
JD: Well, thereís Gold Wheaton Gold Corp. (TSX.V:GLW). Itís based on the premise that some companies have a gold by-product. With their primary production in some other kind of metal, some might like to lay off the gold for a $400 an ounce on-going payment and an up-front purchase amount. Yes, some of the same guys are involved. Iím not convinced itís going to do as well because itís already got a lot of shares outstanding, and I just donít like the capital structure as much. I wouldnít bet against these guys but Iím not a believer.
TGR: And you said youíre not a silver bull. Why is that?
JD: We do cover about 15 silver miners, but reason number one for not being a bull is that itís a by-product. Few mines are built to get just silver; 70% to 80% of silver comes as a by-product to copper, zinc, gold or some other metal. If youíre producing copper, youíre more interested in the copper price than you are in the silver price and you tend to just dump the silver onto the market.
And second, itís not a monetary commodity. It is poor manís goldóbut it doesnít have the universal monetary acceptance that gold does. It has a growing list of industrial uses, but itís not growing at any rate thatís going to offset the falling use in photography. So, the overall demand for silver is not growing at any great rate. Itís not going to go from 800 million ounces a year to 1.6 billion ounces a year; it may get there in 20 years or 30 years, but thatís not our investment time horizon.
I think silver just follows gold along; but, in fact, it hasnít been following gold along because right now silver is trading at a discount to gold. The ratio of gold to silver price, which normally runs around 50Ė55, is now around 80, so silver might have a little bit of a pop-up if the discount closes. But there are a lot of new silver mines coming on line and maybe thatís why the discount exists. Penasquito is one and Silver Standard Resources Inc. (TSX.:SSO) (Nasdaq:SSRI) has a big one starting in 2009. Coeur d'Alene Mines Corp. (NYSE:CDE) (TSX: CDM) has now one ramping up and Apex Silver Mines Ltd. (AMEX:SIL) San Cristobal is now on line at 20+ million ounces per year as a zinc by-product. Thereís potentially more silver coming to market than the world really needs. We do recommend Silver Wheaton, but thatís our single play.
TGR: Can you give us any comments on Minefinders Corporation (AMEX:MFN) (MFL.TO)?
JD: Well, you know, itís in the uncertainty phase as to whether or not the new Delores mine in Mexico is going to work. Now built, itís just starting up. We like the stock as we think itís going to work. The question is: will it? Two mines in the areaóMulatos, owned by Alamos Gold Inc. (TSX:AGI), and Ocampo owned by Gammon Gold Inc. (GRS) did not start up smoothly. The market is betting against Delores starting smoothly, but this is the last of the three mines to come on line, and the first two minesóAlamosí and Gammonísódid get fixed and are now running okay. So, I think Minefinders has probably learned from the experience of the others, and the mine should start up all right. But, you know, the proof will be in the pudding. If you take its market cap per ounce on the forecast 185,000 ounces of production in 2009, or its almost 5 million ounces of reserves, and compare it to the industry averages we calculate, itís potentially a double or triple from here.
TGR: So, the start-up issues of the other two mines, were they politically related?
JD: No, it was metal related. Processing facilities arenít like televisions; you donít just turn them on. Itís more like buying a new fancy computer system that needs to be twiddled and tweaked and loaded with the right programs. And you know, all geology is different, so things seldom start up properly; and, given the long teething problems at the other two mines, thatís sort of been a curse. If Minefinders can beat it and start up on plan, itís an easy winner in 2009.
TGR: So, John do you have a prediction on where you think gold will go in Ď09?
JD: People talk about $2,000 or $5,000óitís all pie in the sky, you know. Gold might get there; but the bigger question is: whatís the timeframe? Will I be around when gold is $5,000? I doubt it. Will it get there? Probably.
But we look for undervalued situations no matter what the gold price. And in the Ď90sóyou know weíve been writing Gold Stock Analyst since 1994óin the mid-90s gold did nothing for three years, it traded between $350 and $400. With our methods of selecting undervalued stocks, we had a couple of years of the Top 10 portfolio up 60% and 70% but gold was flat. Until mid-2008 the GSA Top 10 was up almost 800% in the current gold bull market. When gold does go up, the stocks go up more; but, in general, even if gold does nothing, we can still find good buys. Royal Gold is an example of finding winners in a tough market. Made a Top 10 stock at $23 in mid-2007, it gained 60% in 2008 and has doubled over the past 18 months.
We donít follow the explorers, in part because there is no data to analyze beyond drill hole results, which are a long way from showing a mine can be built and operated at a profit. For us, the pure explorers are too much like lottery tickets. The producers do exploration and you can get your discovery upside from them. Bema Gold (acquired by Kinross Gold in February 2007) was a Top 10 stock with 100,000 ounces per year of production when it found Cerro Casale and it did very nicely on the back of that find. So, with the smaller producers you can get plenty of exploration upside. You donít need to focus on the greenfield explorers because itís just too hard to tell whoís going to win and whoís going to lose.
John Doody brings a unique perspective to gold stock analysis. With a BA in Economics from Columbia and an MBA in Finance from Boston University, where he also did his Ph.D.-Economics course work, Doody has no formal ďrockĒ studies beyond "Introductory Geology" at Columbia University's School of Mines.
An Economics Professor for almost two decades, Doody became interested in gold due to an innate distrust of politicians. In order to serve those that elected them, politicians always try to get nine slices out of an eight slice pizza. How do they do this? They debase the currency via inflationary economic policies.
Success with his method of finding undervalued gold mining stocks led Doody to leave teaching and start the Gold Stock Analyst newsletter late in 1994. The newsletter covers only producers or near-producers that have an independent feasibility study validating their reserves are economical to produce.
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