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Adrian Day: Buy Gold Bullion, Royalties and Juniors
Source: Brian Sylvester and Karen Roche of The Gold Report (6/11/10)
Chairman and CEO of Adrian Day Asset Management and Author of the Adrian Day's Global Analyst newsletter, Adrian Day never fails to deliver keen market insight or offer ways to safely grow your money. Many of his firm's biggest holdings involve gold, where he sees plenty of opportunities. In this exclusive interview, Adrian explains why he "loves" gold royalties and offers up some promising names in the junior gold space.
Adrian Day: That's a good question. First of all, we have to recognize that the economy and the market don't always go hand in hand. The market tends to anticipate developments. That is very clear that at the bottom of recessions when the market turns around and starts moving up because it anticipates recovery. What perhaps we're seeing with the market's action this year—and particularly in the last six weeks—is a look ahead to a second leg down in this recession.
But what am I seeing? Clearly there's been some positive news on the economy, but there's also been negative news—especially if you look at consumer spending, which was up at the end of last year and the beginning of this year, but the most recent consumer spending numbers turned down again. I think that speaks to the psychology of people—they pretty much went a whole year without spending a lot of money, certainly not spending money on discretionary items. A lot of people said: "We gave up Christmas last year; we're not giving it up this year whatever we have to do." So people spent money on the holidays, but there's a limit. If you don't have the cash and your credit card company doesn't increase your limit, there's a ceiling on how much you can spend.
TGR: But the employment numbers are higher. We're seeing a little bit of improvement in the employment numbers, though we have to recognize that a lot of that is temporary jobs and government jobs; in last month's report, new jobs were almost entirely temporary census jobs. Unemployment still remains very high. It's a mixed picture but at this stage of the recovery, things should be considerably better than they are.
One of the things that concerns me is the lack of lending by the banks, particularly to small businesses—that is of grave concern for the economy. As for the stock market, you just have to look at a graph to see that it's stopped going up; it's rolling over. I am not a technician by any means; but you can that see it bounced right up against that 200-day moving average and fell, and you know the market just looks very much as though it is moving downwards and the risk in the market has gone up.
TGR: Are there any particular areas where you're looking to sell?
AD: It's generally across the board, and it's really a matter of valuation for us. Clearly, one tends to sell things either when—or I do because I am a fundamental value investor—things go wrong or when the company deviates from its strategy. But I certainly don't sell because a good quality company that is doing everything right goes down and becomes a better value. I don't sell on that. We're just selling things that look overvalued to us. We have also been selling some things in Japan, for example, because the economy in Japan appears to be turning downward again.
TGR: You said earlier that at this stage of the recovery things should be better and that you were specifically concerned about the lack of lending by banks. Is it a matter of a reluctance to lend or is it that there are few good lending opportunities for the banks?
AD: The banks have a good deal going frankly. Banks have been able to borrow from the Fed in almost unlimited amounts at exceptionally low interest rates. If you could borrow billions of dollars at a quarter of a percent from the Federal Reserve, perhaps you wouldn't feel inclined to take risks. You'd just put it in Treasury Bills and make a nice risk-free profit. That's what the banks have been doing. That is one reason I like some of these business development companies. These are companies that lend money to small businesses; that's their job—the banks pull their horns in, which means that the business development companies (BDCs) are able to see better opportunities at higher rates of interest.
TGR: Yesterday, the European Central Bank (ECB) warned that the region's banks may face losses of 195 billion euros in a second wave of potential loan losses over the next 18 months. In light of this, many investors are turning to gold as a safe alternative to paper currencies. Gold is above $1,200; do you expect the gold price to soften for the summer, and where do you see it heading by the end of 2010?
AD: I would definitely say that the risk of a decline has increased in recent weeks. Clearly in the past five to six weeks gold has risen well above trend—a lot of it from frantic buying from Europe, particularly Germany. We're also seeing signs of scrap sales in India picking up; and, if that continues, it could put pressure on the price because that's a very large market for gold. Of course, seasonality is the foundation of the question. June, July and the beginning of August are typically the weak periods for gold. There is a risk of gold being soft over the next couple of weeks, but I am certainly not suggesting anyone sell. A little bit of caution is called for in chasing gold right now.
I always like to focus on the big trend, and the big trend for gold is up. A period like this might give me pause, but we want to avoid trying to be too clever in selling and buying back and that kind of stuff. I definitely think gold is going up by the end of the year, by how much I don't know. Someone once said: "Never predict the price and the timeframe, either one or the other." I definitely think it's going up. All the reasons people have been buying gold over the last six to nine months are still there; they haven't diminished at all, in fact, the reasons have even increased due to the sovereign debt risk.
TGR: You said there was frantic buying in Germany. Please explain why.
AD: With the bailouts, essentially from Germany to Greece, which is what it was, a lot of Germans are extremely concerned about the value of the euro and what's next. Is Spain next? Is Italy after that? Is Portugal behind that? And so a lot of Germans have been moving out of the euro and putting their savings into gold, gold coins. Most of the mints and refineries in Europe and the storage companies are sold out and way behind. Premiums on coins have gone up; premiums on Krugerrands—a popular coin in Germany—have gone from 3%–4% to 7% or 8%. There is no room in storage vaults. Those are indications of a mania, but it's very new and very short-term. There's no sign of a mania in this country—increased interest, but not a mania.
TGR: Are you using currencies as a way to hedge against USD devaluation along with gold?
AD: Yeah, a little bit; I prefer gold for a lot of reasons, and let's not forget that every currency we look at is simply paper; there is no currency backed by gold. But clearly some are stronger than others, and it strikes me that the Asian currencies, outside of Japan, are the strongest of all. The governments have better balance sheets, the banking systems tend to be stronger. The Asian currencies tend to be less leveraged, and so we like some of the Asian currencies a lot. Two that we hold right now are the Singapore dollar, which is extremely liquid and can be purchased in small amounts; the other is a little bit unusual—the Hong Kong dollar. Some people might say: "Why buy the Hong Kong dollar? It is tied to the USD." That's actually true, and that's partly the rationale to buy it. If you're a USD investor, the downside risk in buying the Hong Kong dollar is extremely low. The thought that Hong Kong would break the link and that the Hong Kong dollar would decline against the U.S. dollar is such a low risk that you can almost call it 'zero.' However, at some point given the stronger balance sheet in Hong Kong, one can easily see that it's going to rebound against the dollar. I should point out that neither of these are investments; they're merely ways of holding savings.
TGR: What about the yuan?
AD: We own the yuan and we own it through the WisdomTree Dreyfus Chinese Yuan Fund (NYSE:CYB); but in a way, the Hong Kong dollar is a bet on the yuan because, if the Chinese currency appreciates in any significant way, it's only a matter of time before the Hong Kong dollar will have to be revalued. Today, the Chinese currency is so much more important for Hong Kong than the USD. In the meantime, you get downside protection against the USD.
TGR: There may not be any gold-backed currencies but there are ways to get exposure to gold. What are some of those?
AD: I think people should always start with bullion. I am always amazed at how many people own a bunch of tiny little gold stocks, but don't any bullion or own any of the big royalty, or more-established, companies.
TGR: What are some ways you recommend people hold bullion?
AD: There are many different ways to own it, and a lot depends on your timeframe for owning. Obviously, if you own bullion and store it, that's a very safe way—except there are costs to storage. We're perfectly comfortable buying the GLD, the ETF, which is extremely liquid and reflects the price of gold.
TGR: You also mentioned royalty companies. Could you talk about some of the royalty companies you hold?
AD: I just love the royalty model because it is a good way to get exposure to gold but at much lower risk. The business model itself is very low risk, very high margin. My favorite, Franco-Nevada Corp. (TSX-FNV), in Canada, has a margin of 86%. You also get a lot of the upside because with the royalty companies; as the price of gold goes up, more of the properties on which they hold royalties become profitable. A lot of the royalties go up, as the price of gold goes up, and then a lot of these companies have an exploration upside because they own the royalty on a whole piece of ground. If the producing company at the mine starts exploring the ground around the mine and finds more metal, the royalty gets the benefit of that as well. There's very little downside, so I like the royalty companies a lot. My two favorites are Franco-Nevada and Royal Gold Inc. (NASDAQ:RGLD; TSX:RGL), which are the two large ones with strong balance sheets, strong management and excellent pipelines. To me, these are just a core low-risk gold exposure positions.
TGR: Another way of getting exposure to gold is through junior gold equities, companies. What are some of your favorites?
AD: Allied Nevada Gold Corp. (NYSE.A:ANV;TSX:ANV) is one I've recommended a lot. That's one of the larger juniors; it's a bit insulting to call it a junior at this point, though it was at some point. It has a very large and growing deposit in Nevada, the Hycroft. Mine Right now, they've got about 12 million ounces of reserves, but this is clearly this is getting much, much bigger. At the moment, they're only mining the near-surface oxides and working towards a prefeasibility on the sulfides. I think when that's done, certainly when the sulfides are moving towards production, we'll be looking at a company with maybe 20 million ounces of resource and annual production of 500,000 ounces. Allied Nevada is obviously a takeover candidate at some point for one of the big seniors that's involved in Nevada. There is no other large-scale deposit readily available in Nevada.
Even if it is not a takeover candidate, it's a company that is increasing its production year by year. It's going to produce 100,000 ounces this year, moving towards 300,000 in two years and then 500,000 once the sulfides come online. It's got about $90 million in cash right now; I like that one a lot. (The company just raised C$283,500 subsequent to the interview.)
TGR: What about some smaller juniors?
AD: Moving down the chain a little bit, there's Kiska Metals Corp. (TSX.V:KSK). That's a junior that I've always liked. It was formerly known as Rimfire Minerals before its merger with Geoinformatics. Rimfire traditionally followed the joint venture (JV) model with properties primarily in Nevada, Alaska and Australia. They had the opportunity to get involved with Whistler up in Alaska. Whistler is a very large property, very underexplored with lots and lots of targets. Most of your readers will probably know that Kennecott has the right to buy back the property.
TGR: Kennecott is a subsidiary of Rio Tinto Ltd. (LSE:RIO; NYSE:RTP; AUS:RIO), correct?
AD: Correct. It's kind of a complicated deal. The essential point is that, at some point, over the next 60–90 days, Kennecott will have to make a decision as to whether they want in or not. I suspect they will let Kiska have the property; obviously, they will get something in return. I don't think they're going to want to take it over because so far they have not found large, or potentially large, copper properties, which is what Kennecott wants. Kiska, on the other hand, is quite happy with gold properties, even small gold properties. They have, I would say, so far been very successful in drilling several targets and finding gold.
It's a huge property with lots of targets; but, the downside, if you want to put it that way, is if Kennecott walks away, this will be a very expensive project. It will take a lot of time and a lot of money to explore properly. It is still unclear what Kiska's strategy will be; the company's actively joint venturing a lot of its other properties to get some money, and then devote all of its time to Whistler.
Once Kennecott has made its decision, which I suspect will be to walk away and let Kiska have the property, then I suspect the market will revalue the stock upwards. But you should be aware that it will probably be a volatile ride because Kiska will have to raise money, before the end of this year, to explore Whistler. But it's a good company with a lot of targets. . .a lot of potential.
At the recent gold show, Esperanza Silver Corp. (TSX.V:EPZ) had a new slogan, something like 'We went looking for silver, but we found gold.' That's been true on their two main properties—San Luis, which is a JV property in Peru with Silver Standard Resources Inc. (TSX:SSO; NASDAQ:SSRI), and also on their 100%-owned Jumil property in Mexico. They thought both of those were silver properties, but they turned out to be primarily gold.
The key to Esperanza in the near term is what Silver Standard is going to do on San Luis. They just released the feasibility study; it's a small project, but very simple with a very high return. Silver Standard owns 70% of the project and has various options. One is to keep it at 70% and Esperanza would have 30%; one is to raise it to 80% and carry Esperanza; and the other would be to negotiate to buy the entire property. That's where the value comes in and the potential move for Esperanza. Frankly, any one of those three would be a good result. Unfortunately, Silver Standard is not known to throw its money around; I suspect there will probably be some pretty hard negotiating. In the meantime, it's a good property, good balance sheet, people and assets.
TGR: In a previous interview with The Gold Report, you talked about Miranda Gold Corp. (NYSE.A:VGZ; TSX:VGZ), Vista Gold Corp. (NYSE.A:VGZ; TSX:VGZ) and Midland Exploration Inc. (TSX.V:MD). Could you give us an update on these companies?
AD: Let's start with Midland, which has been doing extremely well. It's a JV company focused on Quebec, just like Virginia Mines Inc. (TSX:VGQ), which also remains one of my favorite companies. Midland's doing everything right and it's growing very, very well. They've got two joint ventures now with Agnico-Eagle Mines Ltd. (TSX:AEM, NYSE:AEM); one in the southern end of Quebec in the Maritime Cadillac Trend, where it has just decided to up its interest and spend more money on another drill program. In all, Midland has four drill programs either underway or to be underway in the very near future, which is quite a lot for such a small company. They've got a good balance sheet, they don't need to raise any money. The company just did a JV on a rare earths property with the Japan Oil Gas and Metals National Corp. There's some good potential for some good news over the next six or nine months. The stock remains very cheap.
Miranda is a solid prospect generator; it has good management and a good cash position. The company did a fundraising a few months ago, which kind of raised a few eyebrows because they didn't really need the money. But people always say: "Raise money when you don't need it." They have most of their good properties in Nevada farmed out in JVs, and now they've done a deal in Colombia where they're looking for the same deposit type that they are currently exploring in Nevada. Their chief geologist used to work in Colombia, so he's familiar with the territory and has some good contacts. Colombia has a long history of gold mining; but, in recent years, with the violence and the drug war and everything else, it's kind of gone into the background. The recent elections I think demonstrate very clearly that the country has turned the corner and is on a new path.
So, Miranda's got maybe 10 active projects in Nevada with several JV partners, some of them drilling in the next few months. There's also the big package of properties in Colombia, and Miranda plans to review those quickly and start joint venturing them under the same model used in Nevada. Clearly, the company needs a discovery; it's been around for a long time and what we're seeing today other than the Colombia news is pretty much the same as what we saw a year or two ago. But I think all the ingredients are there—the people, the capital, the properties; it's just a matter of being patient. I like that one a lot; I'd certainly be a buyer at this level.
And Vista, of course, has had a couple of hits in Mexico at the Paredones property. Their land use permit was revoked, and it's taken them over a year now to get a new permit and they still don't have one. That's really hurt the stock.
Their other big asset is the Mount Todd property in northern Australia, which is moving toward a prefeasibility study. Mount Todd has a checkered history. That was the last straw for Pegasus before it went bankrupt. There is no question that this a difficult project, but with the high price of gold, there is every indication that this could be a successful and profitable gold mine. The prefeasibility study, which they're working toward, will give us an indication.
On the negative side, we're waiting on the land use permit, and there's no question that Vista is going to have to raise more money; it has a convertible debenture that it has to deal with next March and is also spending money quite aggressively in Australia. It's going to have to raise more money and the market knows that. The value is there, however, so patient investors can buy on dips.
Adrian Day is a British-born writer and money manager, a graduate of the London School of Economics, who has made a name for himself searching out unusual opportunities around the world, with two books on the subject. At his money management firm, Adrian Day Asset Management, he specializes in global diversification and gold equities for individual and institutional clients. Adrian is a frequent speaker at international seminars, and is a frequently guest on CNBC and The Wall Street Journal Radio network and has been interviewed by Money, Straits Times, Good Morning America and others.
Adrian's forthcoming book Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks will be published by Wiley this autumn. He is also a contributor to the recent The Golden Rule: Safe Strategies of Sage Investors.
You may learn more about his services at www.AdrianDayAssetManagent.com, or via email [email protected].
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1) Brian Sylvester and Karen Roche of The Gold Report conducted this interview. They personally and/or their families own the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Franco-Nevada, Allied Nevada, Kiska, Esperanza, Miranda, Midland and Vista Gold.
3) Adrian Day: I personally and/or my family own shares of the following companies mentioned in this interview: Royal Gold, Vista, Allied Nevada, Virginia Mines and the SPDR Gold Trust. On behalf of clients, our firm holds and controls shares in all companies mentioned and are 5% holders of Midland, Miranda and Virginia. I personally and/or my family am paid by the following companies mentioned in this interview: None.