TICKERS: AEM, EMX; EMXX, LRA, MD, MAD, REO,
Adrian Day: Tax-Loss Selling May Hit Gold Stocks Soon
Source: Karen Roche of The Gold Report (11/16/11)
After a big spike up and an overdue correction in the gold price, Adrian Day, chairman and CEO of Adrian Day Asset Management, says that the king of metals is settling back into the steady rise in price that we've grown accustomed to over the past several years. He expects that to continue because the demand drivers have not gone away. But gold equities? As Day tells The Gold Report in this exclusive interview—conducted during the New Orleans Investment Conference—their lackluster performance in light of the gold price's ever-upward march is "just astonishing." To top it off, tax-loss selling at year-end may mean these equities have yet to hit their bottoms.
Adrian Day: Gold had been on an extremely steady uptrend with few notable deviations either up or down until this year. At the beginning of summer, it moved well above its trend and then we started getting a bit of speculative activity. The gold price reaching $1,950/ounce in August was quite an anomaly in terms of the trend, so it was overdue for a correction.
Then when the stock market crashed in September, gold did what it often does in periods of extreme market stress—it became a source of liquidity, or an asset of last resort. A lot of margin calls and widespread hedge-fund redemptions forced people to raise money. In those circumstances, you liquidate not what you want to sell but what you can sell, namely gold, which is a very liquid asset.
That's why it was not really surprising that the gold price came down the way it did in September. It was above trend and it came down. I think it's now found that trend again, and we are back to the steady climb that we have seen for the last several years. The reasons people have been buying gold have not gone away.
TRG: What do you consider the primary reasons?
AD: For one thing, the central banks of emerging market countries want to diversify away from the U.S. dollar and gold is one of the assets they're buying. Mexico, Korea, Thailand and Russia all have bought gold this year, and I'm probably leaving some out. As for individuals, a primary reason they are buying gold is that they do not trust paper currency. I don't see anything that has changed on either front, so I think we're back on trend now and it looks very good to me.
TRG: How about the equities?
AD: The gold stocks, of course, fell sharply in September—not only because the gold price was going down but also the overall stock market. Senior gold stocks today are trading very close to 20-year lows by many metrics in terms of valuation relative to gold. That's just astonishing when gold is doing so well.
TRG: A thread common in many of the New Orleans Investment Conference presentations is that it's a good time to get into the gold seniors and juniors for the reason you mentioned—that they are at 20-year lows and have had quite a pullback. In essence, they are on sale. But another trend people are talking about is that we haven't seen the bottom yet. What is your opinion in terms of timing?
AD: I tend to be a long-term value investor and buy good-quality companies when they are at a good price. If that is the only criteria, this is certainly a good time to buy. There's no question, however, that sharp collapses such as we saw in the stock markets in September normally don't have a V-bottom. Prices do not typically just go straight down and then go straight up again.
Given that phenomenon, we could see further weakness, particularly in the juniors where we should expect some tax-loss selling at year-end. In fact, a lot of people anticipate vicious tax-loss selling this year, so investors need to be alert to any of their stocks that were trading at significantly higher prices because they could be susceptible to tax-loss selling next month.
TRG: Considering the factors you mentioned—stocks being susceptible to tax-loss selling, margin calls and hedge-fund redemptions—it seems that the gold price could still bounce around as we move toward year-end. So even if stocks are at bargain prices and it's a good time to get in now, might it be even better for investors to wait?
AD: I don't think we're going to see significantly lower prices, but it's always good to be incremental. I certainly am seeing some very, very good buys now, but certainly would not put all my money to work right now.
On the issue of margin calls, what typically happens when you get a margin call or redemption or in my money management business someone wants $50,000 from his account by the end of the week, you sell what you have to sell. But, if that person says he needs another $50,000 by the end of the year, you start to look to sell what you want to sell. As we saw in 2008, the hedge funds liquidate gold in that first round of redemptions because they liquidate what they can. But if you think you're going to get more redemptions over the next few months, you start raising cash in other assets. We saw this in 2008 as well, and then gold came crashing down in September but then bounced back very quickly and ended the year up. So I think the same pattern could show here. And even if you didn't get the exact bottom, buying the gold stocks at the end of 2008 was a very good move.
One other point on the issue of timing. Juniors can bounce back very quickly when the selling dries up. So, I don't think you want to be too clever in waiting too long for the absolute bottom because you might find you've missed a 30% or 40% move.
TRG: If we look at the 2008 parallel, though, the seniors came back first and the juniors took quite a long time. Is there a strategy that says we're at a bottom, let's put our money in the seniors, and after they come back, we'll put money into the juniors?
AD: It's interesting you say that, because in my last report to clients I said that we are actually over-emphasizing seniors. We have had very little in the seniors for several years due to all the problems that we know about in the seniors. So we've emphasized the juniors. But now we're actually emphasizing the seniors more.
Nevertheless, there are still some very good buys among the juniors. I think that the key is to go for the companies with good balance sheets that don't need to raise money, that are not susceptible to tax-loss selling and that have good prices.
TRG: When you say to look at companies that don't have to raise money, how much of a cash cushion do you like to see?
AD: I generally prefer to see at least two years of cash ahead. Different companies would have different criteria, of course. Miranda Gold Corp. (MAD:TSX.V), for instance, likes to have more than two years' cash on hand. Other companies play it a little shorter, which I don't like.
TRG: Global Resource Investments Founder Rick Rule's big buzzword at this conference has been private placements. He contends that good companies will need to raise cash, but they won't be doing it in this equities market because their stock prices are so low, and therefore they will go for private loans. Do you agree with that view?
AD: I agree in general, but the companies highest on my list have good balance sheets and do not need to raise money in private placements with five-year warrants. I'm not a geologist, so when I look at a junior company I'm looking for good management, a good business plan and a good balance sheet.
TRG: Can I infer that companies needing private placements have had issues or unexpected events causing them to seek financing?
AD: Those really aren't the companies we are investing in, but that's probably a fairly reasonable inference. If a company's stock price was at $1 in February and dropped to $0.80 in April, management might have said, "Oh, let's wait for it to come back to $1." The price never did come back, so nine months later, the company is stuck and needs the money now. I think you will find a lot of those, companies that wait far too long to raise the money they need. Of course, when they need the money, they need it. My point is that they shouldn't put it off until the need becomes critical. If they can anticipate the need, they can raise money at a better price and on better terms.
Suppose this hypothetical company's share price dropped to $0.80, but it decided to wait and the stock falls to $0.40. It is going to have to raise money under some pretty onerous terms. This is a big problem in the junior sector when companies have to keep raising money. When they have to raise money continually, everybody knows, so the terms become more and more dilutive.
TRG: Does that present an opportunity for individual investors or do you have to be pretty savvy and wait for the good private placements?
AD: We tend to be extremely selective on what we own in the private placements we do. I will never do a private placement if I wouldn't be happy buying the company at that price anyway. And the warrants are a bonus. But I never buy a private placement just because the terms are great. To me, the company comes first and then whether the terms are good comes second. Nine times out of ten, we're buying private placements in companies we already own.
TRG: You have been a big proponent of the prospect generator model, Adrian. What is their special appeal?
AD: Those who invest in a company that focuses on a single property, or a key property, and spends its own money on that property better really know something about geology. They had better be able to analyze that company and assess whether it is worth investing in or else follow someone who can. For instance, investors who subscribe to Brent Cook's newsletter (read Brent Cook's interview with The Gold Report here) and just do what he says will be fine.
But one way or another, investors need a way of understanding a property and not go in blind. At some point, the company will have to raise more money, so the property should be one that is more likely to generate the kinds of results that can enable that company to raise more money when the stock's at a higher price.
TRG: As you suggest, though, most investors don't know geology and how to interpret results.
AD: Those who are geologically challenged are better off focusing on other things. Look at the company's business plan and its balance sheet. See whether it has the money necessary to carry out the plan. The beauty of the prospect generator model is that once a prospect generator gets going, it doesn't have to raise money. Because it generates the prospects and finds partners for exploration and for carrying projects forward, some haven't had to raise money for 10 years. Whether prospect generators team up with senior companies or junior companies, they're using other people's money rather than drawing down their own balance sheets.
TRG: That sounds almost like a slam-dunk.
AD: No, using the prospect generator model by no means guarantees success. This is a long-odds game. It is said that only one anomaly out of 6,000 ever becomes a mine—staggeringly long odds. Being a prospect generator improves the odds, but doesn't guarantee success. More importantly, spending other people's money on your properties means you don't have to keep going out diluting. As a result, even a prospect generator who fails to come up with anything year after year after year won't implode. It will just stay flat. Investors who own several prospect generators can expect that two or three of them won't work, but they'll get the returns from the two or three that do.
TRG: Adrian, what companies do you continue to follow because you still like their stories—even if they're among the many that have pulled back so much in this market?
AD: We're always looking to re-think—that's an ongoing process—but I'm not the type to sell a stock just because it declines 20%. If I like the company, the management and the balance sheet, and if nothing much has changed in the company except for a 20% decline in the stock price, I'm more likely to want to buy more.
TRG: Any examples?
AD: We bought more of Lara Exploration Ltd. (LRA:TSX.V) when it pulled back, for one example. The share price was up at $1.70, and then it fell all the way down to $1.20, $1.10. At that level, it was a staggeringly good buy. But let's put this in a broader perspective of the market as a whole.
As you know, we had a big decline in June/July and then another big one in September through the beginning of October. We saw some staggeringly good buys, in my view. Since then, we've seen a bit of a rally in many of these stocks. Lara's share price, for instance, was at $1.01 early in October. It's at about $1.45 right now, and I don't chase stocks that have just moved up 40%. Thus, as we speak, I'm a little more cautious, but two weeks ago I was extremely aggressive about buying. And, perhaps, in two more weeks I'll be very aggressive again.
At $1.45, Lara is still a very, very, very good value. It's not that I don't think this is a good price, and not that I'm selling it or anything like that. I just don't like chasing stocks that move. And with a stock as volatile as that, you just try to pick it up cheaper.
TRG: Is it more volatile than most?
AD: No, a lot of these companies are volatile because they are very thinly traded.
TRG: Any other examples?
AD: Another company we've followed for a long time that's on sale right now is Eurasian Minerals Inc. (EMX:TSX.V). Eurasian is a prospect generator with properties around the world from Haiti to Turkey to Sweden to Arizona. So, it's all over the place, and several of those properties already are joint-ventured. Eurasian is spending very little of its own money.
At $2.15/share as we speak, with about $0.97/share in cash, nearly half its market cap essentially is in cash, and it has a very low burn rate. With about $45 million in cash and no debt, it has a very strong balance sheet.
That's a company that will not need a private placement on arduous terms. It has the money. And, as I say, it's a stock that's on sale. We would buy that pretty aggressively.
Several others are good as well. Midland Exploration Inc. (MD:TSX.V) is another company that has fallen back. It is a relatively illiquid company that tends to have a wide bid-ask spread. We picked some up in the low $1.30s/share a few weeks ago, and you can still get it in the low- to mid-$1.40s/share.
That stock was $1.90/share earlier in the year. But, more importantly from where the stock price was, it's a game. The company has some $4.5M in cash, which is small, but all of its properties are joint-ventured out, and it has an extremely low burn rate. It won't need to raise money this year or next year—and certainly not on arduous terms. Do you want another one?
TRG: What about some new ones?
AD: First, let me put on the record that what's important to me is not whether a company is new and exciting. I'd rather have an old company whose name everyone knows that is better value. That's what is important to me.
That said, one that I think could be very attractive just started trading a couple of weeks ago. You know Reservoir Capital Corp. (REO:TSX.V), the renewable-energy company in southeast Europe? A lot of mineral properties in Serbia were actually the foundation of the company, but very little work was done on them over the last few years because the company focused on hydro. It has spun off the mineral properties and put them into a new company, Reservoir Minerals Inc. (RMC:TSX.V). Miles Thompson, chairman of Reservoir Capital and president and CEO of Lara, will be overseeing the new company, but Simon Ingram will be running it as president and CEO. I've met Ingram; he's very strong and has a background with several senior companies.
Reservoir Minerals has a good property portfolio in Serbia, one of them a fairly advanced copper project in a joint venture with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE). The plan is to apply the joint-venture model into another part of the world by going into different countries in the Middle East and Northern Africa and picking up more properties to joint venture. That part of the world is very under-explored for some obvious reasons.
At any rate, I expect this Reservoir Minerals to be a good company from out of the gate—with a good balance sheet, good management, several good properties and a good business plan. At the current $0.60, it's a very good long-term buy.
TRG: Very good. Any others you want to mention?
AD: We've just started buying Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE). It's a great company—solid management, very competent. We followed it for a long time but never bought it because it always seemed just a little too expensive relative to other seniors.
This past September and October, though, the market was punishing any company that had bad news. Agnico's news wasn't all that bad. It had a problem at one of its Canadian mines—suspending operations and writing down its Goldex mine—but it's a small mine and not particularly material, not very significant to the company.
In any event, the market didn't like it, and the stock went from more than $70/share at the beginning of September all the way down to $43/share. At that price, it's a very good buy in my view, a good opportunity to get a good quality company as a long-term holding. So we like that one.
But, we're being very selective. You can see I'm not rushing out with a whole bunch of names to buy, am I?
AD: It's really just a matter of being patient and waiting for the opportunity when the stock prices come to you, as they do—as Lara, Eurasian and Agnico have done. Don't spend all your money now, but I definitely think you need to be positioned so you're ready to take advantage of an opportunity when it comes. As you know, some of these dramatic declines don't last very long.
TRG: Those are pretty good last words. Thank you, Adrian.
Chairman and CEO of Adrian Day Asset Management, which manages discretionary accounts in both global and resource areas, Adrian Day is a highly regarded pioneer in the global investing arena. British-born and a London School of Economics graduate, he has made a name for himself searching out unusual opportunities for investors around the world. Also a prolific author, he produces Adrian Day's Global Analyst newsletter and has three books to his credit. The latest, released in 2010, is Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks. He also wrote Investing Without Borders: The Best Opportunities Around the World for the '80s (1982) and International Investment Opportunities (1984). Day also contributed to Jim Gibbons' The Golden Rule: Safe Strategies of Sage Investors (2010). A popular speaker at international seminars and conferences, Day also is a frequent guest of CNBC and The Wall Street Journal radio network who has been interviewed by Money, Straits Times, Good Morning America and others.
Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
1) Karen Roche of The Gold Report conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: Midland and Agnico-Eagle.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Midland Exploration Inc.
3) Adrian Day: I personally and/or my family own shares of the following companies mentioned in this interview: Reservoir Capital Corp., Reservoir Minerals Inc. I personally and/or my family am paid by the following companies mentioned in this interview: None. Clients of Adrian Day Asset Management own shares in all companies mentioned by Adrian Day.