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Navigating Gold Equities During the Weakest Quarter: Barry Allan
Source: Brian Sylvester of The Gold Report (4/23/12)
Barry Allan, vice chairman of Mackie Research Capital Corp.'s mining group, is guarded about gold equities from March to May, statistically the weakest period. However, Allan remains bullish on gold stocks through the end of the year and has Buy recommendations on more than 70% of his coverage universe. In this exclusive interview with The Gold Report, Allan points to where he's finding value during this period of seasonal weakness.
Barry Allan: Market appetite for small-cap equities has eroded as investors clamor for less risky investments. A backdrop to that sentiment is the gold price, which has shown lackluster performance since hitting a peak in mid-2011. The gold price continues to be in a realm of uncertainty, particularly because we are in a seasonally weak period, the second quarter. The second quarter statistically is the weakest quarter for gold equities. There's no good reason for that, but it is a statistical fact. That has also eroded some of the appetite for small-cap gold stocks.
TGR: What is the best quarter for small-cap gold equities?
BA: The fourth quarter, bar none, is the best period for gold and gold-related equities, particularly small caps. On a percentage basis, there's less than a 5% probability that the fourth quarter will be a weak quarter in any fiscal year. There are generally good prices at year-end, which tend to carry through to February. Then March presents the highest risk for price decline. I make this joke about the Prospector & Developers Association of Canada (PDAC) conference, which is always in early March: The rule of thumb is wear a warm coat to the PDAC because we always get a cold snap, but also don't be holding any gold stocks.
TGR: You've said that you have no preference between gold and silver and remain bullish on both in the near and long term. What do you see that has you bullish in the near term given the recent slide in prices for both metals?
BA: Trajectories are never straight up. There are seasonally weak periods. Some evidence indicates that perhaps the U.S. economy is starting to set a base. However, I certainly don't see anything that reduces the attractiveness of either gold or silver looking out to the end of the year. There have been some bumps and grinds, but all the elements that made gold get here in the first place largely remain intact. I'm not prepared to say that I'm negative. I'm cautious about the second quarter, but I've been cautious about the second quarter pretty consistently over the last 10 years.
TGR: About 71% of the companies on your coverage list have Buy recommendations. Is it fair to say you see a lot of value in mining equities at the moment?
BA: Generally, the recommendation list follows my positive bias for the prospects of bullion. A lot of the equities that we have looked at are a pretty good value. Then the question becomes are they value traps? Are they going to continue to just look like a good value, but not show any performance over the next 12 months?
TGR: Where is value consistently presenting itself?
BA: The most compelling theme is those companies where the asset is clearly identified as having merit. The problem is usually getting the money to build the mine. There are a number of examples where there is a positive feasibility study or prefeasibility study. There are ounces and, in some cases, reserves in the ground. But how is the cash flow going to get unlocked? Capital costs could be $400–600 million (M) for a company that probably has a market cap of $120M. How will it get that into production? It will take capital to unlock it.
An example is AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE). It has the best growth profile of any junior-to-intermediate by far. Now it must execute. That is pretty compelling.
The other theme is companies that look like they have decent assets, but do they have mines? There's quite a long list of them: Sandspring Resources Ltd. (SSP:TSX.V), Oromin Explorations Ltd. (OLE:TSX; OLEPF:OTCBB), Klondex Mines Ltd. (KDX:TSX; KLNDF:OTCBB) and Chesapeake Gold Corp. (CKG:TSX.V). There are at least a couple of levels of assessments that say they are economic, but the capital costs are really intimidating.
TGR: Let's talk about dividends for a moment and their impact on total return. TheStreet.com reports that the S&P 500 Total Return Index hit an all-time high of 2,449.1 on April 9. Dividend returns kept the index in the black. About 29% of the companies you follow are paying a dividend. What's your philosophy regarding dividend-paying companies?
BA: I don't want to sound sarcastic, but it's only in the last two years that gold companies could even spell dividend. This has been a sector that historically did not pay dividends.
With the evolution of exchange-traded funds (ETFs), gold companies have vocally come out and said, "Look, buy us because at least we will pay you something back where the ETF will not." They're attempting to recapture some of the valuation premiums that gold equities historically traded at.
Are dividend-paying gold companies enjoying a return to premiums? The answer is no. It's been a flawed strategy in the sense that the traditional methodology of tracking premiums was to show good fundamental underlying performance. The notion of dividend paying for gold companies is a little bit of an anomaly in this market. The broader market is yield starved and looking for dividends. As such, dividend paying companies have attracted more attention than not. But the highest yielding gold stock that we have is 2.5%. A number of yield stocks in the overall universe of coverage at Mackie Research have upward of 4% or 6% yields. We're not buying a 2.5% or 1.5% premium for the yield.
TGR: Newmont Mining Corp. (NEM:NYSE) offers the highest dividend at about 2.5% followed by Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) with 2.3%. Is that enough to lure investors or should these companies be using that money to improve their asset base or increase efficiency at their operations?
BA: It's nominal. A yielding stock isn't going to attract much attention at anything less than 2.5%. I don't know any investor who's saying, "Wow, I like Newmont because it's got a 2.5% yield!" They can buy another stock and get a 6.5% yield with much lower risk. I don't think it cuts it.
TGR: What are some promising stories you want to tell us about today?
BA: If I had to single out a company that is the most likely to enjoy a re-rating in the market irrespective of the gold price, I'd say AuRico. It's pregnant with many near-term milestones over the next nine months that suggest it will get a re-rating before executing its business plan. It has good growth and a group of people whom I trust to deliver the growth.
Another company that follows in the category of good growth, solid management and decent valuation would be Argonaut Gold Inc. (AR:TSX).
TGR: Argonaut is planning to expand production at El Castillo, one of its operations in Mexico. It also has a new resource at its development project, La Colorada.
BA: What we really like about Argonaut is that its core senior management group has done this before. The company has been quite cognizant that it needed to execute a strategy of growth, but at the same time be able to live within its means. El Castillo was exactly that. Argonaut took the asset, ramped it up and optimized it operations. In the case of La Colorada, it is just going to do that again. Argonaut knows its capabilities and can maximize those without overstretching. We expect steady progress with the existing operations and as it goes into its next phase of development with La Colorada. It's about solid, reliable execution.
TGR: La Mancha Resources Inc. (LMA:TSX) more than doubled its resource at the Hassaï project in Sudan. That's a world-class asset. You call La Mancha one of the most misunderstood junior mining stories in the market. Why is that?
BA: La Mancha has been broken out of AREVA SA (AREVA:EPA), a large integrated nuclear entity in France. AREVA had a group of gold-type assets in Sudan, Côte d'Ivoire and Australia. These assets were out of sight, out of mind because they were buried in AREVA. La Mancha really didn't have much of a market profile at all up until very recently. AREVA is selling the whole company and put La Mancha in market play. Even though the resources at the main mine have expanded, one of the driving elements on the valuation will be the sale process. Interested people have been spooling through La Mancha looking at its assets. This is about AREVA maximizing the valuation that it has in La Mancha. AREVA has had a very disastrous financial performance over the last 18 months. It's trying to monetize everything and, unfortunately, La Mancha is one part of that.
TGR: Avion Gold Corp. (AVR:TSX; AVGCF:OTCQX) has its main projects in Mali, which recently witnessed a coup attempt. Some order has since been restored and Avion's share price has begun to rebound. What strategy are you taking with that equity?
BA: We were aware that Mali might be going through some issues, but we still see some value in Avion. We adjusted our target down slightly as a result of production. It was starting to experience some stress at the Tabakoto mine about a week ago. I subsequently had a conversation with management and they are quite pleased that the borders have been opened now and goods and services are freely traveling. Operations are starting to return to normal even though the country itself is probably going to go through a few gymnastics before its issues are solved. We're not out of the woods, but it certainly is looking a little brighter than it was two weeks ago. The value hasn't gone away, but we're waiting to see some better outcome on the political front.
TGR: What did you make of the recent drill results of Southern Arc Minerals Inc. (SA:TSX.V; SOACF:OTCQX), particularly the 83 meters of 0.33 grams per ton gold and 0.080% copper at the West Lombok project in Indonesia?
BA: Southern Arc modified its exploration program for 2012 to focus on areas that are outside of forestry reserve. Historically in Indonesia, a company could operate within a forestry reserve even if it didn't have the official permits as long as it had applied for them. Southern Arc received counsel that that was probably not a good way to operate at this time.
Those drill results were designed to test a porphyry system in the south and west of Lombok Island. It shows there's a system bubbling around there. This area has the right geological conditions to yield porphyry systems. The grade was just not one that you would get all excited about, but good intercepts show anomalous mineralization of copper-gold over good regional widths. I look at it as encouraging. The property's right and the people are right. We'll see by the way it grows that.
TGR: Premier Gold Mines Ltd. (PG:TSX) recently announced that the Red Lake Haulage Drift crossed onto the Rahill-Bonanza joint venture in the Red Lake district. What does that mean for Premier's shareholders?
BA: It illustrates that the Rahill-Bonanza property is strategically located. That is significant in the mind of Premier Gold because that drift will provide access to deep exploration potential in the camp and in an area where the mineralization has shown to be quite deep. It's more of a symbolic statement than anything meaty and juicy. It just says that the company is dead center in that play and is seeing underground access to its project, which will allow it to more completely explore that area. However, you have to qualify the enthusiasm in the sense that Goldcorp Inc. (G:TSX; GG:NYSE) controls the exploration on that joint venture. So, it will be done in Goldcorp's time, not Premier Gold's time.
TGR: Premier also entered into an agreement to buy the Cove gold project in Nevada.
BA: I scratch my head a little bit on that acquisition. It's not clear to me what opportunity Premier sees there other than it was available. My memory goes back far enough to remember when Cove was an operating mine at Echo Bay. I know what the mine did for Echo Bay. I saw what Victoria Gold Corp. (VIT:TSX.V) tried to do with the asset. It's not clear to me what Premier thinks it can do that two previous operators couldn't deliver. There's a small resource there, but the ground was particularly problematic to operate in. It would have to be a particularly good grade to compensate for the poor ground.
TGR: How did Premier make it on your list then?
BA: We have been actively involved in the Red Lake camp going back to the initial days of Goldcorp and Rob McEwen. I have had very good experiences in the area. I feel I have a good handle on what it takes to be successful there. Two companies caught my eye as having the capability to make it: Rubicon Minerals Corp. (RBY:NYSE.A; RMX:TSX), which has been reasonably successful in its exploration, and Premier Gold. Now Premier Gold has moved way beyond the Red Lake camp and has developed a whole U.S. strategy, which involves Nevada. Its Saddle property in Nevada is adjacent to Newmont's assets. I kind of went to bed in Red Lake and woke up in Nevada. It's not where I really intended to be.
TGR: I don't think you're the first to do that.
BA: I'm sure. Premier is a very aggressive explorer. That's what I liked about it. But the move to Nevada is a little bit more of a departure.
TGR: Are there any other companies that really interest you?
BA: There is one company facing some issues, which we're trying to take advantage of for investors. Lake Shore Gold Corp.'s (LSG:TSX) stock certainly would not get you terribly excited, but we recognize there is certainly some very good resource potential. It has already released resources that are well over 7 million ounces. It has an operating mine, but it's not operating up to where it ought to be. This is another story about execution. We also know that if current management does not get it right, there are others in the Canadian mining industry that will. We're intrigued by the asset value, and we're getting it at a good value irrespective of what gold prices are doing.
TGR: Is the message to investors to wait until later in the year for performance and approach with caution?
BA: Yes, take a low-beta strategy through the year, increasing weightings in the August time period to enjoy a better return at the end of the year. Investors just looking for some good companies that will do well irrespective of the gold price should go back to the AuRicos and Lake Shores where there's value to be unlocked and all they need to do is wait for them to execute over the next 12 months.
It doesn't really matter what the gold price does. We're just looking at companies where the value is there and there's a real proposition that that value is getting unlocked within 12 months.
TGR: I enjoyed speaking with you, Barry.
Barry Allan joined Mackie Research's investment banking department in 1998 as a mining specialist and transferred to the research department as a mining analyst in 2001. He has worked in the mining sector for over 15 years, serving as a gold and precious metals mining analyst with Gordon Capital, BZW and Prudential Bache. He holds a Bachelor of Science degree in geology and a Master of Business Administration degree from Dalhousie University.
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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Avion Gold Corp., La Mancha Resources Inc., Southern Arc Minerals Inc., Rubicon Minerals Corp., Premier Gold Mines Ltd., Argonaut Gold Inc. and Goldcorp Inc. Streetwise Reports does not accept stock in exchange for services.
3) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.