The Gold Report: Since November, there's been a decisive break between the S&P 500 and gold, bullion and the AMEX Gold BUGS Index (HUI:NYSE). The HUI has provided leverage to gold, but it's been leverage to the downside. There are new highs on the S&P 500 almost daily. Does that mean that you're looking for new lows in mining equities?
Jordan Roy-Byrne: There's been a negative correlation between precious metals and the equity market that became quite pronounced in November. However, the negative correlation really began in the summer of 2011, when gold peaked at $1,900/ounce ($1,900/oz) and the HUI gold stock index and Market Vectors Gold Miners ETF (GDX:NYSEArca) also peaked.
The negative correlation is in place over a long period and not necessarily over a day-to-day or week-to-week period. The precious metals complex has likely bottomed due to extreme bearish sentiment. In the near term, I think a move higher in the S&P 500 could be speculative and actually benefit mining shares before the larger correlation comes back into play.
Many investors forget history. Everyone is focused on what happened in 2008. There were times in the 1960s through the 1980s, during that bull market, when precious metals were rising along with the stock market. There were times when precious metals went down with the stock market, and there were times when the two diverged, such as from 1972 to 1977. That negative correlation repeated itself in 2000 to 2002, when precious metals began this secular bull market and the equity market was in a bear market.
The key factor is the correlation between the two. If it is positive, then it will remain positive during the next cyclical bear market or recession. Examples include the late 1960s and mid- to late 2000s. If the correlation is negative, then it will remain negative. Examples of that include the late 1990s to 2002, and 1972 to 1977. Currently the correlation is negative, which means precious metals will benefit during the next cyclical bear market or recession.
TGR: This is the perfect setup if you believe there's going to be a top in the stock market on a cyclical basis. Could there be a cyclical top in the market fairly soon?
JRB: Yes. There are many reasons the equity market is headed for a cyclical top. However, we expect it will be a very mild bear market that will probably last several years.
TGR: It goes out with a whimper.
JRB: That is what happened in the late 1970s.
There have already been two 50% bear markets in the last 12 years. It's very likely that the next one is going to be mild, because the average bear market is about 40%. If there are two 50% bear markets, the next one is likely to be 20–25%.
Ultimately, that's going to be very bullish for precious metals due to the current negative correlation and the fact that the hot money will move out of stocks and into precious metals.
TGR: How will interest rates affect precious metals? You've said before that rising interest rates would be positive for precious metals, why is that?
JRB: It depends. If rates are rising because of inflation concerns and rising inflation expectations, then yes, it could be positive for precious metals. If rates are rising because it's an improving macro environment and investors are confident enough to move money out of safe assets, like bonds and gold, then no. The bottom line is that rates have to stay low to keep the interest payments on debt manageable. Eventually it will reach a point where the authorities will have to start doing even more quantitative easing to suppress rates.
TGR: What are your investment themes to profit from that macro scenario?
JRB: Precious metals will be the best performing sector over the next three to five years. I focus on gold and silver companies with cash-flow growth, which comes from production growth. A royalty company produces cash-flow growth from more accretive transactions.
"The precious metals complex has likely bottomed due to extreme bearish sentiment."
The reality is that in any bull market, no matter what the sector or industry is, the market always wants growth. The producing companies that have been able to grow cash flow and production without diluting shareholders and taking on huge amounts of debt are the companies that have performed the best in this difficult period. I call them growth-oriented producers.
TGR: Are there examples of companies that are role models of what you look for?
JRB: Primero Mining Corp. (PPP:NYSE; P:TSX) is a company that I really like. The stock had a huge move in 2012 because of a positive resolution to its tax status. The stock peaked at about $8/share and it has digested that huge run. It bottomed just above $5/share. I forecast that it will likely trade in a range from $6–8/share during the next four to five months.
Fundamentally, Primero has very strong cash flow from its San Dimas mine in Mexico, which is a world-class asset. The company also has more than $100 million ($100M) in cash.
Primero has a strong management team and a world-class board of directors. The roster of people involved with this company is simply stellar. They have done this before, so Primero is a good model for what I'm looking for.
"If interest rates are rising because of inflation concerns and rising inflation expectations, that could be positive for precious metals."
The company has already been a huge winner for us because we got in at less than $3/share. Primero has the capital to continue to grow the San Dimas asset, but it also made an acquisition last year and is hoping to put that asset into production in 2015.
This is a company that's very strong financially. It's strong on the charts. It's not falling apart during this downturn. It has the financial strength to grow its production. I think Primero is going to be the next Argonaut Gold Inc. (AR:TSX). Argonaut is a very strong model and one we've been very positive on for several years now. Primero is where Argonaut was about a year ago.
TGR: Most producers are facing a lot of cost increases across the board in production. But it appears Primero and Argonaut have maintained cost per ounce of production during the last several years.
JRB: In Primero's case, San Dimas is a very high-grade underground mine. Argonaut's assets may not be as high grade, but it's done a really good job managing them.
In both cases, I chalk it up to having management teams with enough experience in this industry to know how to control costs. They're thinking ahead. They're thinking about what could potentially affect costs next year and the year after. For example, last year Argonaut sensed a cyanide shortage in Mexico and was able to secure cyanide for the next several years. Now the cyanide price is more expensive.
TGR: You also believe there is potential for rising valuations among the producers. Wouldn't that require a sustained bullion price increase in a market that hasn't shown a lot of belief in high metals prices?
JRB: That's why valuations are at a trough. The gold price isn't going up. It is going sideways. The market needs the gold price to reach $1,800/oz or more to see valuations increase. There's a lot of potential for these companies to see tremendous increases in their value because, assuming gold breaks out, valuations will naturally increase. Because they are currently at a floor, they have substantial room to move higher. Valuations are currently near 2000 and 2008 levels, and those were the two best buying opportunities in this bull market.
Many stocks are trading at cheap valuations, but that's because those companies don't have the pipeline needed to grow. I'm looking for companies that have the ability to grow production and cash flow in the coming years. Over time, they will be rerated.
TGR: Are there additional companies with good cash flow that are undervalued or ignored?
JRB: The cheapest stock that I'm aware of is producer Lachlan Star Ltd. (LSA:TSX; LSA:ASX) in Chile. The management team acquired a woefully underperforming mine and is currently ramping up production and methodically reducing costs.
The company is not cash-flow positive at the moment. Its all-in costs last quarter were above $1,800/oz. However, costs are trending down and will likely come down this quarter by 15%. It has implemented its own mining fleet, which could save it about $150/oz. The company is also mining its highest-grade pit, which it wasn't mining last year. The company expects to be cash flow positive in Q2/13 and I think all-in costs will be below $1,400/oz in Q3/13.
On the production side, Lachlan should produce 75,000 oz (75 Koz) this year and is targeting 100 Koz in 2014.
The company has a $54M market cap, $7M in cash (as of January) and took out a $10M debt facility. It's going to be fine as long as the gold price doesn't drop below $1,500/oz.
This is a very cheap stock that has strong potential to trade at $2–3/share if the gold price exceeds $1,800/oz.
"Precious metals will be the best performing sector over the next three to five years."
I really like the management team at this company. The chief executive officer, Mick McMullen, has built mines before, and his specialty is turnarounds. I'm confident this stock can make a huge advance over the long term. It has been pounded in recent months, but once the gold price nears $1,700/oz, it will rebound quickly.
TGR: Are there any silver producers that you're excited about?
JRB: First Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE) just commissioned its sixth mine at Del Toro in Zacatecas, Mexico. Del Toro will likely be producing at an annual rate of 6 million ounces/year (6 Moz/year) by the end of next year. First Majestic could go from 9 Moz in 2012 to 15 Moz in 2014. That is substantial growth in a short period of time and few companies can match that.
Also, the stock has held up very well. When the market turns around, it's going to be one of the first to breakout.
TGR: Any other silver companies you would like to talk about?
JRB: I'm not a fan of development stories, generally speaking, but Bear Creek Mining Corp. (BCM:TSX.V) in Peru has a world-class asset, the Corani project, which is moving toward production. This mine could be in production by the end of 2015.
This asset will produce more than 20 Moz silver equivalent in the first five years. The most recent feasibility study, done at a base case of $18/oz silver, showed Corani to be an economic deposit. If silver is at $30/oz, Corani will be hugely profitable. If the silver price is even higher? They will be swimming in money.
Bear Creek had some problems with its smaller Santa Ana deposit. The previous Peruvian government took away its rights to the project, but the company is in negotiations with the new government, led by President Ollanta Humala, and is optimistic.
Investors at the time lumped Corani in with Santa Ana and punished the stock. The reality is, Corani is located in one of the poorest and most sparsely populated parts of Peru. Bear Creek has engaged the community from the start and, overall, the project is well on track to production. The company has $70M in cash and will have no trouble financing the project when the time comes.
It's going to take time for the stock to move back up, but it hasn't hit a new low. It's showing some long-term strength compared to much of the sector. Investors have to be patient, but I believe there is substantial potential and limited long-term risk at this price.
TGR: Are there any exploration plays you're following?
JRB: With regard to mergers and acquistions, I think Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX) fits what major companies are looking for, which are high-grade, high-margin deposits that are 3–5 Moz in size.
It's a question of what the potential is of this deposit. What's the potential metallurgy? How big is this deposit? Balmoral will have a resource estimate out later this year, but it is well funded and has had a lot of drilling success. If you favor exploration companies, this is the type of company that you need to be looking at.
TGR: Any others?
JRB: I also like Corvus Gold Inc. (KOR:TSX), which has a simple, open-pittable and heap-leachable deposit known as North Bullfrog that's going to become a Nevada gold mine in the next several years.
The key for Corvus is that it found some high-grade mineralization on the Yellow Jacket portion of the property. It will be going after that area hard this year. If Corvus is successful and Yellow Jacket turns up a big resource, Corvus shares will move much higher.
TGR: The stock is off of its all-time peak, but it is above its 2012 lows.
JRB: An excellent point that I want to comment on, as it applies to my technical work on these stocks. We're not chasing momentum stocks here. When a stock has fallen and it has no support, unless it's a producing company, it's going to take a long time to rebound. We want to find stocks that are showing relative strength while the market is weak. These are the stocks that are likely to be the leaders, and the first to break out during the next sector-wide advance. The time to buy is now, when they are trading well off their highs. At the same time, if you like a company but it is showing poor relative strength, it is a sign that something is wrong.
"I believe we're going to get a good rally in the mining stocks over the next two months—I'm short-term bullish."
Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) is a simple example. We first bought that in October 2011 at $35. It was a very strong stock that had corrected and appeared to have bottomed. Franco-Nevada went up to $60/share recently, but it's had a severe correction because of a huge amount of redemptions. It's about $46/share, about 20% off its high. It has cash-flow growth, and it's consistently leveraged to the bull market. Now is the time to buy. It's a no brainer. That's what I'm looking for. Don't buy the strong stocks when they are making all-time highs. Buy them after they've corrected, when they offer value.
TGR: That's good advice. Do you have any parting thoughts?
JRB: I believe we're going to get a good rally in the mining stocks over the next two months—I'm short-term bullish. Gold has put in an important low amid extreme bearish sentiment. That is very encouraging. We should see a rally, and then a potential soft period in the summer or early fall. However, by the end of the year I think gold has a good chance to break past $1,800/oz. I'm more bullish on 2014 than on 2013.
Now is the time to do your research. Look at companies that have the ability to grow their cash flow and production over the next few years, because these companies are consistent winners that are consistently leveraged to the bull market.
In regard to the juniors and development companies, I'd offer two criteria for research. Look for companies that are cashed-up, and are trading above their 52-week lows. Cash and relative strength!
TGR: Thanks for speaking with us today, Jordan.
Jordan Roy-Byrne is a Chartered Market Technician, a member of the Market Technicians Association and a former official contributor to the CME Group, the largest futures exchange in the world. He is the editor of TheDailyGold Premium; the TDG Premium Model Portfolio was up 32% in 2012. His work has been featured in CNBC, Barron's, Financial Times, Alphaville, Yahoo Finance, BusinessInsider, 321gold, Gold-Eagle, FinancialSense, GoldSeek and Kitco.
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1) Alec Gimurtu conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He 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: Primero Mining Corp., Argonaut Gold Inc., Balmoral Resources Ltd. and Franco-Nevada Corp. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Jordan Roy-Byrne: I or my family own shares of the following companies mentioned in this interview: Argonaut Gold Inc., Bear Creek Mining Corp., Corvus Gold Inc., Lachlan Star Ltd., Primero Mining Corp., Franco-Nevada Corp. I personally or my family am paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: First Majestic Silver Corp., Argonaut Gold Inc., Bear Creek Mining Corp., Corvus Gold Inc., Balmoral Resources Ltd. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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