The Gold Report: In a 4th of July investor letter, you wrote that the precious metals complex, both mining shares and bullion, appear to be in the process of completing a major bottom, and you're more comfortable with the proposition that the downside potential has been fully exhausted. What are the signs that it's really turning this time?
John Hathaway: The gold futures chart is showing that we are in the process of a reverse head-and-shoulders pattern, which is a sign that a bottom has been completed. It means that downward momentum has been exhausted. This bottom will be confirmed when gold trades above $1,400/ounce ($1,400/oz), which is a stretch from where we are. At least we can say fairly credibly that it's shaping up to be a bottom, but we may test it over the summer.
Source: International Strategy & Investment Group LLC
TGR: Are statistics on money flows telling you that investors are starting to get interested again?
JH: Yes. If we look at the SPDR Gold Shares Exchange-Traded Fund (GLD:NYSE), which is one proxy for money flows into the gold space, the outflows that have been predominant over the last couple of years have pretty much run their course. Now, we're starting to see assets build in the SPDR Gold Shares ETF. At Tocqueville, our fund has seen steady inflows all year, in some cases, very substantial inflows. I don't know if what we're seeing is comparable to other managers in the precious metals space, but our experience this year has been positive.
TGR: Headlines about conflicts in the Ukraine, Iraq and Gaza have bumped gold prices visibly lately. Can these events act as long-term fundamental supports or do they represent short-term volatility that will fade just as quickly as the headlines?
JH: Anything geopolitical always has a knee-jerk impact. I would never recommend gold based on today's headlines, yesterday's headlines or speculation about future headlines. Having said that, geopolitical issues away from the headlines influence the demand for gold. Europeans are probably more conscious of gold today than they might have been six months ago. People want to get their wealth in a safe place. That will reinforce demand for gold as time goes by.
TGR: You have compared gold's fundamentals today to the situation in 1999. What were the fundamentals 15 years ago?
JH: Fifteen years ago, we were at the end of a 20-year bear market, so the psychology was very negative. Gold was never mentioned in polite discussions. We're not that different today from where we were then. Considering the drop from a high of $1,900/oz to slightly less than $1,200/oz, that's a pretty big decline in the space of two and a half years. That makes the setup similar to what we experienced in 1999. Back then, the markets were flush with optimism, and I would say that's the case today. I think there are many parallels.
TGR: One unique thing that is happening right now is that the mining share valuations seem to be leading the commodity prices. What's causing that?
JH: It's not an ironclad relationship, but when the shares outperform the metal, which they've done this year and by a fairly substantial amount, that's generally a favorable setup for a better phase in the gold market. In 2011, the opposite occurred. Gold reached a new high and was in the headlines in every newspaper on the planet, yet the shares were conspicuous by their underperformance. That was a sign that the shares were not confirming the new highs in gold, and we've seen the result. A lack of confirmation between the shares and the metal prices can sometimes indicate the future direction of the gold price, or vice versa, of the share prices.
TGR: One thing that you and I have talked about before is the impact of quantitative easing (QE) on the dollar and the gold price. QE never did seem to weigh down the dollar. Are investors on the sidelines waiting for the impact of liquidity to buy gold?
JH: I think the rationale for owning gold is as strong as ever. Radical monetary policy probably won't end well and any thinking person should be concerned about it. That's why we believe you need to have some exposure to gold. Markets today are over-exuberant: pumped up equity valuations, nonexistent spreads between quality and junk, record issuance of low-grade paper, all of these things are typically indicative of an endgame in financial assets. Gold is not at that party. It's conspicuous by its absence. In our view, it's pretty hard to say that anything represents value these days except precious metals. Gold is wealth insurance.
When we started the Tocqueville Gold Fund (TGLDX) in 1998, we all said, "If this works, we'll be glad we did and if it doesn't work, everything else we're doing will be successful, rewarding and profitable." As it turned out, gold was a terrific thing to be in from 1998 through 2011. And we believe it will be again.
TGR: The Tocqueville Gold Fund was named by Lipper, the Thomson Reuters fund analytical arm, as the Best Fund in the Precious Metals category for the past five years. What is your investment thesis for this fund?
Doug Groh: The gold fund is an alternative to the monetary policies that we're seeing among central banks around the world. While the gold fund has about a 10% direct exposure to gold bullion, we're also invested in precious metal mining equities. Our goal is to capture the optionality to the gold price as these companies make discoveries, build out production and benefit from price volatility.
TGR: Last year was a challenging year for gold mining companies. How are you adjusting based on those challenges?
DG: We're emphasizing those companies that are well managed with good assets and quality balance sheets. Explorers are not as attractive today as they were a few years ago. Right now, we're focused on companies in the mid-cap sector of the gold industry.
TGR: Your quarterly report defines your approach as a growth fund made up of mid-cap companies. How does it compare with the investment styles of the other Tocqueville funds?
DG: Portfolio managers at Tocqueville Asset Management employ a contrarian value investment philosophy that generates attractive risk-adjusted returns over the long term. In fact, the gold fund was created as an expression of this contrarian thought process when physical gold was significantly out of favor in 1998. Although the Tocqueville Gold Fund is the only precious metals strategy at Tocqueville, we do offer other investment styles for those clients who prefer a more traditional allocation to equities. These offerings include a U.S. large-cap fund, a mid-cap value fund, a small-cap value fund, an international value fund, a liquid alternative strategies fund and a mid-cap growth fund.
TGR: Just over 10% of the $1.3 billion Tocqueville Gold Fund is invested in physical gold. Are you adjusting that based on some of the trends we have discussed?
DG: That's about what we're comfortable with. We don't really trade around that position. It's a core position for us. We think that as a gold fund, we should have direct gold exposure. While the gold equities can provide more return, they are more volatile. Physical gold has a stabilizing effect so we keep it at about 10%.
TGR: Let's talk about some of the best performers in the fund on the equity side.
DG: The fund performed well through June on the back of the market's recognition that gold was oversold in late 2013. The initial hostile bid by Goldcorp Inc. (G:TSX; GG:NYSE) for Osisko Mining Corp. helped our dominant position in Osisko. It was one of the top-weighted positions in the portfolio. The company attracted a white knight in Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE), which teamed up with Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) to win the day. During that process, the gold price recovered and the market recognized the value in the sector.
Now we are holding Osisko Gold Royalties Ltd. (OR:TSX), as well as Agnico-Eagle, which is one of the only companies that has increased its original guidance for 2014 after reporting year-end 2013, and is likely to increase guidance again for 2014 as it integrates the Malartic joint venture. It is enjoying a very good year so far and the market is recognizing that.
One of the other names that has done well in the portfolio has been Detour Gold Corp. (DGC:TSX). The market looks at Detour as a potential takeout, similar to Osisko. It has built a new mine in Canada. The market is recognizing that North American operations are more compelling than other parts of the world and worth a premium.
TGR: What is the role of royalty companies in the portfolio?
DG: Royalty companies such as Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX), Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) and Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) mitigate risk and maximize discovery upside. These companies, through their royalties, have a direct interest in ore deposits and the revenues or profits from the operations that mine those deposits, often before shareholders of the mining company that operates those mines. The market has embraced the royalty companies because of the limited risk exposure from a capital and diversification perspective. The business model can also allow for greater return potential.
TGR: How do you decide which royalty companies to include?
DG: Our gold team at Tocqueville is research intensive. We cover and follow the entire gold resource and gold mining industry. In that effort we seek to be well informed regarding the quality of gold resource assets around the world and the royalties associated with them.
We recognize that some of the larger royalty companies, like Royal Gold or Franco-Nevada, have been very good in the deals they have made to either acquire or establish royalties. Our exposure to these companies was relatively early compared to the general market's interest, because we recognized the inherent value of a royalty before the rest of the broader market.
For instance, the new Osisko Gold Royalties, a spin-off from the takeover of Osisko Mining, starts out with its Malartic mine royalty, which provides it with a solid base to build upon. Clearly, the Malartic mine is a very compelling asset as demonstrated by the hostile bid that Goldcorp made and the fact that Agnico-Eagle and Yamana stepped up to partner on a takeout of Osisko. The royalty that Osisko now enjoys from that mine is very attractive. Royal Gold also has a royalty on the Malartic mine, which we view as an endorsement of Osisko Gold Royalties as a company. In addition, Royal Gold has other royalties that are performing very well on developing and producing mines in other parts of the world. So it is a well diversified company.
TGR: Is the Osisko takeover a sign of more mergers and acquisitions (M&A) coming?
DG: M&A of varying sizes has been going on for some time. Many were just not quite as significant in terms of market cap. I think we will see more deals, whether it's actual corporate takeouts, joint ventures or property sales.
The decline in the gold price these last three years has been destructive for mining companies. It has caused them to rethink their business models and their capital spending plans. It's become more difficult for companies to raise capital to move forward. That is why consolidation is underway. That is the nature of the industry. A lot of explorers and developers are good at doing just that. Meanwhile mining companies need to replace the reserves they're producing. They may be good at operating a mine but not quite as agile at doing exploration, making discoveries and developing ore deposits. So we should see more M&A.
TGR: When you are considering adding a company to the portfolio, do you place a value on the chances of it being an acquisition target?
DG: Yes, in a form and fashion. Ultimately we are looking at the assets of a company and the merits of those assets to expand and to attract other investors into the company's register. The potential to get bigger is always of interest to us. If something is getting bigger, it will attract capital, whether it's investors or corporate entities.
TGR: Do you want to talk about some of the other performers in your top 10?
DG: Tahoe Resources Inc. (THO:TSX; TAHO:NYSE) initiated silver production this past year in Guatemala. While it was a slow start-up initially, it seems to have gotten off the ground and is ready to expand operations. We are quite encouraged by the results. We think it is going to be a stellar performer in the years to come. The market has now begun to recognize that and is giving it a much better valuation.
TGR: Company guidance is for 20 million ounces (20 Moz) of silver per year. Is that realistic?
DG: Yes, and I expect beyond that. It is a high-grade deposit with a geometric shape, in terms of its width, that enables bulk-style mining methods, and thus relatively low costs per unit of production. Once it gets momentum, we should see some robust output. Tahoe has been a good performer, and we expect it will continue to be a good performer.
TGR: Any others in the Americas?
DG: Primero Mining Corp. (PPP:NYSE; P:TSX) has been a good performer for us for the last couple of years. It has been successful at managing its mine in Mexico and expanding the operations there. We expect further expansion in the years ahead as this is a great ore deposit.
Plus, Primero's acquisition last year of Brigus Gold Corp. added to its portfolio and gave it diversification. As it establishes itself and mines that ore deposit, we expect the company will find a lot of value opportunities. We anticipate good results from Primero in the year or two ahead.
TGR: How about one more from your top 10?
DG: Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) has been a staple in the portfolio for quite a few years. In some regards, it has been considered a growth stock, but with the pullback in the gold price, it has slowed down growth plans. Still, it is well capitalized and, as we expect the gold price to improve, we anticipate that Eldorado will restart some of its initiatives. Right now, it is more of a value stock. But it has a very good portfolio of assets and projects that once the gold price rises to a higher level and warrants development of those projects, it should be very well capitalized to execute on those projects. So we're pretty enthusiastic about its future as well.
TGR: What words of wisdom do you have for investors who may have been in the gold space over the last three years or are just thinking about getting back into it?
DG: We believe that investors should consider gold and gold exposure as an alternative asset class and as part of an overall portfolio. While there are attractive values in the gold space, investors should think about having broad exposure to the gold sector, whether it's through bullion, mining companies in different stages of development, or producers. Each avenue carries different opportunities and risks. That is why a group of precious metals stocks mixed with an exchange-traded fund or a gold mutual fund like the Tocqueville Gold Fund can serve an investor better than having just one name.
Additionally, I would recommend that investors average their investment over time instead of buying all at once. The gold price is volatile and it's very difficult to get the low points. Averaging over time when the price dips can help financially and mentally even out the ups and downs.
Finally, consider gold as a very long-term investment, not just a two- or three-year investment. We believe it should be a permanent part of an overall portfolio as a non-correlated asset. It doesn't really have counterparty risk and it trades to a different type of profile than other financial instruments. That's why we recommend having a portion of a portfolio allocated to gold and gold mining equities.
TGR: Thank you, John and Doug.
DG: Thank you.
JH: My pleasure.
John Hathaway, senior managing director of Tocqueville Asset Management, manages all gold equity products and strategies at Tocqueville Asset Management. He holds a bachelor's degree from Harvard University, a Master of Business Administration from the University of Virginia and is a Chartered Financial Analyst. He began his career in 1970 as an equity analyst with Spencer Trask & Co. In 1976, he joined investment advisory firm David J. Greene & Co., where he became a partner. In 1986, Hathaway founded Hudson Capital Advisors and in 1988, he became chief investment officer of Oak Hall Advisors.
Douglas B. Groh is a portfolio manager and senior research analyst at Tocqueville Asset Management and has 30 years of investment experience. Before joining Tocqueville in 2003, he was director of investment research at Grove Capital. While an analyst for JP Morgan and Merrill Lynch, he was recognized by Institutional Investor and The Wall Street Journal. He holds a Master of Arts in energy and mineral resources from the University of Texas at Austin and a Bachelor of Science in geology/geophysics from the University of Wisconsin—Madison.
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1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Tahoe Resources Inc. and Primero Mining Corp. Goldcorp Inc. and Franco-Nevada Corp. are not affiliated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services.
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