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Charles Oliver: Out of Africa, into Americas

Source: Brian Sylvester of The Gold Report  (3/4/11)

Charles Oliver Sprott Asset Management Senior Portfolio Manager Charles Oliver says the social unrest in the Middle East could lead to a premium for junior companies operating in North and South America. He's taken profits on companies with exposure to Africa and moved that cash into others with primary assets in the Americas. Charles discusses a basket full of those names in this exclusive interview with The Gold Report.

The Gold Report: Charles, the Sprott Gold and Precious Minerals Fund (TSX:SPR300) had an impressive 74.7% gain in 2010. That same fund was up 114% in 2009. Congratulations!

Charles Oliver: Thank you very much.

TGR: Most of those gains came from dramatic rises in gold and silver juniors but more recently you trimmed back a lot of those positions in exchange for positions in large-cap gold producers. Why the change in philosophy after having such success with the juniors?

CO: It's not actually a change in philosophy. I love the juniors. I believe juniors will give you the best long-term outperformance and alpha. I'm continually upgrading the portfolio and improving it. Generally speaking, I like to have about one-third large caps, one-third mid caps and one-third small caps. The large caps give you liquidity and act as an anchor. In 2009, we saw great performance from the mid caps, but in 2010 they slowed down and a lot of the small caps took off.

In 2003, I did something very similar. I took some of my stocks, which were getting a little expensive on a relative basis, trimmed those positions and redeployed them into the best opportunities out there. Right now, I'm finding the large caps are the cheapest segment out there. I am still buying some mid and some small caps, but I'm looking for those companies that are significantly underpriced. It's a continuing philosophy; there is no change.

TGR: But what's going to make those large caps move? We haven't seen a dramatic movement in large-cap share prices despite having a gold price above $1,300/oz. for some time.

CO: You're absolutely correct. The large caps have performed terribly over the last four or five years for a couple of reasons. When the gold exchange traded funds (ETFs) came out, a lot of money that had been in large caps migrated to the ETFs. That's been going on for several years. When people migrate out of the large caps they help depress the price. So when I look at the large caps today I'm seeing valuations that are cheaper than I've seen this decade. If you look at companies like Goldcorp Inc. (TSX:G; NYSE:GG) and Barrick Gold Corporation (TSX:ABX; NYSE:ABX)—the big boys out there—these companies are trading very close to where they were in 2006 and 2007 when gold was at $600–$700/oz. Today, we've got nearly double that gold price.

These companies are making huge profits and generating a lot of cash flow. I think there's going to be a day when people suddenly wake up and say, "Wow, look at the value!" I think part of the driver will be new investment from dividend-seeking individuals, dividend funds and value funds. If you look at dividend funds, they never held a gold stock because, during the 20-year bear market in gold, most gold companies weren't paying a dividend and those that were certainly weren't increasing it. Today, companies like Barrick are actually increasing their dividends and have the potential to do even more. I'm looking for that tipping point and I believe it will come.

TGR: In a June 2010 interview with The Gold Report, you said gold would go above $2,000/oz. based largely on further paper currency debasement. But, supply/demand fundamentals don't seem to support a higher gold price. A recent World Gold Council report said total investment demand for gold fell about 14.3% in 2010 and scrap supply continues to pour in at record levels, reaching about 1,650 tons that year. Obviously, social unrest in countries like Libya and Bahrain continue to push gold higher based on the safe-haven bid but does it concern you that total gold demand is, in fact, retreating?

CO: It doesn't, actually. If I thought that was a long-term theme, it would be a big concern. But, having said that, I think you have to look at the numbers and make sure you put them in proper perspective. Investment demand is often a plug for all the other numbers that go into the supply/demand numbers. Consequently, many numbers actually don't get included in that final demand number.

Let's look at it in a slightly different way. Gold mine supply today is roughly 2,650 tons. We use the numbers from Gold Field Minerals Services and if you look at investment demand over most of the last decade, basically it's been flat. You didn't really get significant investment demand until 2009 when, by GFMS' calculations, it was around 1,400 tons. Now going from practically nothing to 1,400 tons when mine supply is only 2,500 is a huge difference.

If you look at 2010, GFMS has an investment demand number of 967 tons. Is it a significant decrease? On first blush it seems quite significant, but it's the second-highest level of investment demand in the last decade. The trend is clearly up. I've been reading reports that Chinese and Indian citizens are increasing their gold purchases at record levels. When I look at the other things around me, they suggest that we are more likely to see higher demand in the future. When you look at sales from the U.S., Canadian, Australian or any other Mint, you'll find most of them are running at record production levels due to individuals buying coins.

TGR: And central banks have stopped selling their gold, too.

CO: Yes, that's another good example. If you go back to 2005, the central banks, as a group, were selling about 600 tons of gold annually. When you have mine supply at 2,600 tons, and then you get another 600 tons on top of it, there's a fair amount of gold out there. Today, those 600 tons are no longer being sold into the market. And we are seeing central banks actually buying gold.

In 2010, we saw India announce that it added 200 tons. We've seen some of the smaller banks buying, too, like Mauritius, Sri Lanka. We've seen China indicate that it's been buying over the last several years, though, the country doesn't officially report that on a regular basis. And a Russian minister said the country was looking at adding about 100 tons of gold on average each year to its reserves. So, a lot of the anecdotal evidence suggests that investment demand is actually increasing.

TGR: Let's go back to the Middle East for a moment. The unrest there has pushed gold up about $100 over the past couple of weeks. Have the ongoing issues there or in northern Africa caused you to change your investment strategy in the near term?

CO: One slight difference is that I've become a little more cautious on Africa in general. Many gold companies have exposure to Africa. The speed at which some of these countries are destabilizing has caused me concern. I think that most of the countries where mines operate will be fine; but having said that, I am cognizant there could be some nervous investors who decide they want to reduce their ownership in those areas. I've taken some profits from those areas and redeployed them back into what I deem are safer jurisdictions like North and South America.

TGR: Do you believe what's happening in northern Africa and the Middle East is the "mania" catalyst the gold bugs have been seeking?

CO: Generally speaking, most crises pass and get resolved. Frequently, you see the gold price run up only to fall back down the next day. I try to block out these events because often they don't really change the long-term value of gold. The concern, however, would be if this becomes more systemic and global in nature. In that case, I certainly think it would have a larger, more-lasting impact. But, again, I think you want to look at how destabilizing this is on Europe and the U.S. If it spreads to Saudi Arabia, that would cause me great concern.

TGR: Well, King Abdullah recently announced $37 billion in appeasement money over the next few years in an attempt to stave off any unrest.

CO: That's a nice way to put it. The fact that they're actually doing that leads one to believe that these guys must be getting a little bit nervous about the situation.

TGR: You mentioned safe jurisdictions like North and South America. Is there a price premium on companies with gold projects in those jurisdictions due to the unrest elsewhere?

CO: Over the last decade, there've been periods when I would say there was a price premium on North American projects and some of the other countries have versus those in other less-desirable or more-risky areas. I think we may be embarking upon that situation once again, but we haven't seen a huge movement occur yet. As I said, I've started trimming and moving more money out of my African countries. Again, that's commensurate with the discount rate that should be used for different countries and their associated risks.

TGR: Are you still finding value in companies with projects in North and South America?

CO: When I look at the basket of opportunities in North America, some companies are expensive and some are dirt cheap. I'm finding lots of opportunities to add in the North American space.

TGR: What are some juniors with projects in North America that you believe can be had at good value?

CO: There are companies like San Gold Corporation (TSX.V:SGR); we're big shareholders of San Gold. We're also big shareholders of Kirkland Lake Gold Inc. (TSX:KGI). The company is producing 100,000 ounces (100 Koz.), has the potential to triple that production and is trading at dirt-cheap valuations relative to most of the other companies out there.

TGR: And Kirkland Lake's conducting more underground drilling so it could further increase its resource, too.

CO: Yes, I visited the property last summer and looked at some of the new underground drill platforms. I remember asking about how much drilling the company would be doing from this one particular platform. Kirkland said, "Well, we've got this new area that's never been drilled before. It's right beside our existing underground mine. We're going to drill it for two or three years."

Just this past month, the company announced some of the first drill results from that campaign. It's very early stages but it looks like Kirkland Lake will be adding more resources to an already very significant resource, which would increase its ability to expand production.

TGR: What are its cash costs there?

CO: The cash costs are a little high, about $700/oz. right now. The company's trying to bring it down to a more reasonable level. The precise cash costs for the Macassa mine are $709 in Q111 and $809 in Q211.

TGR: What are some other names that offer value?

CO: Another company I quite like is Osisko Mining Corp. (TSX:OSK). Osisko has had a great run up recently as it's moved toward production. My understanding is it's just about to start running the mill and producing gold.

TGR: Did it alarm you when Goldcorp sold off its 10% interest in advance of production?

CO: No, I think Goldcorp has lots of opportunities. I think it would've liked to have gotten Osisko at a dirt-cheap price because Osisko has done a great job of building up the company—not just with the new Malartic mine in Quebec, but the company also bought Brett Resources Inc. and its Hammond Reef project, which it's drilling extensively. Osisko also got the Duparquet joint venture (JV) with Clifton Star Resources Inc. (TSX.V:CFO).

TGR: And you still have a position in Clifton Star, right?

CO: Yes, I do hold some Clifton Star, as well. We trimmed our position in Osisko earlier this year. It had done very well but we've seen the company consolidate over the last number of months. As it's done further drilling and gotten closer to production, I think the story has improved. You're looking at a company that's trading in the low double digits. I think this company has the potential to be one of the premier emerging gold companies, and it's Canadian.

TGR: You also have a position in Fire River Gold Corp. (TSX.V:FAU; OTCQX:FVGCF). Why do you own shares in Harry Barr's company?

CO: We invested in Fire River Gold almost two years ago. I remember when Harry came in to talk to me in 2009, talking about an asset he bought from a company that was in financial distress. Many companies were caught off guard by the magnitude of the 2008 correction.

TGR: Was he talking about St Andrews Goldfields Ltd. (TSX:SAS)?

CO: Yes. He managed to come up with $500,000 to buy the Nixon Fork Gold Project and plant. Harry bought those assets for a song. It's going to be small scale, but Fire River will be starting production in the next several months. It's got cash on the balance sheet, no debt and some of the highest-grade ore out there—it's nearly 1 oz./ton. And it's planned further drilling programs.

TGR: Some of that is to better understand the geology of the deposit because St Andrews didn't really understand the deposit, so it got into some issues with the recovery circuit and dilution.

CO: Yes, mining is a very tough business. You've got to find the gold, and then extract it economically—that's often quite a challenge. But Fire River has all the parts. It really comes down to execution now.

TGR: Harry certainly has the financing connections and the experience to lure the kind of expertise needed to bring Nixon Fork to production. Another project in Alaska that you have a position in is Kiska Metals Corp.'s (TSX.V:KSK) Whistler project.

CO: Yes, I took a position in Kiska last year. I always liked the management team; I've known them for quite some time. It was probably around the Prospectors & Developers Association of Canada (PDAC) conference last year where I met up with them again and looked at the Whistler Project and thought that looks like a very interesting project. One of the issues I had at the time was that Rio Tinto (NYSE:RIO; ASX:RIO) had a back-in right to the project.

TGR: Not anymore.

CO: Not anymore. I talked to management several months later to schedule a follow-up meeting. This was around the time that Rio Tinto looked like it was about to walk away. As soon as I recognized that it would no longer be involved in the play, I basically decided it was time to become a shareholder.

Kiska has been drilling up the Whistler Property. I think it's got just over 5 million ounces of gold equivalent (Moz. Au Eq.) there now. It's moving on to drilling some of the other peripheral targets where it has some discoveries. That drilling will ultimately decide whether or not Whistler is economical. One thing to remember is that a lot of these plays in Alaska are very remote, so infrastructure is always something you have to consider. Barrick has been looking at using a natural gas pipeline as part of the development model for the Donlin Creek copper-gold project in Alaska.

TGR: That's a 50/50 JV with NovaGold Resources Inc. (TSX:NG; NYSE.A:NG), right?

CO: That's correct. If Barrick builds that nat gas pipeline, basically, it would go right by Kiska's Whistler property. If that happens, Kiska would get some pretty good infrastructure put into place, which would really be a big win for the company—one of those things that's outside of Kiska's hands—but, I'm keeping a close eye on what Barrick does.

TGR: Do you see Kiska as a takeover target, Charles?

CO: At this point, I don't expect it to be taken over. Should the natural gas pipeline get the go-ahead, then I think it would definitely be a takeover target.

TGR: Could you give us one more name before we let you go?

CO: I hate to give you one. Can I give you a whole bunch? We haven't really talked about South America. I always like to give a basket of names because they all have different risks. The companies in which we have significant positions are, alphabetically, Belo Sun Mining Corp. (TSX.V:BSX), Guyana Goldfields, Inc. (TSX:GUY), Magellan Minerals Ltd. (TSX.V:MNM), Minera Andes Inc. (TSX:MAI; OTCBB:MNEAF) and Torex Gold Resources Inc. (TSX:TXG).

TGR: Let's start with Belo Sun with a Brazilian gold project where it's been busy proving up ounces.

CO: Yes, it's got north of 2 Moz. One of the things that's been a really nice surprise this year is that as Belo's done some infill drilling it's actually been able to increase the grade of the resource. What you often see with a rising gold price is that companies use a lower-grade resource. It's nice to see that going the other way.

TGR: You mentioned Guyana Goldfields. Do you see an opportunity for Sandspring Resources Ltd. (TSX.V:SSP), which also has a gold project in Guyana, to join forces with GUY?

CO: I don't think the two will join forces. You've got two very different management teams. Guyana Goldfields looked at Sandspring's properties before Sandspring had even acquired some of them. It would probably make sense to have all these properties under one umbrella, but I doubt it will happen. At some point, I expect somebody will take out Guyana Goldfields. One of the logical buyers would be a company like IAMGOLD Corporation (TSX:IMG; NYSE:IAG), which already has a presence there. But if Sandspring continues to build ounces, and it's had some great drilling success to the north where it added quite a few ounces, then maybe it, too, could get acquired at some future point.

TGR: You mentioned Minera Andes, too. Tell us about that one.

CO: Minera Andes is Rob McEwen's company that has the JV with Hochschild Mining (LSE:HOC).

TGR: And Mr. McEwen is Minera's largest shareholder.

CO: Yes, McEwen's the largest shareholder at 33%. Rob has done very well for those people who've gone along with his investments. I think he's done a great job. Minera Andes has a couple other assets besides the silver play. It also has the Los Azules copper-porphyry deposit, which probably should be spun out. The other thing that gets me excited is that Goldcorp recently bought Andean Resources for about $3.5 billion. Rob McEwen has all the properties surrounding that area.

TGR: Yes, he's hoping some of Andean's high-grade mineralized structures run onto his claims. And there is some evidence of that.

CO: The company will certainly get some. The question always is: Will it be economic? Will the company find enough? And you can't do that without putting in the proper legwork.

TGR: But Goldcorp's never going to take out a Rob McEwen majority-owned company.

CO: I'm going to bite my tongue on a comment right now.

TGR: Right. Well, what should we expect in terms of the near-term gold price?

CO: I'm still extremely bullish on the gold price. As I said, I expect gold to be at $2,000/oz. in the not-too-distant future. Otherwise, I will have to shave all the hair off my head.

TGR: Back in April 2008, you made a statement that gold would reach $2,000/oz. in four years and if it didn't you would shave your head. Are you still standing by your statement and is the deadline April 16, 2012?

CO: Yes. My view is really based on the fact that anywhere I look, I see governments continuing to print money left, right and center. I see deficits continuing to spiral out of control. I think governments are helpless to do the right thing, which is cut spending, because if they cut spending they get voted out of power. Without any other answers, they ultimately decide to print some money. That's easy enough. Nobody complains about that.

TGR: Could gold eclipse $1,500/oz. in the near term?

CO: I wouldn't be at all surprised to see gold break out, make a new high and take out $1,500 in a very short period of time.

TGR: We'll look forward to that. Thank you for talking with us today, Charles.

Bringing more than 21 years of experience in the investment industry, Charles Oliver joined Sprott Asset Management (SAM) in January 2008 as an investment strategist with a focus on the Sprott Gold and Precious Minerals Fund. Prior to joining SAM, Charles was at AGF Management Limited, where he led the team that was awarded the Canadian Investment Awards Best Precious Metals Fund in 2004, 2006 and 2007 and was a finalist for the best Canadian Small-Cap Fund in 2007. At the 2007 Canadian Lipper Fund awards, the AGF Precious Metals Fund was awarded the best 5-year return in the precious metals category, and the AGF Canadian Resources Fund was awarded the best 10-year return in the natural resources category.

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DISCLOSURE:
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: Goldcorp, Fire River Gold, Kiska, NovaGold, Guyana Goldfields and Sandspring Resources.
3) Charles Oliver: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.



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