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Bruce Campbell: No $2,000/oz. Gold in Forecast

Source: Brian Sylvester of The Gold Report  (4/13/11)

Bruce Campbell Not long after a New York Times headline quipped, "Now the Gold Rush Is to the Exits," Campbell & Lee Investment Management Cofounders, Bruce Campbell and Joe Lee, hung out their shingles in Oakville, Ontario. That was late in 1999. With the price of the precious metal (PM) sinking toward its lowest level since 1975, when the U.S. abandoned the gold standard, the new investment management company had no reason to focus on PM companies. Obviously, as Bruce tells us in this exclusive Gold Report interview, the company has since shifted its focus.

The Gold Report: Tell us a little bit about Campbell & Lee Investment Management.

Bruce Campbell: We provide investment management for individuals. We have continued the same positive, long-term track records we had at larger places but because we are smaller, we can have more fun and be a little bit more nimble.

TGR: So, you give your clients at least some exposure to gold in their investment portfolios?

BC: Yes; in fact, we have the highest percentage of gold and silver in our equity model portfolios that I've had in my 35 years—approaching 15% at the moment. It's primarily gold with some silver spread out among five or six holdings at any one time.

TGR: That's a huge change from when you started your business because, at that time, the gold price was headed downward.

BC: The complete bottom might have been $240 for a short period. To show you how the business has changed, at that time we had a minimal gold weight. Anecdotally, I remember visiting Geomaque Exploration Ltd. at its San Francisco mine, a small, low-tech, heap-leach mine in northern Mexico just a couple of hours drive over the border from Arizona. At that time, gold was at around $270/oz. and the company's costs were about $230; so, it was eking out in survival mode. The mine shut down shortly thereafter and Geomaque was taken over, but it sounds as if it's worth bringing it back with gold at $1,460 now. I understand that Timmins Gold Corp. (TSX.V:TMM), which formed in 2005 to acquire the San Francisco Mine, is resurrecting this property now and expects to start producing later this year.

TGR: Until the last few years, gold served mostly as an insurance policy in investment portfolios. It didn't appreciate much, nor did it depreciate greatly. But with gold's 30% or so rise in 2010, investors are now increasing their exposure and expecting large returns from their gold holdings. What do you tell your clients when it comes to investing in gold and silver?

BC: That's a great question and one that all investors should ask themselves. There are a few components to consider. One, the aspect of portfolio insurance remains valid—particularly post-crash; late 2008 and early 2009 is the first time we raised our gold weight. Two, we're now starting to see inflation creep back in, at least as a possibility; so, gold is a nice hedge that way.

With the rise in the gold price, I'm also searching for companies that can raise their production substantially so that I'm not depending solely on the price of gold for the higher stock price. A high gold price becomes a great bonus and produces some really, really high returns; but, given the run we've had, what if we go sideways for awhile? You want good operators who've figured out how to grow a business or are discounted in the market due to some previous problem or whatever the combination might be. With these companies, you can make money in a flat gold environment or make a ton of money in an up gold environment.

TGR: On April 6, gold popped above $1,460/oz., hitting a new all-time high of $1,476.20/oz. two days later when silver hit a 31-year high of $40.63/oz. These levels bring a lot of media attention and buying interest from large funds. Will that "hot money" and renewed retail interest add volatility to the precious metals markets?

BC: I think the answer is yes. In that same period, when gold and silver went up a little bit more each day, the stocks were all down; so, you see this volatility even inside the equities market versus bullion. In other words, the stocks aren't necessarily tracking the price of the metals closely—and haven't been for awhile. Once the market recognized that the stocks were lagging, a number of the stocks went up 5%–7%. First it was the larger caps, and then the juniors as investors got around to them.

The direction is up here. There will be some momentum and fast money players saying, "Gold goes through $1,500/oz.," but it probably won't be without huge volatility.

TGR: One reason for the $30 spike that drove gold up to $1,460/oz. within a span of 24 hours, apparently, was the euro's strength against the U.S. dollar (USD). That seems odd, given that Ireland is being bailed out with Portugal next in line, and we're hearing more about sovereign debt problems in Spain and Italy. What does all of this tell us about the USD?

BC: I think it was a weak-dollar story as opposed to a strong-euro story that triggered that price spike. It's the same with oil. It's been around $105 per barrel lately, but the Canadian dollar got through CAD$1.05 today. That's more a weak USD story than the Canadian dollar being dragged up—and it's not just the Canadian dollar, but also the Australian and New Zealand dollars and the Brazilian real. The euro happens to be caught up in it, as well. All the nice alternatives to the USD are strong. If you looked at the price of gold in euro or yen, you'd see the chart's not nearly as compelling as it is in U.S. dollars.

TGR: With political instability in the Middle East, inflation creeping into developed world economies, a $1.4 trillion U.S. deficit and monetary debasement, is this the "perfect storm" for gold?

BC: To have all of those things going, yes, I believe it is. But just in case that perfect storm reverses somewhat, I think investors should be buying gold producers that will be growth companies. It wouldn't deter a long-term story but gold going down $100–$200 would be a normal pullback. Were it do that and stay down, you'd want companies that can grow their way through it by producing.

TGR: You've said that, typically, equities rise 4% for every 1% increase in the gold price. Is the opposite true?

BC: That has been the historical case, but it's not been working quite to that extent lately. In the last year or two as prices have gone up to the stratosphere, that relationship has broken down. Some days it's something like 1.5%, not 4%. It's just that they're not going up as much. And one of the primary reasons for that is because costs are rising more significantly than normal. The price of oil is up, which is the highest single cost for a gold producer, followed by labor costs. With oil up, the gold producers aren't benefiting to the extent they would normally benefit.

When dollar-related strength causes gold to pull back along with oil, the gold producers tend to go down more than the gold price. It's an instance where they probably shouldn't, but the initial reaction would be as we saw with the recent $100 pullback. The stocks went down more than they should have just on the basis of the historic relationship.

TGR: Beyond the factors you've already mentioned, how do you determine which equities you pick and which you leave on the shelf?

BC: In contrast to non-mining/non-PM companies, where price-to-earnings (P/E) and price-to-book (P/B) are things to consider, in gold companies we look for price-to-net-asset-value (P/NAV), which encompasses the current value of all of the production coming out of mines, minus the cost. That gives us a feel for a company's potential growth and upside. Gold stocks tend to trade on anticipated higher gold prices, increased production growth, increased reserves or a combination of all three.

TGR: Any other metrics you watch?

BC: We also consider price-to-cash-flow (P/CF), which is more of a look at the value of current production. This removes non-cash items (depreciation, etc.) and simply measures the cash being generated relative to the stock price. Generally, companies with a low P/CF are discounted for either geopolitical risks or lack of growth potential.

We look at the balance sheet, too. Depending on their size, it's easier for companies to raise money right now. Juniors, certainly, have been doing a lot of that. As far as senior companies, they don't have to raise new equity that way if they're doing a takeover. I guess Kinross Gold Corp. (TSX:K; NYSE:KGC) might be the last one of size, after taking over Red Back Mining.

TGR: Any other important considerations?

BC: The production profile has become key for us right now, as well as the ability to replace production. The really big guys—the Barrick Gold Corp. (TSX:ABX; NYSE:ABX) types of the world have to consider this. If they produce 8 million ounces (Moz.) this year, they have to pull 8.5 Moz. out of their mines next year to show growth—that's a lot. A small producer can mine a fraction of that and show growth.

TGR: What's the story on that Red Back acquisition?

BC: Kinross is another rerating story, and I think it's now the cheapest senior by far. The stock is probably a full $5 to $7 undervalued on a $15 base, but it looks as if it'll be fine. The company just took analysts and investors on a tour of Tasiast, the Red Back mine in Mauritania, in the western region of North Africa. It's already started working down the $900/oz. it paid for the mine, which is very expensive relative to, say, Goldcorp Inc. (TSX:G; NYSE:GG) getting it out of the ground for $190 (net of byproduct credits).

We think it will take until this fall to fully prove it up; but having proven a bunch of extra reserves up so far, it's off to a good start. The company probably has to find up to 40% more to get that $900 number down to something more reasonable.

TGR: Where do you come by that Goldcorp figure?

BC: Goldcorp just announced the results of an updated feasibility study for the Cerro Negro project in Argentina, which it gained through its acquisition of Andean Resources last fall. This update indicated average gold production of approximately 550,000 ounces (Koz.) per year during the first five years at a production cost of $190 (once you factor in the silver byproduct credit). If you do this in gold terms, at $1,460 minus $190, it'll make $1,200/oz. for the gold with silver as a bonus. And as I've said, the seniors have lagged a little bit; so, there's some value there. Goldcorp is as cheap as it's been for a couple of years.

TGR: You recommended a small-cap stock among your top picks in a February interview with BNN, indicating that it would be a $7 stock by year-end if gold prices remained static. Clearly, prices have been anything but static. How do you feel about that pick now?

BC: That's Argonaut Gold Inc. (TSX:AR), and I still very much like the company. Since that BNN interview, I met with management when they were in town and spoke to them again at the quarterly conference call a couple of weeks ago. Argonaut fits all those parameters. It has growing production; in fact, by 2013, it probably will be four times what it was in 2009. Argonaut will double in production this year, and then double again over the next couple of years. If you put that together with my $7 target, Argonaut would still be a discount to net asset value (NAV). And it's the only gold producer I can find that trades at such a substantial discount; the seniors trade at premiums. If AR was to trade at a premium, it would be an $8 or $9 stock.

TGR: Why, in your estimation, is it trading at a discount?

BC: The market cap is roughly $400 million; so, it's under the radar for a lot of large investors. It's also relatively new; the management team that built up Meridian Gold over the years and sold it to Yamana Gold Inc. (TSX:YRI; NYSE:AUY; LSE:YAU) in 2007 has come back to do it again. Basically, the company is only about one year old and has already acquired Pediment Gold; so, it now has a second producing mine coming onstream. Here I am spreading the word, as are some others, but I'd say probably 80%–90% of senior, large investors in North America still haven't heard of it.

TGR: Currently, Argonaut's only producing mine is El Castillo in Durango, Mexico, correct? How much production should we expect from that operation in 2011?

BC: We're looking at somewhere in the range of 70–75 Koz. I believe El Castillo's number for 2009 was 30 Koz.—so there's your first double. And as I said, the management team has a chance to do again what it did at Meridian. I wouldn't be surprised to see Argonaut do another small acquisition before year-end that may take that 75 Koz. higher, or at least have something with additional production to bring forward before the Pediment Mine comes in 2013.

TGR: So, we can look forward to further growth. That's great. You also imply a preference for precious metal producer versus explorer equities. Could you talk about some specific mid-cap equities where you continue to see value?

BC: Sure. One example, which we bought last summer, would be Allied Nevada Gold Corp. (TSX:ANV; NYSE.A:ANV). It fit all the criteria and was a discount to NAV. The company is in Nevada and has one producing mine and an exploration project a little ways west of that mine. Another criterion that I failed to mention earlier is that you want good finders—good drillers. On that score, Allied Nevada has proven up so much in extra reserves that the stock has gone wild lately. It's obvious that the company has a whole other mine with a large silver content. So, the stock is trading at about $36 on the Toronto exchange and $37.46 on AMEX now. We bought it last June at $19, so it has doubled for us, and we continue to hold it.

TGR: You mentioned silver there.

BC: On the silver side, we've owned Great Panther Silver Ltd. (TSX:GPR; NYSE.A:GPL), which had a nice run. We currently own Tahoe Resources Inc. (TSX:THO), which is doing well with the old Glamis Gold management team from before Glamis was taken over by Goldcorp. This team has come back around again, and it's doing well with a silver project in Guatemala—that one's also pretty good.

TGR: Any other companies you want to mention?

BC: Minefinders Corp. (TSX:MFL; NYSE:MFN), with a market cap of almost $1 billion, is expecting greater production of both gold and silver from its Dolores Mine in Mexico just across the Arizona border. The company has overcome some operational problems that made 2010 a pretty challenging year; so, its stock, which had been lagging and looked quite cheap for a long time, has perked up lately.

IAMGOLD Corporation (TSX:IMG; NYSE:IAG) is another one. This midtier producer's biggest mines are located in Quebec, Guyana (South America) and West Africa. We thought it had the best short-term growth of players in Africa and that's proven true. The stock has done well.

TGR: Could you quickly map what you see as gold's path between now and the end of the year, if not year-end 2012?

BC: My crystal ball gets hazier the further out you go, but I believe that the perfect storm we were talking about earlier will allow a $1,500/oz. price tag on gold at some point this year. We have a bit of momentum here, so I think we might see that—it's only a couple of percentage points away. After that, what's next? Unless there's some further disaster, I don't see why it wouldn't just keep going. Of course, nothing goes in a straight line; so, it would make a lot of sense for both gold and silver to pause—maybe go sideways—and have gold end the year at $1,550/oz. or something like that.

TGR: And if you go further out?

BC: If you go into next year, I think the key will be the U.S. economic recovery. If it's strong enough to take higher interest rates, Canada raises rates and rates start to go up generally, it makes gold less attractive because the dollar will be stronger. But it's also because the costs of holding gold will become higher. That's when you could see a pullback. To me, that's more likely than a doomsday scenario; so, currently, I don't think gold will see $2,000/oz.

TGR: Ever?

BC: No, just in the relatively near term. We'll have inflation over the next few years because we've just postponed it with all this liquidity in the system. With inflation, gold will climb its way upward over the long term, but I don't see a 20%–25% lift right away.

TGR: Thanks so much for your time and insights, Bruce.

Bruce Campbell is a money manager with more than 35 years of experience. The research, portfolio construction and buy-and-sell strategy that he brings to his work produces above-average returns. Bruce began his career as an investment analyst with CIBC and Ontario Hydro, after which he joined Royal Trust Capital Management. As senior vice president there, he managed more than $10 billion of Canadian and U.S. equity money for pension plans and mutual funds. He subsequently served several years as chief investment officer and partner with Nisker Associates. For the past 11 years, Bruce has been president and portfolio manager for Campbell & Lee Investment Management Inc., which he and Joe Lee cofounded. He earned his bachelors degree from McMaster University in 1976 and a masters in economics from York University in 1981.

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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: Timmins, Goldcorp, Argonaut, Allied Nevada, Great Panther and Minefinders.
3) Bruce Campbell: I personally own shares of the following companies mentioned in this interview: Kinross, Goldcorp, Allied Nevada, Tahoe Resources and IAMGOLD. I personally am paid by the following companies mentioned in this interview: None.



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