The Gold Report: The U.S. Federal Reserve has downgraded its forecasts for both economic growth and inflation. That being the case, why would it raise interest rates?
Chris Mancini: There's a certain contingent in the Fed that believes that its zero interest monetary policy might result in adverse consequences going forward. This contingent is dead set on raising rates and trying to get back to some level of normalcy in interest-rate policy.
TGR: There's a school of thought that holds that the U.S. economy has become addicted to cheap money. What's your view?
CM: There's no question that much of U.S. economic growth in recent years is due to very low interest rates. The average interest rate on auto loans is the lowest ever. That obviously spurs auto sales. The rates charged for federally subsidized student loans are close to historic lows. That spurs demand for college and university courses. And even though the housing industry is still struggling with an inventory glut, the 30-year mortgage rate of 3.75% spurs demand for housing.
So, I think that if interest rates do rise, there's a good chance that the economy will slow, and there will be a panicked reaction from the stock market.
TGR: Despite this soft recovery, the equity markets have never been stronger. Why has this happened?
CM: It's another function of low interest rates. If you keep your money in the bank, you're getting zero percent and thus losing money on a real basis. This has forced savers into other asset classes. And money is flooding into America from all over the world because, compared to, say, the Eurozone and Japan, which are struggling with deflation, the U.S. economy looks pretty good.
TGR: Is an economy that punishes savers sustainable?
CM: It's sustainable until it's not. Asset prices continue to increase greatly, and at some point people will start to realize that the value of money is not what it seems. That will lead to a crisis of confidence and, eventually, to the deterioration of the monetary system. The question is when. And I don't know the answer to that.
TGR: Should an interest rate hike backfire, could we see the return of quantitative easing (QE)?
CM: If the economy slows after a rate hike, I think the first thing the Fed will do is to lower rates to zero again. And if that doesn't kick start the economy, which it probably won't, there's a good chance we will get QE4.
TGR: You've argued that "Paper speculators in the gold futures market have been a more important factor in determining the movement of the gold price this year than has physical demand from gold consumers." Does the speculation depress the gold price?
CM: On certain days it definitely does. Days when the shorts come back in and when the speculative longs take their positions off. But speculation can also lead to a higher gold price. For instance, when gold went to $1,300 per ounce ($1,300/oz) at the beginning of this year, I think a lot of this rise was due to speculators putting longs on and covering their huge short positions.
TGR: Aren't these speculators flirting with disaster?
CM: We have recently seen huge moves up or down in the gold price in the space of minutes. That tells me that speculators who are using leverage are making moves to avoid being wiped out.
TGR: Physical gold demand from Asia and from central banks remains strong. Are we getting close to the point where, as you put it, "Rock will beat paper?"
CM: That will happen when Americans lose hope in the ability of the Fed to direct economic policy and buy gold again, whether in physical form or more likely in the physically backed exchange-traded funds like SPDR Gold Shares (GLD:NYSEArca). That's what happened in 2011, when the gold price topped $1,900/oz.
TGR: What's your gold price forecast for 2015?
CM: I expect it will trade in the $1,200–1,300/oz range. There's a very good chance 2016 could be a much better year for gold, especially if the Fed lowers interest rates again and embarks on QE4.
The potential end game for gold is if a complete loss of confidence in the U.S. dollar forces the government to peg it to gold.
TGR: In a Gabelli note dated April 24, you wrote, "High-quality gold mining companies have positioned themselves well during this current downturn in the gold market." What are the qualities that distinguish high-quality gold miners?
CM: We look for companies with very little debt on their balance sheets, low operating costs and very good management. One example would be Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE). It has net cash on its balance sheet, no debt and great management. Its all-in sustaining costs (AISC) this year should be around $900/oz. Randgold would be able to survive a significant drop in the gold price. And this company has the means to make good acquisitions at low prices and arrange profitable joint-venture (JV) deals on strong assets. Its management has been talking about doing just that.
TGR: What other miners do you consider to be high quality?
Fresnillo has a very small and manageable debt burden. It is in a growth phase now. It's operating costs are declining because of the Mexican peso's weakness against the U.S. dollar and declining construction and drilling costs. The cost of labor in Mexico is not declining, but it's not increasing as it did in the recent past when there were lots of projects being built in Mexico. This company's AISC are around $5/oz for silver and $800/oz for gold. Fresnillo is well positioned for the future.
TGR: Do you have any concerns about the political and social climate in Mexico?
CM: There are issues in Zacatecas and Sonora where Fresnillo operates. I expect that the company will take steps to increase security to the extent that it's necessary. Fresnillo is a Mexican company that has been operating in the country for over 40 years. The recent robbery of McEwen Mining Inc. (MUX:TSX; MUX:NYSE) was a wake-up call for the industry.
TGR: What do you like about Agnico?
CM: Agnico has debt, but it's manageable. Its Osisko acquisition last year positioned it as the 800-pound gorilla in the Abitibi Belt, one of the best places in the world to mine. Agnico is a low-cost producer with management that has a track record of investing capital wisely. And it has good growth potential.
TGR: Besides Osisko, Agnico has also bought Cayden Resources Inc. and Soltoro Ltd. What do you make of this strategy?
CM: Agnico has been taking advantage of the downturn and buying these companies very much on the cheap. Because the company didn't come into the downturn with much debt, it was able to borrow money to buy Osisko, which is cash-flow generative.
TGR: And what impresses you about Tahoe?
CM: It has Escobal in Guatemala, one of the best primary silver mines anywhere. The merger with Rio Alto Mining Ltd. gives it cash on the balance sheet, La Arena in Peru, which produced 222,000 ounces (222 Koz) gold in 2014, and the Shahuindo gold-silver project in Peru. Both of Tahoe's producing mines are low cost.
Tahoe will able to build Shahuindo at low cost. After that goes into production, the company will then have three cash-flowing mines and no debt. This gives it the opportunity to make another acquisition and use its cash flow to build it.
TGR: One of Tahoe's employees is being confined by a Guatemalan court. Does this concern you?
CM: Guatemala is a difficult place to mine. The people are great, but the politics are a mess. It was a huge shame to see the royalty rate increase after a last-minute deal with no consultation with the mining sector. It is a real testament to Tahoe and to the Guatemalan people that the company has been able to ramp up production to 4,500 tons a day from an all-underground mine with an almost exclusively Guatemalan workforce trained onsite.
TGR: Which streaming companies does Gabelli hold?
CM: Our biggest holding is in Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) followed by Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX), Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) and Osisko Gold Royalties Ltd. (OR:TSX).
Franco-Nevada is the gold standard of royalty and streaming companies. It has some of the highest-quality streams and royalties in the world, a well-diversified portfolio, cash on its balance sheet and management that is willing to invest at the down points in the cycle.
Royal Gold's portfolio isn't as diversified as Franco's, but it has some very good royalties, including Goldcorp Inc.'s (G:TSX; GG:NYSE) Peñasquito mine in Mexico and Thompson Creek Metals Co. Inc.'s (TCM:TSX; TC:NYSE) Mount Milligan mine in British Columbia. It has been a little bit less aggressive in deploying its cash during this downturn, but it has done some prudent deals recently.
Silver Wheaton has been very aggressive and has royalties on some very good projects, including Peñasquito. It has been dealing with a tax problem in Canada, but I think that will be resolved this year. It does have debt, but this company is a very good buy today.
TGR: Will Silver Wheaton go more aggressively into gold?
CM: It is doing that already. Its most recent deal was buying an additional 25% stream of Vale S.A.'s (VALE:NYSE) Salobo mine in Brazil for $900 million ($900M). That was a very big deal for Silver Wheaton and pleases us because we prefer gold streaming to silver streaming.
TGR: And what do you like about Osisko Gold Royalties?
CM: We got Osisko Gold Royalties after Agnico and Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) bought Osisko. Now, after its takeover of Virginia Mines, Osisko Royalties has royalties on Éléonore and Canadian Malartic, two of the world's best gold mines in a fantastic jurisdiction, Quebec. These are net royalties, so the money comes off the top line. Osisko Royalties has a lot of cash, which it can use to make further acquisitions.
TGR: Do you expect to see any merger and acquisitions among the gold majors?
CM: The proposed merger of Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Newmont Mining Corp. (NEM:NYSE) would have made sense from an operational point of view because of the synergies it would have created in Nevada. The new chairman of Barrick, John Thornton, saw an opportunity, but it didn't materialize. I don't expect we'll see any mega-mergers anytime soon.
TGR: What do you think of Barrick's prospects?
CM: We have a position in Barrick. It has some of the best assets in the world, but it's over-leveraged and going through a structural reorganization. If the company executes this properly, the stock will do very well. It's cheap relative to the quality of its assets, and it's cash-flow generative even at $1,200/oz gold.
TGR: What can you tell us about the other gold majors the Gabelli Fund holds?
CM: Newmont Mining has really executed on its plan of bringing down costs. The company has maximized the potential of every single asset it has, and has sold some assets to deleverage its balance sheet. Now it's in a good position to produce profitably, pay a small dividend and also build projects that generate good rates of return. Newmont is building two projects now: Merian in Suriname and Long Canyon in Nevada. Newmont is now producing close to 5 million ounces (5 Moz) of gold per year. The company has a lot of upside if and when the gold price moves back up.
AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) has a lot of leverage relative to its cash flow and level of production. If the gold price does go up, AngloGold is going to go up, by multiples. The company has good assets, and we like its management.
Goldcorp is another high-quality gold miner. It has a very manageable debt position and low costs and has been taking advantage of the current downturn in the market.
TGR: Let's talk about companies that are less loved by the market than they should be.
TGR: Why are they unloved?
CM: The bear market has driven out the generalist investors. To the degree you have anybody getting back in, they will first look at royalty/streaming companies, then safe producers like Randgold, Fresnillo, Agnico and Goldcorp. Then leveraged producers like Barrick, Newmont or AngloGold. Finally, they would look at mid-tier producers like B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX), Centerra Gold Inc. (CG:TSX; CADGF:OTCPK) or AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE). Companies like MAG Silver, Mandalay and Richmont aren't getting the attention they deserve.
TGR: What impresses you about MAG Silver?
CM: It has one of the best undeveloped silver deposits in the world, Juanicipio, a JV with Fresnillo, which is adjacent to Fresnillo's flagship mine in Zacatecas. This will be extremely cash-flow generative with an AISC of about $5/oz. MAG Silver has a great exploration team. Peter Megaw is one of the best geologists around, and he has discovered another silver deposit in Mexico called Cinco de Mayo, which I think will be the company's second mine. MAG Silver is trading at a big discount relative to just its Juanicipio deposit, so once its permitting problems at Cinco are sorted, shareholders will be getting that for free.
TGR: What do you like about Mandalay?
CM: This is a company with three assets: Costerfield in Australia, Cerro Bayo in Chile and Björkdal in Sweden. The company's philosophy is to buy small projects, turn them around and make them bigger, and it is proving this again with Björkdal. We like Mandalay's management and its strategy.
TGR: Do you see future acquisitions in their future?
CM: Not in the near term. Perhaps after it builds the Challacollo deposit in northern Chile. Mandalay is very prudent from a balance sheet perspective.
TGR: And what impresses you about Richmont?
CM: It's a small producer now, but it has a lot of growth potential at its Island Gold mine. It's in a great jurisdiction, northern Ontario. From a valuation perspective it's trading at a big discount to its potential net asset value based on currently delineated resources. It's a lot less risky than a predevelopment company because the operation is built, and we know how much it costs to mine and mill there. Richmont has an unleveraged balance sheet and net cash.
TGR: Let's talk about some near-term production stories.
CM: Romarco Minerals Inc. (R:TSX) has the Haile gold mine in South Carolina. The company's share price is depressed because it raised $200M when gold was spiking to $1,300/oz. I think a lot of demand for its stock was sopped up in this big equity offering.
TGR: Is Romarco a possible takeout target?
CM: There's definitely potential there. This is a fully financed and permitted project in the U.S. with a long life, low costs and good exploration potential.
TGR: Which other near-term project could be bought out?
CM: Dalradian Resources Inc. (DNA:TSX) has the Curraghinalt project in Northern Ireland, a good jurisdiction. The company has delineated over 3 Moz of resources there. It is exceedingly high grade: 9.3 grams per ton (9.3 g/t) with an AISC of $485/oz. I think this will be a mine, but its initial capital expenditure (capex) is $249M, which is a lot of money in this market. It could be that Curraghinalt will languish until the market turns.
TGR: Which other smaller companies does Gabelli hold?
CM: Eastmain Resources Inc. (ER:TSX) just updated the resource on its flagship Eau Claire project in northern Québec. It's around 75 kilometers south of Éléonore. It's a very good deposit. Eastmain has delineated 885 Koz at an average grade of 4 g/t, which is really high-grade for an open pit. It has also delineated around 220 Koz of 7.3 g/t closer to surface. This enables the company to start small at 2,500 tons per day, which would give it 100 Koz gold per year. Eastmain could then repay its capex quickly. Either Eastmain will build it, or somebody will buy it.
Comstock Mining Inc. (LODE:NYSE.MKT) is a small producer now: around 30 Koz gold this year. The real potential here is that the company is in the old Comstock Trend in Nevada, which produced many millions of ounces of silver during the 1800s and essentially paid for the building of San Francisco. Comstock could delineate by the end of 2015 a deposit that has over 1 Moz oxide gold and silver with an AISC of less than $1,000/oz in a great jurisdiction with exploration potential.
TGR: Given your belief that gold will likely have a good year in 2016, what's your advice for investors today?
CM: Investors should have a bunch of gold equities. They should look first for companies that will do well in a higher market and are also protected on the downside. They should then look for companies that are unloved now but whose leverage will make them lovable when gold goes higher.
TGR: Chris, thank you for your time and your insights.
Chris Mancini is a research analyst for the Gabelli Gold Fund, specializing in precious metals mining companies. He has over 15 years of investment management experience, including research analyst positions at Satellite Asset Management and R6 Capital Management. Mancini earned a bachelor's degree in economics with honors from Boston College and is a holder of the CFA designation.
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1) Kevin Michael Grace 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 independent contractor. He owns, or his 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., Silver Wheaton Corp., MAG Silver Corp., Richmont Mines Inc., Romarco Minerals Inc. and Comstock Mining Inc. Goldcorp Inc. and Franco-Nevada Corp. are not associated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services.
3) Chris Mancini: I own, or my family owns, shares of the following companies mentioned in this interview: Agnico Eagle Mines Ltd., AuRico Gold Inc., Centerra Gold Inc., Comstock Mining Inc., Eastmain Resources Inc., Franco-Nevada Corp., Fresnillo Plc, Goldcorp Inc., MAG Silver Corp., Osisko Gold Royalties Ltd., Randgold Resources Ltd., Romarco Minerals Inc., Royal Gold Inc., and Tahoe Resources Inc. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. The Gabelli Gold Fund holds the following companies: Agnico Eagle Mines Ltd., AngloGold Ashanti Ltd., AuRico Gold Inc., B2Gold Corp., Barrick Gold Corp., Centerra Gold Inc., Comstock Mining Inc., Dalradian Resources Inc., Eastmain Resources Inc., Franco-Nevada Corp., Fresnillo Plc, Goldcorp Inc., MAG Silver Corp., Mandalay Resources Corp., Newmont Mining Corp., Osisko Gold Royalties Ltd., Randgold Resources Ltd., Richmont Mines Inc., Romarco Minerals Inc., Royal Gold Inc., Silver Wheaton Corp., Tahoe Resources Inc. and Yamana Gold Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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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