The Gold Report: Gold continues to languish under $1,300 per ounce ($1,300/oz), even as full economic recoveries in the U.S. and the European Union (EU) have yet to occur, despite trillions in new debt and stimulus. Meanwhile, we have two wars in the Middle East that could escalate, as well as reports that Russian troops are in Ukraine. With all that in mind, do you think that gold’s fundamentals are less important than they once were, or is the price of gold being held back by other factors?
Charles Oliver: Gold is just as valuable today as it was 100 years ago. There was an orchestrated takedown of gold in April 2013. It has since traded between $1,200/oz and $1,400/oz, and this flies in the face of the conditions you mentioned.
We’re going to have to be patient. We have gone through a bottoming process. We’ve had similar conditions before. In 1974, after the oil embargo, U.S. inflation was increasing dramatically, yet gold fell from about $200/oz to about $100/oz in 1976. Then over the next four years gold subsequently rallied to over $800/oz. In this decade, gold has fallen from $1,921/oz to $1,180/oz, but the fundamentals remain intact, and gold will regain its reputation as a unique store of value.
TGR: You used the phrase “orchestrated takedown.” Do you agree with the thesis advanced by the Gold Anti-Trust Action Committee (GATA) that gold and silver prices are manipulated downward by central banks?
CO: A decade ago I was on the sidelines. Then, after 2008, when the Federal Reserve gave us quantitative easing (QE) 1, 2 and 3 and increased its balance sheet by $4 trillion, effectively fixing the bond market and price, I became convinced that GATA was correct. All the price-fixing scandals we’ve seen are not isolated incidents. The gold market is a relatively small one. When 400 tons of gold rapidly came onto the market in April 2013, I was persuaded that this was definitely an orchestrated takedown.
TGR: Can this gold repression be maintained, or is it a dam about to burst?
CO: I like that metaphor. Eric Sprott did an analysis that suggested that a fair amount of the gold putatively held by the Federal Reserve may not actually be in its vaults. Footnotes in the Fed’s records indicate possession of about 8,000 tons but also suggest that some of that might have been loaned out. We don’t know how much, but supply-and-demand numbers suggest it could be a very significant amount. I believe that the gold exchange-trade funds (ETFs) were raided because gold could not be found where it was supposedly held, so it was taken from the ETFs instead.
Much of the gold sold out of Western vaults has found its way into Asia, China in particular. To run a trading platform requires a certain amount of physical bullion to meet delivery demands. If deliveries cannot be met, confidence in the system will fail, and paper trading will dry up. I must say I was quite surprised that after Germany asked for its gold back from the U.S. and it was informed that delivery would take seven years, the market did not suddenly unravel. Nevertheless, I believe the central banks are running out of bullets, and when they do, we could see a very significant rise in the gold price.
TGR: Is control of the gold bullion market shifting from London to Shanghai?
CO: The amount of trading in Shanghai is increasing, and I would imagine that the gold bullion repositories in London are diminishing. Over time, control of many components of the world economic system will shift to Asia as it becomes a more powerful entity on the global stage.
TGR: As mentioned earlier, central banks continue their attempts to force demand, yet economic recoveries remain elusive. How will this play out?
CO: QE was a dirty word five years ago, but today governments tout it as a triumph, even though the economies are still not that healthy, while record-low interest rates and record-high stimulus will continue. The U.S. is currently winding down QE, but the EU looks as if it may start up. I do believe that the U.S. may once again ramp up QE because its interest rate policy hasn’t worked.
Countries are debasing their currencies, which leads to investors moving into hard assets, as confirmed by U.S. stock indexes reaching record levels. We saw this in the Weimar Republic in Germany, when stocks soared because they were inflation hedges. A collapse in confidence in paper money is not something I want to see. If that happens, all bets are off. In the meantime, currency debasement should lead to a recovery in the values of gold, silver and other precious metals.
TGR: Do you anticipate higher gold and silver prices following the historic return of market interest in September?
CO: I think there is a very real chance that gold might hit $1,500/oz by the end of the year.
TGR: It is has been reported that higher tariffs on gold buying in India have resulted in the substitution of silver for gold there. Do you think this will spur a higher silver price and that the current gold/silver ratio of 1:66 will fall as a result?
CO: We have seen in India an increase in silver purchases. That said, the gold purchase figures from India do not include smuggling, which soared in the 1990s and is rising again.
At Sprott, we believe very strongly that the next decade will see the gold/silver ratio move toward its historic rate of 1:16. The last time this happened was in 1980, when the gold price was $800/oz and the silver price was $50/oz. Under this scenario when the gold prices rise to $1,600/oz, I could expect silver to hit $100/oz. That would be a 500% increase in the silver price, versus a 30% increase in the gold price. I have taken a fairly significant weighting in the silver sector.
TGR: Gold equities outperformed bullion by a significant margin earlier this year. Can we expect more of this, or is the value of gold equities now constrained by the current gold price?
CO: The gold price bottomed out in December 2013, and as a result, gold equity valuations were destroyed. To some extent, the outperformance we’ve seen in 2014 is a return to more normal valuations, but a continuation of this trend will require higher bullion prices.
TGR: When the Sprott Gold & Precious Minerals Fund considers the companies it holds, which qualities are paramount?
CO: We look first to management. We want management teams with track records of performance, teams with share ownership of their companies. A deposit’s geology is just as important. Without the geology there is no mine, there is no cash flow, there are no profits. We evaluate ore bodies by all the various parameters: quality, strip ratios, underground versus open pit, access to water and power, ease of permitting and local taxation regimes. Finally, we examine a company’s valuation and how it compares to its peer groups. That includes dividends, cash flow, cash-flow growth and many other aspects.
TGR: Which gold and silver companies are your favorites?
CO: Within my top 10, I have Osisko Gold Royalties (OR) and Tahoe Resources (TAHO). They both have great management. Tahoe is run by Kevin McArthur, the ex-CEO of Goldcorp (GG) and Glamis. Osisko is run by Sean Roosen, who discovered and built the Canadian Malartic mine in Québec.
Among explorers, other companies in my top 10 include Guyana Goldfields (GUY), run by Scott Caldwell, whose CV includes Kinross Gold Corp. (KGC) and Freeport-McMoRan (FCX), and Dalradian Resources (DNA), run by Patrick Anderson, who built up Aurelian Resources, which was sold to Kinross.
TGR: Why do you like Tahoe and its Escobal silver mine in Guatemala?
CO: I visited the mine in March and was very impressed. The company has ramped it up over the last year, and the process has been almost flawless. Tahoe has delivered what it promised and is exceeding guidance. It looks to produce 20 million ounces (20 Moz) silver equivalent at below $5/oz for over a decade. This is one of the largest producing silver mines on the planet, and to accomplish that in the first year of operations is outstanding.
TGR: How does Tahoe’s balance sheet look?
CO: Tahoe is going to be paying down the debt it took on to build Escobal. It should announce a dividend sometime this year.
TGR: Does operating in Guatemala negatively affect Tahoe’s valuation?
CO: There is a discount, no question about it. There was local opposition to Escobal, and there are still holdouts, but I think the company has done a good job with community relations and brought most of the population to its side.
TGR: Guyana is another burgeoning mining jurisdiction. What impresses you about Guyana Goldfields and its Aurora gold project?
CO: I’ve been a shareholder for many years. The management and board of directors are large shareholders and have participated in the most recent round of financing to a large degree. Guyana Goldfields has a nice asset in Aurora: 6.54 Moz Measured and Indicated, and 1.8 Moz Inferred. The after-tax internal rate of return (IRR) is great at 31%, as is the net present value (NPV) at $735 million ($735M). Aurora is fully funded, and the engineering, procurement and construction management contracts are complete. Guyana Goldfields is building the mine.
TGR: When will mining begin, and how much gold will be produced annually?
CO: Commercial production is scheduled for mid-2015. The number of ounces per year will depend to a certain extent on whether they go underground or not, but first-year production is estimated at 126,000 oz (126 Koz), ramping up to about 300 Koz by year six or seven. Aurora has a 17-year mine life, and all-in sustaining costs will be lower than $700/oz.
TGR: If Guatemala and Guyana are burgeoning jurisdictions, then Northern Ireland is virgin territory. What impresses you about Dalradian’s Curraghinalt gold project there?
CO: The management has been buying into the company, and Curraghinalt is an exceptionally high-grade underground deposit. The after-tax IRR and NPV are exceptional as well. Based on $1,378/oz gold, they are 41.9% and $467M, respectively. There is some concern about opening a mine in Northern Ireland, but they are gaining the goodwill of the people, and permitting is moving forward.
TGR: The company closed a $27M financing at the end of July. How does it stand for cash?
CO: That placement gives Dalradian the cash and permits it needs to fund its current underground exploration bulk sample program. I think this stock is extremely undervalued.
TGR: Let’s talk about some of your fund’s other holdings.
CO: Asanko Gold (AKG) is in my top 15 companies. It features top-notch management, including much of the ex-team of LionOre Mining International Ltd., which was bought out by GMK Noril’skiy nikel’ OAO (NILSY) after a bidding war with Xstrata (XSRAY). Asanko’s team paid about $30 million to take over Keegan Resources, which merged with PMI Ventures and now owns two Ghana deposits within 10 kilometers of each other. They can be processed by the same plant. The company has begun construction of its first phase of the Asanko gold mine at Obotan.
This is a very cheap stock. In fact, before the merger with PMI, Keegan was trading very close to cash. It has great assets, and I have a big position in it.
TGR: Asanko announced Aug. 27 it has eliminated a 2% net smelter royalty (NSR) on the Asanko gold mine. Is this good news?
CO: I am always happy when companies can buy back royalties at a reasonable price, because NSRs skim the cream off the top.
TGR: Your fund holds Pretium Resources (PVG). In June, the Supreme Court of Canada awarded substantial, yet undefined, rights to native Indians on British Columbia’s Crown Lands. This was followed in August by the tailings spill at Imperial Metals’ (III) Mount Polley mine. What implications do these two events have for mining in British Columbia?
CO: They are very negative. It will be more costly, time consuming and challenging to build mines in British Columbia. That said, Pretium’s Brucejack has a great many positive attributes. It is a very small, very high-grade gold-silver mine with a very small environmental footprint. So tailings will be a relatively smaller issue for Pretium. Indeed, it is so high grade that dry-stack tailings may be possible.
On permitting, Brucejack was a historic mine as recently as the 1980s, which will make approvals easier to get. The project is going underground, so Brucejack will not have one of those big open pits that some people do not like.
TGR: Pretium’s gold and silver assays have been spectacular for several years, but many people point to this resource as being nuggety. Could you speak to this issue?
CO: They’re absolutely correct, but many nuggety gold deposits have been produced successfully in the past, and they will continue to be produced successfully in the future. Brucejack has the advantage that it has seen a surprisingly large number of high-grade nugget hits. The resources are there. Mining this project may result in some lumpy quarters, but I do believe that the mine will be permitted and will be very profitable.
TGR: Let’s discuss gold explorers in your portfolio.
CO: Unigold (UGDIF) is one of them. The company is drilling a very prospective land package, the Neita concession, in the Dominican Republic. Unfortunately, there is not much financing available to the small-cap sector. For companies like this to recover, we’ll need higher gold and silver prices.
TGR: The company announced in November 2013 an initial Inferred resource of 2 Moz. Yet shares are trading at $0.04. Can this be attributed to the specifics of Neita?
CO: No, it’s the market, which currently is paying nothing for ounces in the ground.
TGR: This bear market in junior precious metals companies is now 3.5 years old. How long will it continue?
CO: As I said at the beginning, we could have $1,500/oz gold by Christmas. Should gold reach that price, interest in juniors will revive, and valuations will come up quite dramatically.
TGR: Do you see any potential takeover targets among the companies we’ve discussed so far?
CO: Dalradian, Guyana and Asanko could all be targets.
TGR: The gold and silver royalty/streaming sector has done quite well compared to the general market. Will this continue?
CO: This sector will continue to grow and prosper but is somewhat countercyclical. The best time for such companies is when the general market dries up, when companies cannot access capital and are forced to sell royalties or streams. And so the last two to three years have been very good for royalty streaming companies. Higher gold prices will result in higher profits for this sector, but I expect the mid- and small-cap mining companies will do better in relative terms.
TGR: Pierre Lassonde of the World Gold Council told The Gold Report in May he believes that the relatively small size of its market will compel silver streamers to move into gold contracts. Do you agree?
CO: I do. I have long thought that limiting a company to gold or silver is not completely logical, although I don’t believe it’s in the interest of gold and silver companies to move into base metals. I would expect that over time we will see companies such as Silver Wheaton (SLW) take on more gold transactions.
TGR: What’s your opinion of Silver Wheaton?
CO: It has been one of the best performers over the last few years. Silver streamers do not run much risk of operating overruns and higher costs. It’s a nice business when you know you’re going to get a profit, and the only question is how big it will be.
TGR: Are you bullish on Silver Wheaton going into the future?
CO: I am, but given the higher bullion prices I’m expecting, my preference is for increasing my weights in some of the midtiers.
TGR: Osisko Gold Royalties is a newcomer to the streaming sector. It has a 5% NSR on the Canadian Malartic mine and 2% NSRs on the Upper Beaver and Kirkland Lake properties and on the Hammond Reef project. Will it aggressively seek further streams?
CO: The management team has significantly invested in the company, and I think they will take their time and do what they think is appropriate. I do expect, however, that significant assets will be acquired in the next year.
TGR: Even before the takedown of the gold price, precious metals valuations collapsed, and the last few years have been dire for many investors in gold and silver companies. What are the reasons for investors to feel positive?
CO: We’ve seen an awful lot of capitulation. Barrick Gold (ABX) just announced it will eliminate its entire corporate development team. I’ve lost a lot of good friends and analysts who have left the industry. These are all signs of a bottom.
I look around the world and see European Central Bank President Mario Draghi talking about rolling out QE. I see the continual debasement of currencies. And I see China buying gold left, right and center. I am convinced that gold and silver and precious metals equities will recover in the not-too-distant future.
TGR: Charles, thank you for your time and your insights.
Charles Oliver joined Sprott Asset Management in 2008. He is lead portfolio manager of the Sprott Gold and Precious Minerals Fund. Previously, he was at AGF Management Limited, where his team was awarded the Canadian Investment Awards Best Precious Metals Fund in 2004, 2006 and 2007. His accolades also include Lipper Awards’ best five-year return in the Precious Metals category (AGF Precious Metals Fund, 2007) and the Lipper Award for best one-year return in the Precious Metals category 2010.
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