When it comes to picking gold mining names in the current market environment, John Stephenson, author and portfolio fund manager at First Asset Investment Management, believes that buying the “best of breed” is the way to go. In this exclusive interview with The Gold Report, he explains his reasoning in light of how the current global economic environment is affecting prospects for the metals markets and valuations of mining company stocks. He also talks about his favorite picks in a range of three production classes and why he likes them.
The Gold Report: As a portfolio manager and an author of two books, The Little Book of Commodity Investing and Shell Shocked: How Canadians Can Invest After the Collapse, how do you see the prospects for the resource commodities in 2012?
John Stephenson: I think, in general, my prospects and outlook are very bullish. The story continues to be one of strong demand out of China. I don’t see that story changing. Obviously, there have been a lot of headlines and the Purchasing Managers’ Index data in China recently are not as robust as they were, but its economy is still going to grow at 8.5–9%. That’s pretty darn good. That’s really where demand for most of these commodities will come from. Certainly, any improvement in Europe and the U.S. will be good news for commodities.
TGR: Are there any specific ones you think will do better than others?
JS: I’d have to say that oil will do very well. I think we’ll see oil exit 2012 north of $130/barrel. Certainly, copper looks very strong. I could see that at $4.50/pound (lb) by the end of the year. Gold and precious metals will do well, also. Gold and precious metals are in a different category than the others, but, nonetheless, what I think is going to continue to drive that is Europe, and I think you’ll see $2,500/ounce (oz) gold.
TGR: So in that light, I guess $4.50/lb copper isn’t that far out of line, if you’re expecting gold in the $2,500/oz range.
JS: I think what you’re seeing across the board in commodities is very strong demand and weak supply. Nothing has happened that will improve that situation and the volatility we see daily has only made the situation worse. Suppliers have struggled to keep up. The smaller, more marginal players have had trouble getting financing as the volatility has increased. The eventual supply response, which would normally end a bull market, is going to be a long time coming.
TGR: In this recent semi-panic where gold dropped into the low $1,500/oz range and people were saying it was all over—you’re certainly not a believer in that if you’re predicting $2,500/oz gold.
JS: No. I’m not a believer in it. Gold shares some characteristics with other commodities in terms of supply and demand. Over the last 40 years, the average grade globally was around 9.6 grams/ton (g/t). It’s now around 1 g/t. So, we’re potentially facing a peak gold scenario as we may be in oil.
Look at Barrick Gold Corp. (ABX:TSX; ABX:NYSE). It recently acquired Equinox Minerals Ltd. (EQN:TSX; EQN:ASX), a copper miner. That’s how it’s struggling to find replacement gold reserves. It had no better idea than to buy a copper miner. This is typical across an industry facing very challenging supply conditions.
Gold is really taking on a different characteristic; it tends to be a commodity that is more of a currency than a commodity. I see it going higher ultimately because the solution to what ails Europe will be the need for the European Central Bank to step in line and start to print money. Once we have that, you’re going to see gold move higher. What’s kept gold down in the last few months has been that the U.S. dollar and U.S. Treasuries have become safe havens. But how much worse can things get in the world when you have the 10-year U.S. Treasury trading below 2%?
TGR:: So you’re pretty well convinced that we’ve seen the lows in the gold price?
JS: Yes. There were several reasons why the low price dropped recently. Fund managers facing redemption requests looked around and said, “Well, this has probably been the best-performing asset in my portfolio this year and maybe the last 11 years.” They felt that to meet these requests, they needed to sell. So there were a lot of things that were happening that weren’t really related to gold or to the bigger story of what was happening within Europe. We have an enormous amount of paper money out there being debased. And the solution for these debts really is to debase more of this paper money. In that environment, people around the world are saying, “I want something tangible. I want something real. I want something I can hold in my hand, store, put in the bank or under my mattress.” And the demand is going to remain very strong. I don’t see that changing.
TGR: So regardless of how all these problems evolve, as far as you’re concerned, gold is going higher, no matter what?
JS: No matter what!
TGR: Obviously, you’re a precious metals bull. What’s your preference among the equities, the physical metal and exchange-traded funds (ETFs)? Or is it a combination of all of them?
JS: A combination makes sense. The reason people have held the equities is because they get leverage to the gold price. So assuming that costs don’t increase at the same rate as the metal itself increases, you get increasing earnings and, therefore, on a consistent multiple basis, you get a higher share price and greater leverage to it.
The situation for gold miners has really changed over the last, say, four to five years. If we look back, 12 or even 15 years ago, we saw that for the first three or four years of that period, from early 2000–2004, the actual miners outpaced the metal by a three times multiple. Right now, evaluations have fallen so steadily for the miners that probably the smarter bet is to look at the equities. Certainly, the physical metal has some storage and handling costs associated with it. So I would say if you had to choose between the three, you would probably, at this point, look mainly to the miners, somewhat toward the ETFs and maybe hold a small amount physically for safekeeping.
TGR: In your portfolio management business, what criteria do you consider in selecting companies for your funds?
JS: Valuation is obviously one. We do a fair bit of work in terms of determining what we think the fair value is relative to what particular miners are trading at. We also look for reserve growth and the potential for production growth. Then I think a very important consideration is where in the world they are producing it, because geopolitical risk has taken on a whole new concern. As the traditional supply basins have started to run dry, companies have had to go further and further afield, creating additional problems. So we try to look at stable geopolitical jurisdictions that are attractive and mining friendly. We look for companies that have production histories that are strong and likely to continue, coupled with outstanding management.
TGR: Makes sense, although it is a moving target as things change, and what once appeared to be stable doesn’t look so stable anymore.
JS: That’s right. You can’t just buy and hold. You have to keep following up.
TGR: 2011 was a tough and disappointing year for a lot of investors considering what the metals did and the resource stocks didn’t do. What are you expecting to happen this year with the mining equities? Are they going to finally catch up with the commodities price?
JS: Yes. Our view is that mining equities will outperform the metals in 2012 and that now is a good time to be looking at the mining companies themselves. We think that the commodity itself will be very strong because the Europe situation is coming to a head and will be a catalyst to lift prices higher. The miners will play catch-up and multiples will go from compressing to expanding, or at least not compressing any further.
TGR: You do quite a bit of research and have become quite familiar with a broad range of companies in the mining development and production business. Can you talk about some of the ones you like, maybe starting with some of the seniors and working your way down?
JS: In terms of relative size and scale, you don’t get any bigger than Barrick. The stock is trading at less than 10x earnings, which in itself is phenomenal and less than 1x net asset value (NAV). It has better growth than Newmont Mining Corp. (NEM:NYSE), and it’s the largest producer in the world. It has struggled, there’s no question about it, but if you’re looking for a value play, something that is liquid, well managed and has very strong growth. Going with the largest in the industry at almost 9 million ounces (Moz) per year, you have to look at Barrick.
TGR: Barrick has gotten to be so big. Is it going to be able to grow internally or will it just have to continue making acquisitions?
JS: I think that’s the issue, and you have correctly identified why investors have been a little skeptical on the name. At some point, things get cheap enough that you have to look at it and give it some credit. Looking back over the history of Barrick, it had a hedge book and much of its upside was hedged. Then as gold took off, people said it wasn’t going to get credit for it if it had the hedge book on it. So the hedge book was taken off and unwound. Then people said it needed to show production growth, which it did. At some point, when the chips are down, people are going to say, “Here’s a company that’s delivered.” But, you’re right. It’s hard to see how it can become a 10–11 Moz producer from around 9 Moz and continue to replace reserves, particularly in a world of declining ore values. But, if you think that the world of investments is going to bounce all over the place as the headlines out of Europe dominate trading, then I think you need to be somewhere where they’re printing money, and this is what Barrick is doing.
The next senior I would highlight is Goldcorp Inc. (G:TSX; GG:NYSE). This is the third largest gold producer in North America. What’s unique about Goldcorp is that it offers a blend of things that are almost never found in one company. It has good growth and great production diversity—not just producing from a single mine. It’s the lowest cost major producer, with cash costs at roughly $550/oz. Typical industry average is closer to $875/oz. It has a strong balance sheet, and it’s operating in politically secure parts of the world. So the chance of expropriation is pretty low. And, it’s liquid. So we really like this.
TGR: How about Intermediates?
JS: On the intermediate producers, with production in the 800 thousand ounces (Koz) to 1–1.5 Moz per year range, we like IAMGOLD Corp. (IMG:TSX; IAG:NYSE). It has a number of mines around the world, largely in the Americas, but also in Africa. It has recently brought in a new management team, which is focused on really servicing value. It brought in someone who is not from the industry but a turnaround expert, and it’s looking at really harvesting this value. With its good mines and good operating profile plus a bent toward servicing value, this name should move higher.
Another intermediate that we like is Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE). It has a number of mines in Finland, Canada and Mexico. This was a company that was a Street darling for many, many years. It probably has the best management team out there. It has had a few stumbles lately. It actually closed one of its mines, Goldex in Quebec, and wrote off the asset, so the stock has fallen because people have probably lost a little confidence in management’s ability to deliver. It was essentially trying to bring on five mines in two years’ time, and that’s really just too high an expectation. But at this price level, it has excellent growth and still is a name to look at.
TGR: And then Juniors?
JS: In the junior producer category, there are two names I think are worth looking at. One is Osisko Mining Corp. (OSK:TSX), which is very quickly moving into the intermediates. Until we get robust global growth, a company that is going to make this transition very quickly is obviously desirable for that reason, if nothing else. Osisko is already producing from its Canadian Malartic gold deposit in Quebec even though it just finished the original mine plan. It’s already producing around 600 Koz/year and has some catalysts for growth. Once you start production, you see a re-rating in your shares. This is trading at a discount to its junior and intermediate peers in terms of a multiple basis, but we think that multiple will expand as it continues to produce. It also has another property that gives it some option value and some further upside.
Lastly, we like AuRico Gold Inc. (AUQ:TSX; AUQ:NYSE) with three operating mines in Mexico and two in Australia. It recently commissioned a new mine at the Young-Davidson project in Ontario. We think this is another company that has a very strong growth profile and has been a bit in the penalty box, but it’s really too cheap at this point not to be looked at. So we think this is a potential double in terms of per-share value over the course of the next year to year-and-a-half.
TGR: AuRico has somewhat come out of nowhere with a name change and then these acquisitions. It’s actually quite a diversified situation with these properties spread out all over.
JS: Yes, it is. It used to be called Gammon Gold and then bought Northgate. We think that this is a name that should do very well. Given that it’s trading below its NAV at this point, it’s just too cheap to be ignored. It has a heap leach at its Ocampo property that continues to struggle a little bit. But I think all these issues are well known. At this level, this name and really all the others, should be bought, if you believe that gold prices will move higher, which we certainly do.
TGR: You probably look at a lot of other little companies that maybe are not suitable for your portfolio. Do you have any you might like to mention that you think are good speculations but not necessarily investment quality?
JS: Yes. Obviously, lots of gold companies come along that we think are interesting. I’m skeptical to mention some of these names because I think that for most investors, they’re a binary outcome. They either make it or they don’t, and in more cases than not, they struggle. I think, certainly, you could make a case for Pan American Silver Corp. (PAA:TSX; PAAS: NASDAQ) and some of these other names that are smaller, but they’re really a beta play on gold because when you start looking at some of these silver names, they typically trade in a much more volatile pattern than the gold producers. I think for many investors, the volatility isn’t worth the ride.
TGR: What sort of strategy are you suggesting investors use this year for maximizing their gains or not having the same sort of performance we had last year?
JS: We’ve seen mining company valuations trend down for many years. Now is a good time to start building positions by buying the best of breed—the ones that will do well in an increasing gold scenario that have little or no operational risk and are larger-cap names. Besides Barrick and Goldcorp, certainly, Kinross Gold Corp. (K:TSX; KGC:NYSE) would be another name to look at. I think its growth comes a little further out, probably in 2013, but you can start to take a look at that. I think turnaround situations like Agnico-Eagle Mines might be very good to look at. Keep in mind, if you’re buying a mining company, it’s making lots of money at $1,500–1,600/oz gold, but if you buy an ETF or the physical metal, you’re hoping it goes from $1,600/oz to $2,000/oz or $2,500/oz in order to make a profit. In the case of a mining company, you don’t need it to go anywhere. All you need is some recognition that there is value today in these companies, and there will be value tomorrow, as they, it is hoped, find more reserves and produce them.
TGR: Are there any parting thoughts that you’d like to leave with our readers?
JS: I would advise people to keep in mind that if there ever was a time for an investment in gold and gold equities, it is now. We have a very unusual situation in the global economy, where there really isn’t any obvious exit path other than the monetization of the debts. Gold companies have suffered because people have flocked to other safe havens, namely the U.S. dollar, but the U.S. has its problems as well. In general, if you’re with a company that has more than one operating mine in geopolitically safe parts of the world and has a demonstrated track record of increasing reserves and production, then I think those are the things that will, in the longer run, reward you. Short run speculating may be exciting but I think most people need to invest in things that have the potential to be higher a year from now than they are today. I think, right now, this is gold equities.
TGR: Thank you for your thoughts, input and insights. I hope 2012 will be a better year for everyone. We look forward to seeing how all of this comes about.
JS: I hope so.
John Stephenson is a senior vice president and portfolio manager with First Asset Investment Management Inc., where he is responsible for a wide range of equity mandates with a particular focus on energy and resource investing. He has been recognized by Brendan Wood International (BWI) as one of Canada’s 50 best portfolio managers for the past three years. He is the author of The Little Book of Commodity Investing (John Wiley & Sons, 2010), which has been translated into five languages, and Shell Shocked: How Canadians Can Invest After the Collapse (John Wiley & Sons, 2009) and writes a free bi-weekly investment newsletter, Money Focus, which reaches a global audience of more than 125,000 (www.reportonmoney.com).
Stephenson is regularly quoted by Bloomberg News, Reuters, The Associated Press, The Wall Street Journal and The Globe and Mail and is a frequent guest on Bloomberg TV, CNBC, CNN, Fox Business and Canada’s Business News Network (BNN), Sun TV and the CBC. He is frequently the keynote speaker at investment conferences throughout North America. Stephenson holds a degree in mechanical engineering from the University of Waterloo, a Master of Business Administration from INSEAD, as well as the Chartered Financial Analyst (CFA) and Financial Risk Manager (FRM) designations.