Everyone and their dog owned gold mining stocks at the top. But in 2016...?
ERIC COFFIN, editor of the Hard Rock Analyst family of publications, believes the bear market in gold is over, and it's time to load up on the best companies with the best assets, as he tells The Gold Report here.
The Gold Report: You have singled out negative bond rates and a downward New York stock market as two of the factors that would make gold look more attractive in 2016. What are the other forces pushing gold to the $1200 an ounce level?
Eric Coffin: I think we're simply getting to the end of the gold bear market. We may just be running out of sellers. I think all of the hot money – and even the warm money – is pretty much out of it. Most of the funds were completely out by late 2015. That's part of the reason why I suspect that even though the major markets in New York are likely to fall at least 20% from the highs this year, I don't expect a repeat of 2008 and the wholesale selling in gold stocks.
Back then, gold and gold stocks bottomed four months before New York did but that came after selling that ended a multi-year bull market. Everybody and their dog owned gold stocks heading into 2008. At the start of 2016 "nobody" owned them.
So I don't think we have a similar situation where a fall in New York means gold stocks get thrown out like the baby with the bath water. I think this time around you'll actually see more buying than selling because most traders are still very underweight gold stocks and gold itself, for that matter.
Plus, central banks seem to be running out of rabbits to pull out of their magic hats. Some hedge fund managers are expecting Quantitative Easing 4. Maybe we'll see it, but Congress would go nuts if the Federal Reserve announced another QE program during an election year. There is a chance of a return to near zero rates later this year in the US. We already have negative rates in some countries. There's no indication that's going to change any time soon.
The European Central Bank is making noises about going even more negative, and Japan may too. I don't think this is a short-term thing; it's a trend that's going to take a while to resolve. That's positive for the gold market.
TGR: How big of a factor is China for gold and other commodities?
Eric Coffin: Gold is a funny market. There's a large contingent of traders and most trading occurs in the futures market where it's paper rather than actual bullion changing hands. It's hard to argue that physical gold buying in China, India or anywhere else matters when trading volumes in the futures markets are so much larger and drive the price most of the time.
That said, there is no doubt that saleable global physical gold supply has been shrinking for some time. Gold generally moves from West to East and gets put into people's safety deposit boxes and central bank vaults. The day may come where that movement is large enough that it's really going to start pushing the price. I don't think there's a lot of doubt that central bank buying and buying out of China is taking all of the annual production and then some.
Plus, I think we've seen peak gold production for the foreseeable future. We're far enough now from the highs of the gold price and the funding capital expenditures (capex) for new mines that I don't think we're going to see growth in mine production now for probably several years. All of those things are positive.
TGR: Are you anticipating that the gold mining equities will outperform the price of the metal, because of the lack of investment in exploration over the last few years?
Eric Coffin: Normally, when you get a trend change like this, the miners tend to be more volatile and have higher beta than the actual underlying commodities. So I think it's reasonable to assume that if the metal price goes up, say, 25%, select gold equities could go up 100%. I would expect the gold miners to significantly outperform the gold price on the way up in percentage terms. That's normally how it goes.
TGR: Will some do better than others?
Eric Coffin: In percentage terms, if you're 100% convinced that gold is going to be, say, $400 per ounce higher next year, theoretically you'd probably get your biggest percentage gains from the really crappy miners that are very marginal right now. If they are on death's door and priced that way, a big move gives them a new lease on life and they should see the biggest gains. I don't argue that logic but I have always had a philosophical issue with following the really crappy miners. I prefer to follow companies that have strong management and the best-looking projects. That gives me some downside protection if the commodity they mine doesn't have a big short-term move.
But if gold goes up 20% from here, which I don't think is an unreasonable target, and builds a new base around $1200, the next target on the upside is $1500. With that kind of a move, all the miners will do really well.
TGR: Do you anticipate more mergers and acquisitions once things start to look up?
Eric Coffin: Probably. Companies have had their heads handed to them for the last three or four years for some fairly stupid and expensive M&A. But when a sector gets hot, M&A always seems to come back. I would think some of these companies also need to restock their project pipelines. None of them really wanted to do deals with cheap stock, but if their stock goes up 50% or 100% and they view it as being expensive currency again, I think you'll see M&A lift again. The market has a short memory.
TGR: What does your thesis on China mean for copper?
Eric Coffin: China has been a huge negative for base metals. It is negative in actual terms – changes in demand – and even more so in sentiment terms because traders fear the slowdown will worsen. But the actual import numbers for December 2015 show imports of finished and unfinished copper into China were the second highest month in history. Copper inventories are not really that ugly. It is always difficult to know what to believe when it comes to Chinese economic readings, but based on the current supply/demand structure, copper probably gets significantly better going into next year.
There is a lot of concern about supply growth, but in my experience, mines never get built as fast as predicted. That is why I'm pretty skeptical of the projection of a 6% or 7% increase in copper supply in the next couple of years. I don't see copper prices getting much below $2 per pound and staying there for very long and, if China doesn't really decelerate this year, we could see some price gains by year-end. I've been mildly bearish on copper for two or three years. But I think the worst is over.
TGR: Silver did not outperform when gold jumped at the beginning of this month. What does that mean for silver mining companies?
Eric Coffin: It means times are a little bit easier but not a lot easier just yet for silver mining companies. It's gone up some, but at the prices prevailing a month ago, I think you'd be hard pressed to find many companies that were making money.
Silver is not viewed as a currency. Silver does have a big industrial component, so when commodities in general are getting sold, it's going to have more of a problem fighting that pro-cyclicality. If gold prices get positive enough, at some point during that move I would expect to see a larger percentage move in silver simply because some people who are looking for precious metals will jump on that. And it's a much smaller market. It's a market that can get moved a lot farther percentage-wise. At some point the silver people are going to get some joy out of it, but I just don't think it's a natural asset class that gets bought when markets are uncertain.
TGR: Why have oil prices turned out to be a depressant rather than a supporter of the overall stock market? Shouldn't lower energy prices help most companies?
Eric Coffin: They do in theory. The problem is that you have to get past the fact that the oil sector is a pretty important one. When that entire sector has been decimated for two years, that's a big drag on the equity indexes before you even start looking at what it does for the rest of the economy. Also, it doesn't seem that the American consumer is spending this effective tax break from low oil prices. There is a school of thought that says those savings are just getting eaten up by things like higher medical costs so they're not turning into discretionary spending.
Wall Street also underestimates the importance of the oil and gas sector as an employment driver. I've seen estimates of the employment loss from the falling oil price of about 100,000 jobs. Those are not waitress jobs. These are people getting paid $50 an hour. That's been depressing the average wage and keeping the country from seeing a wage gain everybody expected when the unemployment rate hit 5%. That's just my pet theory.
Plus, the US simply isn't a big oil importer anymore. So it didn't do as much good for the US economy as it might have for, say, the European economy, which is not a significant oil producer.
TGR: Do you see oil prices turning around in 2016?
Eric Coffin: I think probably before the end of 2016. They have had a nice bounce here. Turning around? Yes. Are they really going to go very far? I have trouble envisioning the oil price getting much more than $35-40 a barrel this year unless there is actually some kind of an agreement between OPEC and Russia, cutting production by 2 or 3 million barrels a day. I think it would take something that dramatic to give oil a big move because there are massive aboveground inventories now, and they're still growing. I'm not sold on the idea that we're not going to still see a little lower oil price before we see a higher one. I don't see oil above $50 per barrel for a couple of years.
TGR: Do uranium prices depend more on oil prices or reactor restarts in Japan, and construction in China and India?
Eric Coffin: Short term, you seem to get moves in the uranium price based on the oil price swings, which makes no sense to me whatsoever. I see no reason why there should be any connection at all. They are very different things, and the timelines are so long in the uranium sector that the price of a barrel of oil should be irrelevant to buying a contract to fuel a nuclear reactor. But when you get big swings in oil, it seems to affect uranium prices at least on the edges.
The bigger thing for uranium is it also has aboveground stock that has to get worked through. That's going to take a couple more years. After Fukushima, when essentially the entire Japanese and German reactor fleet was shut off, that added a lot more aboveground stock. That's probably going to take another two or three years to work off. That said, I don't think it will take two or three years for the price to start to move because the utilities tend to want to lock in supply years in advance.
When you're running a reactor, you want to be running it near capacity. Reactors are so bloody expensive to build and operate, you don't want to be running them at 50% capacity. Paying an extra $20/lb for uranium is negligible in what it does to your operating costs. Forward charts of what's contracted for by utilities fall off in the next year. I think as we get later into this year and into next year, there are going to be more utilities saying we want to know we're going to have these deliveries five years out, so we're willing to pay up a bit to make sure we have those.
On the other side, with prices at the current $33-34 per pound, there is going to be virtually no production growth whatsoever. Even the ISR guys are essentially trading Dollars for Dollars. Those projects don't get capitalized at $35 per pound unless you have a government of Korea or China that doesn't really care what the price is. They just want to know they're getting the supply security.
TGR: Tell me about the summit and what you hope the attendees will take away from the event.
Eric Coffin: The Subscriber Investment Summit will be held in Toronto on March 5, the day before the PDAC Convention starts. It's at the Hilton downtown. Keith Schaefer, Tommy Humphreys and I will be doing short presentations on where we think the market is going. We also have three pretty interesting guest speakers. One of them, an energy expert out in the US that Keith swears by, heads an extremely expensive institutional service, so that will be pretty exclusive. The other two people are hedge fund managers. One of them has some pretty pointed things to say about a number of oil and gas companies. The other person made a name for himself shorting Bre-X.
Plus, some 15 companies will be presenting. I'm hoping attendees come away with a set of really good ideas for a market that is bottoming. The worst is probably just about over. So now is the time you want to hear from mining CEOs. There are two hours of catered lunch breaks and coffee breaks, plus a cocktail reception after the show so investors will have plenty of time to talk to the CEOs and get questions answered. Everybody walks away with a set of all the day's presentations on a stick. You should be set up to be able to narrow it down to three or four deals to put on your radar screen. It's a very strong set of companies. What differentiates the Subscriber Summit from a lot of the other resource conferences is that it is a curated list. The companies have to be invited by the newsletter writers. And we turn away a number of companies at every one of these shows.
We limit attendance to no more than 300 people. Because the attendees are also invited – most of them are off the subscriber list for the newsletters – you don't have 5,000 people who are running in there, trying to grab pens and squeeze balls. It's a couple hundred people who are there because they actually buy this stuff. They're there to do deals and they're serious. They find the Summit is a great networking opportunity, not just with the companies but also with other investors like themselves.
TGR: Thank you for your time, Eric.