The big money is getting very picky...
IN ORDER to make wise investment decisions, gold investors must coldly assess economic realities, says Eric Coffin, publisher of Hard Rock Analyst Advisories. Coffin tracks a range of gold explorers with the bling to weather the long capital drought. He has figured out how to separate the winners from the losers and, in this interview with The Gold Report, he shares his outlook on the world economy and its implications for gold investors.
The Gold Report: In your January Hard Rock Analyst Journal, you remarked that 2012 "sucked" for precious metal investors. What happened?
Eric Coffin: Last year was a very difficult time for junior gold miners to raise funds and there has been no improvement in the financing environment yet in 2013. There were a few bright spots.
The basic problem is that with such a weak market backdrop, the financial sector is focused only on companies with strong management and proven projects. That's a very small subset of the explorers.
TGR: Are the small companies going to wither on the vine?
Eric Coffin: Companies with large shareholders that can be tapped for cash to keep things going might eke through. Companies that did not have a lot of success in the last two years are going to have a real problem—unless the fundraising situation improves soon.
TGR: Are the capital markets for gold miners likely to improve this year?
Eric Coffin: I believe that the financial market will get better for the juniors, but selectively. Money will go to development stories with clear top-quartile economics and successful exploration stories. And the devil will take the hindmost. A few hundred companies could disappear over the next couple of years. That stinks, but on a rational, sector-wide level, it is better for everybody in the long run if there is more focus on a smaller number of companies that have multiple targets and the ability to deliver. That's where the real game is.
The thousand other companies hoping to be able to option a property to a major are just not going to get any attention. It is easy to see the writing on the wall: Today's tiny financings are via insiders. Those are guys in the front office putting in $100,000 among them to keep the door open for another three months. You can only do that for so long. Without real funding to generate real news, companies are stuck.
TGR: Is there a feeling out there that the price of gold is too high, that it's going to collapse and not be able to sustain development and exploration?
Eric Coffin: When gold was at $280/ounce (280/oz), mining companies were trading at 50–60 times earnings. That's because investors were not trading on earnings; they were buying for leverage on gold reserves. But after the price of gold went up more than fivefold, the market shifted to trading on earnings. The firms that get higher multiples, as in any other sector, have convinced the market that they can grow earnings. That's fairly normal market behavior, but it is shocking to a lot of people in precious metals. Plus, there is just a lot of competition for capital, although a fair amount of it will eventually return to the gold sector.
TGR: Large corporations are sitting on trillions of Dollars that have to find a home.
Eric Coffin: There is definitely a lot of big money around, but it is very picky. In 2007, 2008 and 2010, there were a lot of large takeovers. Some of those deals came back to haunt the executives who did the takeovers, because many of them lost their jobs. And the executives who replaced them are very hands off, thinking, "I don't want to be the next person to do a $5 billion takeover that blows up in my face." But the pendulum will shift back, because executives who work 120 hours a week want to run big companies and to do takeovers. That's who they are!
TGR: Were expectations too high with the takeovers?
Eric Coffin: In some cases, acquirers just paid too much. In other cases, there were difficulties with permitting or construction that slowed things. Take a deal that has, say, $1M net present value (NPV). Push the start of the cash flow of that project back a couple of years and you reduce the NPV by 15–25% just based on the start of cash flows being pushed back. It may still be a good project, but in terms of what was paid for it, it suddenly does not look so cheap. There's not much you can do about that. A lot of big low-grade bulk tonnage projects in South America, for instance, have really big capital expenditures (capex) required to build them and their payback periods are just too long. Those types of firms are having trouble finding buyers. Massive increases in the cost of mine building is a problem across the sector.
TGR: On the other hand, gold stocks that were trading for Dollars are now trading for pennies. So for the average investor, it could be a pretty good deal if they can wait for these companies to come back into the game.
Eric Coffin: Long-term investors who have done well are game for that. They know that when stocks are cheap is when you make the big money. It's not for the faint of heart, though, as you usually only see bottoms in the rear-view mirror and companies need to survive until things improve.
TGR: You've recently made some gold buys in Serbia. What's the infrastructure for drilling in Serbia?
Eric Coffin: It's good. The foreign investment rules are quite good in Serbia and it is a mining region. There is a famous copper mine there called Bor, a high-sulfidation epithermal deposit. Serbia has lots of good geologists. The permitting system is well understood. Because it's a mining area, people do not freak out when they see a piece of flagging taped to a tree. There are lots of miners living in the area.
TGR: What about North America and Canada?
Eric Coffin: Mexico lost its flavor of the day status for a while, but it's starting to get traction again. Mexico is simply a great exploration address. It has excellent geology, lots of discoveries, mineral tenure and a smooth permitting system. You don't get a lot of permitting surprises in Mexico. A number of the new mines are not gigantic, but they are low-capex, low-cash-cost-per-ounce mines that are proving to be quite profitable. I think that track record will lure people back.
TGR: Let's talk for a minute about how gold investors should view the macroeconomic situation. Is the debt ceiling back and forth a real crisis?
Eric Coffin: The whole debt ceiling thing just makes me crazy. It's a farce. Since World War II, they've raised the debt ceiling 90 times. Politicians like to have it around because they can feel like stewards of the public interest when they raise it. I'd like to see it abolished.
TGR: What about the outlook for the world economy?
Eric Coffin: The numbers are improving. We are emerging from a long balance sheet recession. It takes a long time for people to clean up their balance sheets, not just the government, but also companies and individuals that have a lot of debt on the books. I don't expect growth to go back to where it was six or seven years ago, and it shouldn't, because that was a bubble. But it will return to something more like normal. The rebound in housing and slow healing of the labor market continues in the United States. It should be a relative bright spot and I expect it to surprise to the upside with growth in the 2–3% range later in the year.
I think Japan is going to get a bump—which it desperately needs —thanks to the new Prime Minister. Japan has been the poster boy for deflation for 20 years now. Shinzo Abe is starting to crank up the government's printing presses. I don't know if it's the best idea ever but I have to agree that the deflationary spiral has to be broken or Japan will never get anywhere.
With the installation of the new Politburo, China's numbers have gone positive in the last few months. It is working on rebalancing its economy and I think China can continue to grow at 7–8% for a while yet.
Europe is still a basket case, although the bond markets have calmed down. Europe has seen a lot of austerity and a lot of budget cutting. A lot of people in my line of work tend to think good fiscal policy is all about austerity and cutting budgets. But there is a limit to that when austerity chokes the growth rate. And at the end of the day, most governments will do what governments do: try to grow their way out of recession by increasing government spending. It is a short-term political solution but these are democracies and politicians want to get re-elected. The most painless way to reduce your debt load long term is to grow and/or inflate your way out of it. Governments have been doing this for centuries and I see no evidence the current crop of world leaders is planning anything different.
TGR: Maybe they should buy some gold stocks.
Eric Coffin: Not a bad idea. All of these countries are trying to get a currency advantage. In Japan, there's no pretense. It is saying, "We are going to devalue the yen. We're just going to keep printing yen until the price goes down." We will see governments continue with this competitive devaluation, so gold is going to bounce around for a while. It's not an easy algorithm to track because gold is trading in a variety of currencies—like a currency itself.
Gold has gotten hammered because traders worry about the US Dollar staying "strong" because others devalue, and worrying about the US Federal Reserve taking away the punch bowl. Both are possible but I think the Fed will keep monetary policy loose for a while yet and that things settle out once currencies find some new equilibrium. I view gold as a currency but it's also a commodity, one that gets harder to find and more expensive to mine every day. Medium term, I don't see huge downside in gold because the mining sector simply will not produce enough to meet demand at prices much below current levels. That's not politics, it's the realities of the mining business.
TGR: Thanks for your time, Eric.
Eric Coffin: You are welcome, Peter.
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