And the "irresponsibility" of the "new paradigm" in funding...
SMALL and mid-sized junior Gold Mining producers and developers are the "sweet spot" in the gold equities space, according to Michael Fowler, senior mining analyst at Loewen, Ondaatje, McCutcheon.
In this interview with The Gold Report, Fowler also shares his views on the irresponsibility of the "new paradigm" of large-scale financings now in vogue.
The Gold Report: Let's start with the changing risk picture in the gold space. Are there no low-risk companies in the gold space today?
Michael Fowler: I think that is correct. Right now, any gold stock is fairly risky due to a combination of factors. First off, gold stocks and the Gold Price are very volatile. Second, Gold Mining is a tough business, subject to unforeseen circumstances.
TGR: If investors have to assume risk with gold equities, does it make sense to go with small- and mid-cap companies where the rewards can be higher?
Michael Fowler: Yes, I think investors should be more focused on junior producers and, to some extent, explorers. That is where you will get the most gain.
TGR: On March 14, the Gold Price dropped $40/ounce (oz); in late February it crashed $110/oz in one day. Is this due to the perception of a strong US economy, or is that too simplistic?
Michael Fowler: I think that is correct and somewhat simplistic. Before the recent release of good economic data, the feeling was that the Federal Reserve would enter into a third round of quantitative easing (QE3), to increase its balance sheet and monetary liquidity. Now that the US economy is moving along at a reasonable, although slow, clip, the Fed is hesitant to go the QE3 route. As a result, gold has sold off.
TGR: Should we expect more of the same in 2012?
Michael Fowler: While gold will be difficult in the short term, my thesis on gold is very bullish. The whole world is involved in increasing both the money supply and liquidity. Interest rates are very low and it seems as though the Federal Reserve will not increase them for the time being. Countries around the world are engaging in almost competitive devaluation of their currencies. For the longer term, this is very good for gold.
TGR: When do you expect that uptick to occur, perhaps when the next battle over raising the US debt ceiling starts?
Michael Fowler: That would help, I suppose. When the US presidential election gets closer, there will be more fuel for gold. For the next month or so, gold will have a problem but after that, it will turn around.
TGR: Your varied coverage in the gold space generally consists of small producers and near-term developers. Are they the sweet spot in the gold space in terms of risk versus reward?
Michael Fowler: Yes, in particular the junior producers. Eventually, the developers and explorers will catch investors' interest. We focus on this area because: number one, we see ourselves delivering service to our clients; number two, we believe the returns in the smaller cap names will outperform the larger caps.
I think the whole of the gold sector is on sale at the moment, although you have to be selective in where you invest.
TGR: What is the risk profile of the one-mine miners and developers versus the majors?
Michael Fowler: Quite frankly, it is high. In general terms, a multi-mine company has lower risk than a one-mine company. However, if you have one really good mine, that is better than having a number of very poor mines.
Among developers, their biggest hope is to be taken over because the history of developers going on to be producers is not very good at all.
I would recommend having a basket of junior producers and developers, such that you are not dependent on one particular company that could blow up.
TGR: For developers, is this the best place to be just before they bring the mine into production?
Michael Fowler: No. I'll expand on the answer to that question; there are various stages. The first place to be is in companies that have one or two mines and look to be growing by 20–25%/year.
The next place to be is in an emerging producer with good grades that could work out well. Lastly, I would suggest a developer that is likely to be taken over in one or two years.
TGR: Why are producing companies performing so poorly, given that most of the feasibility studies on their mines were done using a Gold Price of $1,000/ounce, hundreds less than the current price?
Michael Fowler: I think there are numerous factors behind that. One, investors can avoid all of the issues producers present by putting money into exchange-traded funds. Two, there have been some production hiccups recently. Three, some equities have been over-diluted. I have been critical of deals made where the company did not need the money, but nonetheless diluted its share base when the performance was not there. Four, there has been cost and capital inflation in the sector.
TGR: Do you remember another time when gold equities performed so poorly versus the Gold Price?
Michael Fowler: The 2008–09 debacle comes to mind, but that was less to do with gold equities and more to do with the risk environment in the general market. Gold Prices stayed fairly firm then, but gold stocks got clobbered in the risk-averse trading that went on.
TGR: Should investors be concerned?
Michael Fowler: They certainly should take account of what is going on. The good news is that many gold producers are showing margin increases because the Gold Price has gone up faster than cost inflation.
There is a ray of sunlight coming through. We will not return to the same multiples we were at in the 1990s and mid-2000s. Instead, we will go back to something closer to the mean. Longer term, margins will continue to increase, earnings will go up and, eventually, so will stock prices.
TGR: Is it difficult for juniors to raise money, given that they are pure exploration plays?
Michael Fowler: The financing environment is a bit eclectic at the moment and probably is getting worse as we speak. But there is money out there, focused on selective companies or selective deposits.
We usually find that the time to invest in a company is when essentially nobody likes the sector. You do not want to be buying when every institution is buying; that is a good signal that you are on a high.
I want to emphasize that we have seen a lot of companies raise $20M or $30M when they did not need the money. There is a new paradigm going on. We used to raise money for one or maybe two field seasons, and the amount raised was $5–10M, maximum. Today, some of these guys are raising $30–40M. Quite frankly, I think that is irresponsible.
TGR: That's a pretty brash statement.
Michael Fowler: Over-equity dilution depresses the company share price. From the companies' perspective, managements are running scared. They say that they have to raise money now to take care of themselves for many years.
But you have to ask why institutions are giving juniors money every time they come back to the well. If you give a company $40M, you will not see that company for the next five years; it can do anything it likes with the money. Management no longer has any incentive to perform on the exploration programs. There is no accountability in the one- to two-year time horizon.
I do not think that is a good thing.
TGR: Do you have any other parting thoughts for us?
Michael Fowler: I realize that I have talked a lot about problems, but essentially I believe the Gold Price will rise. In particular, junior producers will be the first to start moving, their cash margins will increase and their earnings will rise. Then, some of these junior explorers and developers will participate in the upcoming bull market.
TGR: Michael, thank you for talking with us today.
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