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Lulls Ahead for the Gold Mining Sector?

Statistically, the second quarter tends to be the weakest for Gold Mining stocks...

BETWEEN March and May is statistically the weakest period for Gold Mining equities, says Barry Allan, vice chairman of Mackie Research Capital Corp.'s mining group. However, he remains bullish on gold stocks through the end of the year and has Buy recommendations on more than 70% of his coverage universe. 

In this interview with The Gold Report, Barry Allan points to where he's finding value during this period of seasonal weakness. 

The Gold Report: When we last spoke in May 2010, small-cap mining plays were poised to go on a bull run that would last almost a year. However, the mining sector has underperformed expectations recently. Why do you remain optimistic?

Barry Allan: Market appetite for small-cap equities has eroded as investors clamor for less risky investments. A backdrop to that sentiment is the Gold Price, which has shown lackluster performance since hitting a peak in mid-2011. The Gold Price continues to be in a realm of uncertainty, particularly because we are in a seasonally weak period, the second quarter. The second quarter statistically is the weakest quarter for gold equities. There's no good reason for that, but it is a statistical fact. That has also eroded some of the appetite for small-cap gold stocks.

TGR: What is the best quarter for small-cap gold equities?

Barry Allan: The fourth quarter, bar none, is the best period for gold and gold-related equities, particularly small caps. On a percentage basis, there's less than a 5% probability that the fourth quarter will be a weak quarter in any fiscal year. There are generally good prices at year-end, which tend to carry through to February. Then March presents the highest risk for price decline. I make this joke about the Prospector & Developers Association of Canada (PDAC) conference, which is always in early March: The rule of thumb is wear a warm coat to the PDAC because we always get a cold snap, but also don't be holding any gold stocks.

TGR: You've said that you have no preference between gold and silver and remain bullish on both in the near and long term. What do you see that has you bullish in the near term given the recent slide in prices for both metals?

Barry Allan: Trajectories are never straight up. There are seasonally weak periods. Some evidence indicates that perhaps the US economy is starting to set a base. However, I certainly don't see anything that reduces the attractiveness of either gold or silver looking out to the end of the year.

There have been some bumps and grinds, but all the elements that made gold get here in the first place largely remain intact. I'm not prepared to say that I'm negative. I'm cautious about the second quarter, but I've been cautious about the second quarter pretty consistently over the last 10 years. 

TGR: About 71% of the companies on your coverage list have Buy recommendations. Is it fair to say you see a lot of value in Gold Mining equities at the moment?

Barry Allan: Generally, the recommendation list follows my positive bias for the prospects of bullion. A lot of the equities that we have looked at are a pretty good value. Then the question becomes are they value traps? Are they going to continue to just look like a good value, but not show any performance over the next 12 months? 

TGR: Where is value consistently presenting itself? 

Barry Allan: The most compelling theme is those companies where the asset is clearly identified as having merit. The problem is usually getting the money to build the mine. There are a number of examples where there is a positive feasibility study or prefeasibility study. There are ounces and, in some cases, reserves in the ground. But how is the cash flow going to get unlocked? Capital costs could be $400–600 million (M) for a company that probably has a market cap of $120M. How will it get that into production? It will take capital to unlock it. 

TGR: Let's talk about dividends for a moment and their impact on total return. TheStreet.com reports that the S&P 500 Total Return Index hit an all-time high of 2,449.1 on April 9. Dividend returns kept the index in the black. About 29% of the companies you follow are paying a dividend. What's your philosophy regarding dividend-paying companies?

Barry Allan: I don't want to sound sarcastic, but it's only in the last two years that gold companies could even spell dividend. This has been a sector that historically did not pay dividends. 

With the evolution of exchange-traded funds (ETFs), gold companies have vocally come out and said, "Look, buy us because at least we will pay you something back where the ETF will not." They're attempting to recapture some of the valuation premiums that gold equities historically traded at. 

Are dividend-paying gold companies enjoying a return to premiums? The answer is no. It's been a flawed strategy in the sense that the traditional methodology of tracking premiums was to show good fundamental underlying performance. The notion of dividend paying for gold companies is a little bit of an anomaly in this market. The broader market is yield starved and looking for dividends. As such, dividend paying companies have attracted more attention than not. But the highest yielding gold stock that we have is 2.5%. A number of yield stocks in the overall universe of coverage at Mackie Research have upward of 4% or 6% yields. We're not buying a 2.5% or 1.5% premium for the yield.

TGR: Should dividend yields be enough to lure investors or should companies be using that money to improve their asset base or increase efficiency at their operations?

Barry Allan: It's nominal. A yielding stock isn't going to attract much attention at anything less than 2.5%. I don't know any investor who's saying, "Wow, I like Company X because it's got a 2.5% yield!" They can buy another stock and get a 6.5% yield with much lower risk. I don't think it cuts it.

TGR: Is the message to investors to wait until later in the year for performance and approach with caution?

Barry Allan: Yes, take a low-beta strategy through the year, increasing weightings in the August time period to enjoy a better return at the end of the year. Investors just looking for some good companies that will do well irrespective of the Gold Price should go back to companies where there's value to be unlocked and all they need to do is wait for them to execute over the next 12 months. 

It doesn't really matter what the Gold Price does. We're just looking at companies where the value is there and there's a real proposition that that value is getting unlocked within 12 months.

TGR: I enjoyed speaking with you, Barry.

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