The outlook for Gold Mining producers as QE3 hoves into view...
A MINERAL PROCESS engineer and Gold Mining specialist by training, Robert Cohen is vice president and portfolio manager for GCIC Ltd, the investment management division of Dundee Wealth.
His experience in the Gold Mining industry is extensive and includes work as an engineer and a corporate development adviser for an international producer. Here he tells The Gold Report how he expects a third round of quantitative easing in the United States, and what that means for precious metals and miners...
The Gold Report: Robert, British Prime Minister David Cameron said that the European debt crisis could "get a lot worse." What's your view on the likely outcome?
Robert Cohen: I think he's right. It has the potential to get worse before it gets better. Europeans are going to have to deal with some sort of Eurozone fracture. Greece could certainly exit the Euro within weeks rather than years. It has an election on June 17, and it will probably be bankrupt by the end of June.
TGR: Can the Eurozone survive without Greece?
Robert Cohen: It can survive, but other countries could leave or it could break into two parts, like a northern Eurozone and a southern Eurozone.
TGR: Is the debt crisis in Europe a continuation of the 2008 market meltdown?
Robert Cohen: Absolutely. It's just another chapter of the global financial crisis. There's been a buildup of global foreign exchange reserves. I think that's the root cause of a lot of the problems in the Western world. The foreign exchange reserve buildup globally, probably generated out of China and Organization of Petroleum Exporting Countries, circulated into the developed bond markets of the world.
The whole notion of the Eurozone was poorly planned. It doesn't give individual central banks the ability to manage their balance sheets to debase their own currencies. Different countries with different economies have the equivalent of one Fed. It's hard to get decisions made in Europe swiftly and effectively. It's dysfunctional.
TGR: How long before it spreads to North America – or does it?
Robert Cohen: We're all connected to the global economy. It can spread very quickly depending on how interconnected the financial systems are with one another.
TGR: Was J.P.Morgan's $2 billion loss related?
Robert Cohen: I think that was just a rogue trader. However, it still has to be investigated.
TGR: How is what's happening in Europe impacting your day-to-day fund management? How do you manage against fear?
Robert Cohen: What's going on macroeconomically is causing dysfunction in the stock market, but not the underlying metals. I'm actually quite comfortable with the Gold Price around $1600 per ounce, oil at $95 per barrel and copper at $3.75 per pound.
Paper money is losing its purchasing power. What's happening globally is creating fear and contagion that's spreading into the stock market. We're at a unique place in history where the metal prices are robust and yet the stock prices are the cheapest I've ever seen them relative to the underlying commodity prices. It's a behavioral finance issue. Investors are cranking up the risk premiums and their perception of risk. It's manifested in the stock prices across the board.
We use quantitative models that statistically measure observations of the stock market. You already know stocks are cheap. The model concludes when stocks are cheap, we should to buy more stocks and less bullion. We run a secondary model that actually brings in other effects, such as the US monetary base. That model has a bit more of a neutral stance between equities and bullion at present. While one of the models is indicating to put the pedal to the metal because equities are super cheap, the other model is saying to ease up slightly. I take a neutral stance between the results of those two models.
The other fund strategy is an all-equity fund. We keep it defensive by owning a tight number of equities. Two-thirds of the fund is in 20 names. The remainder is in another 20-30 names. It's a very concentrated portfolio. We've hunkered it down into our favorite stocks because you could be a genius stock picker and still miss in a market that is being ruled by fear.
TGR: Was there any point in the last 18 months when you wished you could have been invested in 100% bullion in your strategic gold class?
Robert Cohen: It would have been doing a "George Costanza" of what our models are saying. The models would indicate to go to 100% bullion when the market is over-exuberant on stock valuations. Stocks have undoubtedly been undervalued since 2007.
Our models don't indicate if the market is going to get more fearful in the next chapter. We can't predict that. We just observe and allocate accordingly.
TGR: Are precious metals equities still safe havens or is that status all but gone?
Robert Cohen: Gold bullion and Gold Mining equities are two different asset classes. Gold is a monetary asset that works through time. If you wanted to protect your purchasing power, you could have put an ounce of gold in your safety deposit box in 1971 or 16.5 bbl oil in your garage, and today, 41 years later, swapped them at the same ratio. That tells me that gold keeps its purchasing power. Gold is an ideal way to protect your purchasing power – not to mention that barrels of oil in the garage would have taken up a lot of space and been a fire hazard.
We are going through a period of the erosion of the purchasing power of money. We've always gone through that – our parents, grandparents. One of the slides I use in my presentations is a bunch of Vancouver kids in 1947 protesting a hike in the price of chocolate bars from $0.05 to $0.08. You can look back on it today at how laughable and cute that is, but it was a serious matter to them. Monetary reflation is constantly chipping away at your purchasing power.
Now, are precious metal equities safe havens? While equities are never safe havens by definition, gold equities can provide the potential for capital appreciation over the long term. However, the last four years have witnessed a change in the stock market functionality. The financial crises unfolding in Europe, fiscal deficits, government debt piling up in the US and global trade imbalances have put a lot of fear into the equity markets. It's going to bounce along the bottom here for some time. Often quantitative easing (QE) is a trigger to get the market functioning well. In January 2009, after QE1, functionality returned to the market. Then it sort of wore off again. Then QE2 put some more functionality into the market. QE2 has kind of worn off. Here we are, wondering what the governments are going to do next.
We need the functionality back in the stock market. QE could help. The market is like a kid that can only ride a bike with training wheels on it. If the training wheels start breaking or you try to take them off, the kid can't ride the bike. We need new training wheels right now.
TGR: Are you expecting QE3?
Robert Cohen: I am, which presents an opportunity in itself between now and the time it comes. It's a good time to accumulate patiently.
TGR: Are you following stories in West Africa?
Robert Cohen: We're following quite a number of stories in that region. Geologically, it hasn't been as well combed over as other parts of the world. Political risk isn't as bad as the worst places in the world. It's not a bad risk-to-return ratio. You have to select your countries. There are obviously going to be problems in West Africa, usually infrastructure related – be it power, water or skilled labor. Even with those hurdles, there are some robust projects with decent internal rates of return (IRRs), good payback and relatively fast payback periods. West Africa is where the interesting up-and-coming companies are working.
TGR: Can retail investors still make money when the markets go down and sideways as they have in 2012? If so, what strategies would you suggest?
Robert Cohen: That's the million-Dollar question. If markets are flat to oscillating, investors can make money with short-term trading, but I don't encourage that. Like Warren Buffett, I encourage investing in good-quality businesses because just picking the right projects doesn't guarantee that you'll make money.
TGR: Thanks, Robert.
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