But will investors hit many "home runs"...?
NEW DEPOSITS and economic triggers will move Gold Mining shares, according to Eric Coffin, editor of resource stock publication HRA Journal. In this interview with The Gold Report, Coffin identifies the management characteristics of gold juniors that make money for investors.
The Gold Report: Eric, why is there a bear market for metal mining companies in a season of bulls?
Eric Coffin: Post-recession, there was a good bounce for commodity stocks. Two problems have slowed things down during the last year. One was fear of the fiscal cliff as the politicians in Washington argued about raising the debt ceiling. Banks were blowing up in Europe. Most important, weakening numbers out of China scared off a lot of investors, particularly from the base metals. There are simply a lot of people concerned about the economy in general, and, specifically, the growth economies where metals are keys to industrial development.
On the gold and silver side, the real issue is that gold is over $1,700/ounce (oz) and silver is now over $30/oz. It sounds as if I'm being ironic, but I'm not. At the start of this major cycle, Gold Prices were $300/oz. It was not the price-earnings (P/E) ratio that was determining the value of a lot of mining companies, it was the P/E ratio plus a very large amount added for in-the-ground resources. Goldbugs at the start of this cycle expected gold and silver prices to go up 500%. They were as interested, if not more interested, in the leverage, the "ounces in the ground per share" that gold stocks represented.
I'm not going to assume that gold is going to $10,000/oz. I'd be really happy if it does, but I'm not expecting it. What we are seeing now is that the P/Es for the gold firms are returning to the market average. In the past, gold companies could trade at 80–90 P/E. The earnings part didn't matter very much. It was all about the amount of gold resources on hand. Now investors are taking a harder look at how much money these firms are actually making. We can't just assume that gold is going up another 400–500%. So the P/Es have normalized.
Another concern is profit margins. Costs have gone up very rapidly in the mining business. For a long time that was because there was a skills shortage. Part of the reason why we expected this to be a long secular bull market was because we knew how short the industry was on all kinds of skills, material and equipment. The mining sector was not going to turn around and suddenly start producing twice as much copper, zinc or whatever at the same cost. As the price of metals rises, so does the price of a geologist, the price of an engineer, the price of a ball mill.
The situation will improve over time as more professionals are trained and the production capacity of industry suppliers is increased, but this takes time. The final piece of the cost equation for many metals is grade. As the "low hanging fruit" is picked and the industry moves to tougher terrain with less infrastructure and deposits with lower average grade, the cost of production rises. While I'm not a big believer in things like "peak copper" (at least not any time soon), supply is very much a function of price. If the world wants ever increasing amounts of metals it will have to pay up and pay the mining industry to supply them. The days of cheap metals, in most cases, are over.
TGR: You observed recently in HRA Journal that the currently depressed junior gold explorer market is showing signs of life. Can you explain that?
Eric Coffin: One reason is that the market is running out of sellers. People who wanted out of gold equities are largely gone; there is a huge amount of money on the sideline. That puts in a bottom but doesn't cause a turnaround. I think the spark that gets the juniors moving again, as it has in many past cycles, is new discoveries. We haven't seen many discoveries that grabbed the market's attention in the last couple of years.
Exciting discovery stories are critical to the junior mining sector. People need to be reminded of why they buy these high risk stocks. Investors do not buy a $0.10/share junior as a widow or an orphan stock, they buy it because they are swinging for the fences. It's hard for investors to talk themselves into swinging for the fences unless they are seeing others hitting one out of the park.
A couple of recent home runs have generated a bit more liquidity in the market, but not as much as I'd like to see. The summer is always slow. The real test is going to come in the next month or two. However, we are starting to see financings close again. And companies that have done well off of drill discoveries are getting big increases in stocks prices and, critically, we are seeing more of these companies maintaining higher prices; that generates money that gets redeployed.
TGR: How does a smart investor in gold juniors separate the wheat from the chaff?
Eric Coffin: It's wise to focus on a geographic area that's already generated a lot of good news. If a company is looking for a bulk tonnage open-pit-type deposit, I look at the target size to be sure there is enough scale potential. I don't have a problem with the high-grade ore. Good high grade deposits can be very profitable even though the market tends to focus on the big low grade systems. But to get the market's attention for an underground operation, there needs to be a minimum of 6–8 g/t and, ideally, more than 10 g/t in intercepts.
In many areas you can make money on lower grades than that if there is good thickness but the market tends to ignore grades below 10 grams unless they are at least several meters thick. With bulk tonnage, you can get away with 1 g/t or 1.5 g/t, but for drilling at those grades, you want to see 60, 80, 100m drill intercepts. The property has to look strong from the outset, because the company has to keep raising money. That being the case, one looks for a management group with a strong brand and a track record of success—both in market terms and in technical terms.
Things can get difficult even when a discovery has been made if management isn't able to get the market to take notice. Having access to capital is huge for a junior. It's even more critical when the market is weak as it has been the past 18 months. When the market's great, everybody's happy, people will say "yes" to anything and it's much easier to raise money. But when the market is weak, management must be able to convince people to write a check. Of the 1,500 or so junior companies, there may be 100 that can do that in this type of market on non-dilutive terms and no more.
TGR: What kinds of economic triggers are likely to affect gold equities positively or otherwise in the foreseeable future?
Eric Coffin: For the next three months, it's central banks, central banks and central banks. Everybody is expecting Federal Reserve Chairman Ben Bernanke to kick in Qualitative Easing 3 (QE3). I'm slightly less convinced, but I'm not going to complain if he turns on the printing press. The latest monthly employment report in the US was quite weak so that may be the trigger for a QE announcement.
What Bernanke said at Jackson Hole brought the Gold Price back up through $1,700/oz. We are seeing similar indications out of the European Central Bank (ECB). Mario Draghi is telling the European countries that are anti-stimulus, "I'm going to do it with you, or without you!" And Germany's Chancellor Angela Merkel, who hasn't exactly been a proponent of bond buying, is now saying they have to stimulate. It looks like we could have stereo printing presses humming along on both sides of the Atlantic before long.
Perversely, weak employment numbers and weak purchasing manager index numbers help precious metals. Weak economic indicators convince traders that Bernanke and the ECB are going to have to pull the trigger. On the base metals side, the easing could have the opposite impact, with one exception. If we continue to see weak numbers out of Beijing, the traders will think that Beijing is going to stimulate, too. But not with bond buying. The Chinese can simply loosen reserve requirements for the banks. They hold trillions of Dollars in foreign reserves. Unlike Washington and most of the debtor countries in Europe, China can simply start writing checks.
It, too, has been putting out weaker numbers and making more noise about stimulating. China does have slightly higher inflation, which makes things trickier, but I expect it to step up stimulus toward year-end as the next generation of Communist Party leadership is sworn in.
TGR: What effect would QE3 have on mining interests, generally?
Eric Coffin: It will help. QE3 will weaken the US Dollar. It will cause traders to buy treasuries all the way up and down the yield curve, thereby lowering the yields. In the last couple of weeks, the US Dollar index has dropped a couple of points, which is a fairly big move. As it moves lower, gold and silver prices in US Dollars will strengthen. Then we will see better numbers in the US as businesses gain confidence and start hiring. Those hiring decisions are being held back right now because managers aren't comfortable with the slow growth rate. Virtually all traded commodities are priced in US Dollars, so it should help them all, though precious metals will get the biggest, quickest boost.
TGR: How will monetary easing affect mining in Mexico?
Eric Coffin: In Mexico, the Peso is relatively weak by historic standards, which helps with mining costs. It has good mining infrastructure and good mining legislation. It doesn't have any real royalties to speak of. You don't get a lot of surprises there. However, areas of the country are bloody dangerous; that's the one thing that has held Mexico back recently. The drug cartels have scared people out of some areas. Nobody really knows who is calling the shots. You certainly don't get the impression that it is the Federales; the drug cartels do whatever they want. But people more or less know where the growing is and where the drug routes are, so they stay out of those areas. I'd like to think that crime is not going to be a long-term problem. There are still plenty of areas in Mexico that work out fine for miners.
You must have agreements with the local ejitos, however. Although the ejitos don't own the mineral rights, they do have surface rights and they have local political power. So you need to sit down, talk to the locals and make sure that everybody is happy, because an angry ejito can really make your life miserable. There are some ejitos who just don't want development. And when the locals don't want you, there's just no point in bothering. All that said, it's a good country with lots of good geology and plenty of recent discoveries. If the government can get the crime issue under control, I don't doubt the high level of mining investment would continue and probably grow again.
TGR: Thanks, Eric.
Eric Coffin: You're welcome.
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