Have we seen the beginning of outperformance...?
THIS SUMMER'S rally in Gold Mining equities is the beginning of the outperformance that Joe Foster, portfolio manager of Van Eck International Investors Gold Fund, has been looking for. Federal Reserve quantitative easing and other monetary policies will fuel both gold and gold equities says Foster in this interview with The Gold Report.
The Gold Report: In the first decade of this century, the Van Eck International Investors Gold Fund gave its investors an annualized average return of about 25%. How has the fund performed since we last talked in August 2010?
Joe Foster: Gold stocks have had a tough time in the last couple of years and the fund was essentially flat during that period. The stocks have underperformed the Gold Price, which is up about 38%, and that is reflected in the fund performance.
TGR: In a September management commentary on vaneck.com, you suggested that adding liquidity to a heavily liquid market would not have a dramatic effect. Gold has been trending lower for weeks and is now just about $1,700/ounce (oz). Has the effect of quantitative easing (QE) 3 come and gone?
Joe Foster: The comments on liquidity reflect the pushing-on-a-string theory. The Federal Reserve can only reduce rates so far and can pump only so much money into the system. At some point, it no longer does any good. We may have reached that point.
The Fed's aim is to reduce unemployment and get the economy going, but the massive doses of liquidity already administered have not sparked the economy. We doubt further QE measures will have much impact.
Gold responds to debasement of a currency; it is a form of alternative currency. The QE does just that: it debases the currency and gives investors a reason to go to gold as an alternative. As long as the Fed continues this type of activity, it should be good for gold.
TGR: Then why are there signs of weakness in the Gold Price?
Joe Foster: The weakness in the last two or three weeks is simply a correction from the strong rally in August and September, leading up to the QE3 announcement. Things do not always go up in a straight line. We are just having a bit of consolidation in the short term.
TGR: You remain bullish long term?
Joe Foster: Sure. The Fed announced it would be buying $40B of mortgage-backed securities a month, on an open-ended basis. It will be keeping interest rates targeted at zero for two or three years at least. These policies are very bullish for gold in the long term.
TGR: You have suggested that one reason gold stocks have underperformed gold is rising production costs. What are the other reasons?
Joe Foster: That is the core reason and the other reasons are related to those higher costs. We have seen an unprecedented rise in operating and capital costs over the last couple of years. There is a global mining boom, and not just in gold. Gold miners have to compete with iron ore producers, tar sands producers and base metals companies. That has driven up the costs of labor, materials and equipment. I think the rate of cost increase caught a lot of managements off guard.
Because of those rising costs, many gold companies have missed expectations. Higher costs put the squeeze on earnings. The market hates it when companies miss their forecasts. Missed expectations may be the reason for underperformance, but rising costs have driven the missed expectations.
TGR: You have predicted better performance for gold stocks once the investing environment takes a positive turn. How far off is that positive investing environment and what will signal its arrival?
Joe Foster: I think it has arrived. With QE3 and gold breaking out in August, the gold stocks really kicked into gear. Our fund's performance in August, September and October is up about 20%; gold is up about 6%.
This breakout looks like the beginning of the outperformance in the stocks that we are looking for.
TGR: Do you expect that to continue?
Joe Foster: Yes, for a couple of reasons. First, the boards of the large gold companies that have been missing expectations have woken up to the fact that management changes are needed. Some very high profile CEOs and COOs have departed. There has been a shift in focus toward more profitability and less growth. That shift toward profitability, shareholder returns and returns on capital should bode well for the industry.
Second, costs could be coming more under control in the months to come. The slowdown in the global economy caused a slowdown in mining activity across base metals, coal companies and iron ore companies. More labor is now available. Lead times for equipment and materials are shorter. That should translate into less cost pressure as we move through 2013. That could be another catalyst for the industry.
TGR: How will you position the fund in the gold equities market? You have the majors, the midtier producers, developers and explorers. Where is the sweet spot right now?
Joe Foster: Throughout this bull market, we have been overweight in the midtiers and junior stocks. That is where we find better opportunities for growth. We have been underweight in the large-cap companies, the ones that have struggled to generate growth. We will have to see if the management changes being made by the majors will enhance their profitability and help them do a better job of meeting expectations.
In the meantime, we are happy to be overweight in the midtier and small-cap stocks where we find more opportunities for growth.
TGR: Your fund has a fair bit of exposure to West Africa, which is rapidly becoming a Gold Mining district.
Joe Foster: We have positions in a handful of large, low-grade properties in West Africa in various stages of development. Some may need a slightly higher Gold Price or more engineering to enhance the rates of return. We see them all moving forward in the course of this bull market.
TGR: Could you give our readers, some reasons to stay positive about investing in precious-metals equities?
Joe Foster: All of the things that have been driving Gold Prices throughout this bull market remain in place. The US is still running trillion-Dollar budget deficits. Central banks all over the world have incredibly easy monetary policies in place. They are printing money in one form or another, holding interest rates at extraordinarily low levels and generating negative real interest rates.
These trends are not going away any time soon and are creating the financial risk that is driving the gold market. We expect that to continue in the longer term. Gold stocks will reflect the underlying Gold Price. While the gold stocks have underperformed over the last couple of years, we see reasons to believe they are reversing that underperformance. If the Gold Price trends higher, these stocks could do very, very well.
TGR: Joe, thank you for your time and your insights.
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