"Very Positive" on Gold Prices

Gold is cheap at these levels, reckons money manager Adrian Day...

 

FOUNDER of Adrian Day Asset Management, Adrian Day reckons the glass is definitely half full for gold mining investors right now.

 

Adrian Day believes that volatility in precious metal stocks will continue, but he also believes that gold's extreme bottom is behind us and macroeconomic and geopolitical conditions will continue to support prices, as he explains in this interview with The Gold Report...

 

The Gold Report: Gold had a somewhat remarkable August. What's your view? Is the bottom behind us?

 

Adrian Day: I think it's behind us. The principal reason gold rallied is the sense that the decline was overdone. We got an extreme bottom, and then gold started to slowly move back up. All Federal Reserve chairman Ben Bernanke ever said was that there might be a cutback in bond buying later in the year if the economy continued to improve. That's a rather mild statement, simply saying that additional bond-buying might be reduced; nobody is talking about actually reducing the Fed's balance sheet.

 

During the last few weeks, gold has really responded to the situation in Syria. Gold declined when the British parliament voted down joining the US strike effort. When the US Foreign Relations Committee approved action, gold went up.

 

The third factor is short covering. The shorts both in gold and in gold stocks reached record high levels at the end of June and beginning of July. There's been a significant decline in the shorts since then, from 130,000 short future contracts held by speculators to about 71,000 in the last month, but that is still a very high level of shorts historically.

 

TGR: You take reasonably high net-worth clients and invest them in individually managed accounts, many of which are anchored by gold assets. How are you managing the risk inherent in gold equities?

 

Adrian Day: If you're involved in gold, it's going to be volatile. There is no way around that.

 

We manage the risk by buying companies that are low risk. For the senior companies, that might mean diverse assets around the world not exposed to one political jurisdiction, or it might mean more royalty companies, which have a low-risk business model by definition and strong balance sheets. We buy companies that don't have any significant negatives. In the junior space, I've always thought that certain well-picked juniors with good balance sheets can be low-risk investments even if the stock price is volatile.

 

TGR: How does the Fed's monetary policy factor into your management of gold accounts?

 

Adrian Day: The comments from the Fed that caused gold to go down gave us the opportunity to buy quality gold stocks at much lower prices. The reaction to Fed comments was overdone. The most I've heard any analyst mention is Fed bond buying going from $85 billion a month to $65bn a month. That is still $65bn of additional money creation every month, an enormous amount of stimulus for the economy.

 

TGR: You talked earlier about investing in low-risk or lower-risk gold assets. You've had a lot of investment success with precious metal royalty companies. Are these companies still worth the premium investors have to pay for them?

 

Adrian Day: I'd say yes. The royalty companies make an investment, and once they do they're not responsible for anything going wrong. Just think of all the things that have gone wrong in the mining business over the last few years. That's the beauty of the business model. Essentially, you don't have the risk of mining, and mining's a very, very high-risk business.

 

A lot of senior companies are struggling. They're closing mines, delaying projects; there are capex overruns and huge write-downs. A lot of juniors are also struggling because they don't have the cash. A company that has the cash is in a beautiful position to invest in other companies that need the money and to get a royalty in return. 

 

TGR: Do you see any value left in the gold and silver royalty space?

 

Adrian Day: I think there's a lot of value in some of the smaller royalty companies or companies that are morphing into royalty companies. 

 

TGR: We talked about gold royalties as one way of mitigating risk in the gold space. Certainly another way is the major producers, although you wouldn't think that given their performance over the last couple of years. 

 

Adrian Day: Generally, I'm less favorable toward the major mining companies than I am toward the smaller miners or toward the royalty companies or the explorers. However, there are some good names. 

 

TGR: Do you have any parting words about the space to leave with us?

 

Adrian Day: The reason to be positive on gold right now is, first, I think gold is cheap. The selloff was grossly overdone and it wasn't only the possibility of the Fed cutting back on stimulus, but at the same time we had concerns about China's economy.

 

I think both of those concerns had been mitigated to a large extent. China's economy, looking at the latest manufacturing statistics, seems to have stabilized. Growth at 7.25% with low inflation is still pretty good growth and still translates into ongoing demand for gold from China.

 

I feel very positive on gold. If the Fed tapers less than expected, that should be seen as a major positive for gold prices. Even though there has been a mining stock rally, on a historical basis these stocks are just very cheap. On any metric you care to look at: price to earnings, price to cash flow, price to ounces in the ground, price relative to gold, price relative to ounces on production, etc., the major mining companies today are as cheap as they have ever been throughout this entire bull market other than for a few weeks at the end of 2008. In 2009 the gold stocks rebounded dramatically. I feel very positive, not just on gold, but also that the gold stocks are simply not reflecting the positives in gold.

 

TGR: You seem to be more hopeful than you have been in recent interviews.

 

Adrian Day: Let's not say hopeful. Let's say positive, exuberant. I'm very positive about the gold price and at the same time the gold stocks are just extremely oversold in my view, the good ones and the bad ones. I feel very positive about the gold stocks right now.

 

TGR: Thanks for your insights, Adrian.