Gold Price Outlook for Miners
Friday, 11/01/2013 13:08
How near-term gold prices could affect the mining industry...
ENCOMPASS fund managers Malcolm Gissen and Marshall Berol don't agree on the timeline for gold's recovery, they have faith that it will come.
In the meantime, as they explain in this interview with
The Gold Report, their focus is on gold mining players already in production, generating cash flow with top-notch management teams.
The Gold Report: It's almost Halloween and we remain in the clutches of a tricky market for junior resource equities. What are your perspectives on how long it's going to take before investors see another treat-filled year like 2010?
Malcolm Gissen: The last couple of years have been frightening for investors, in both gold commodities and gold stocks. Gold prices have been rising the last few weeks, allowing some people hope, but I don't expect an appreciable change in the gold price and the appeal of gold mining companies until 2015.
Marshall Berol: I'm more optimistic than Malcolm. I think the market will change, possibly in as little as five months. The underlying fundamentals that have driven gold up over the last dozen years are still in place: the money printing presses, supply and demand for bullion, bars and coins. Costs are going up, so is the need for higher prices.
I would like to see the market refocus on fundamentals and get away from tracking the hour-to-hour and day-to-day activities of the financial players. What they are doing in the futures markets is driving the price of gold and other commodities up and down incessantly. The Dollar is up; the Dollar is down. Oil is up, oil is down. Stock prices react to whatever news is coming out of Washington, Europe or Japan. At some point, investors will realize that gold's underlying fundamentals have not changed and that there are reasons to buy it.
Malcolm Gissen: We started investing heavily in gold in the accounts of clients of our RIA firm, Malcolm H. Gissen & Associates, in 2002, when the
gold price was under $300 per ounce . We built allocations to precious metals of 15-18% by 2004. When Marshall and I launched the Encompass Fund in mid-2006, gold companies was the largest asset class. We believed that gold was deeply undervalued and with India and China, cultures that value gold and use it as a currency substitute, developing a middle and upper class, demand for gold would increase exponentially. We also knew that many investors would come to realize that the gold price would go up because of inflation and currency devaluation – the historical reasons people buy gold.
That attitude has changed over the last two-and-a-half years. Fundamentals no longer seem to play a role in attracting investors to buy gold or gold stocks. Marshall thinks it would be nice for people to go back to looking at fundamentals; I'm not sure that will happen. The information explosion – gossip, rumors and trying to guess what hedge funds and private equity investors are doing – plays an increasingly larger role in decision-making.
One factor that would cause gold to rise would be the realization that the US government is printing money to deal with its tremendous debt. This is not sound policy. This should scare people, but it doesn't seem to at this time.
The Federal Reserve is doing everything it can to keep interest rates low, which is good for corporations and good for the economy, but it is doing that by buying bonds and mortgages. Eventually, we will have to pay the piper. At that point, hard assets like gold and silver will look a lot more attractive. Until we get to that point, I'm concerned that gold will not break out of the range it has been trading in for the last couple of years.
TGR: Change will require the onset of fear.
Malcolm Gissen: Fear is definitely one strong motivator. Unlike Halloween, where children (and many adults!) love going to haunted houses to be frightened, people do not seek fear in their investments. Rather, they avoid fear, often at all costs. If fear returns in the markets, Marshall and I think that gold is likely to be a place where investors will move their money.
Another new development affecting gold and silver prices in the long run could be supply constraints. The world's largest mining companies have realized that they must be more sensitive to escalating costs of building and operating mines, especially with gold and silver at present prices. They can't rely on $1600-1900 per ounce gold prices to pay for $3-7 billion expansion and construction projects and remain profitable. With gold in the $1000-1300 range, some companies are not profitable.
I just attended an excellent presentation by Juan Carlos Artigas, head of investment research at the World Gold Council. While arguing that all investors should have a 3-10% allocation to gold because it is an asset with low correlation to almost all other assets, he pointed out that all-in costs for some gold producers were in the $1200 range. As a result, CEOs are less willing to build large projects. We also have seen much less merger and acquisition activity among the majors. I believe that will, over the next few years, threaten the gold and silver supply.
If gold supplies are threatened, it could raise gold prices. I can't say whether that will happen in six months or three years, but I believe that we're headed in that direction.
TGR: Do you expect the trend of up-and-down gold prices with no real pattern and with little consensus to continue until there is a decided move upward?
Marshall Berol: Although we disagree on timing, we agree that gold will continue trading in the $1200-1450 range until it breaks out to the upside.
Malcolm Gissen: I think there's a floor in the $1100-1200 range. When gold goes below a certain level, companies will stop producing, there will not be enough gold to meet demand and we'll see higher prices.
Industry executives tell us that if gold should ever get to $1000 or $900 per ounce they expect many of their colleagues to go on care and maintenance, because they can't make any money at that price. They'll go to a skeletal crew and cut back on production.
TGR: Let's look at silver. New York's CPM Group expects silver prices to consolidate for another three years, at an average of $18 per ounce. Do you support that forecast?
Malcolm Gissen: I don't, for a couple of reasons. First, it's very difficult to make forecasts for a specific timeframe. I cannot predict what will happen in three years. It is difficult enough trying to forecast where prices will be in three or six months! Second, because silver has so many more industrial uses than gold, I don't see silver prices declining by an additional 15% after the sharp decline of the past year. I also do not believe that silver prices will break out until factors – similar to what I mentioned for gold – change.
Marshall Berol: Silver's current price is $21-22, so CPM's forecast implies that the price will decline over the next three years. I don't agree. About half of silver usage is industrial – electronics and medical, for example – all of which are increasing.
Silver tracks the price of gold investment-wise, but I think it could do better than gold percentage-wise over three years. Historically, silver has been more volatile than gold. It goes up or down to a greater percentage than gold.
TGR: Malcolm, we're just a couple of weeks beyond the federal government shutdown in the US. What are your thoughts on the long-term health of the American economy and the American political system?
Malcolm Gissen: I'm going to stay away from the politics, because my politics and Marshall's politics are almost diametrically opposite.
I believe the US economy is much healthier than a lot of Americans realize. Our entrepreneurial spirit is extraordinary; the number of young people starting companies has never been greater.
Sometimes government can get in the way. We need more reasonable, workable regulation than we have now. If we do that, the sky is the limit for the US economy. I don't think that will change for many years; I'm very bullish on our economy.
TGR: In 25 years, will the US greenback still be the world's reserve currency?
Malcolm Gissen: I think it will. Twenty-five years would be too soon for the American Dollar to lose its position as the world's basic currency, just as English is the dominant language used around the world.
Marshall Berol: You also have to ask yourself what the reserve currency would change to. The Euro isn't in any position to become a reserve currency. Nor will it be the Yen, the Ruble or the Peso. It may one day be the Chinese currency, but not that soon.
That brings us back to gold. It would not replace the Dollar, but central banks are adding gold to their reserves to lessen the impact of the Dollar on the percentages held in their reserves.
TGR: Did you make changes to your Encompass Fund due to the government shutdown?
Malcolm Gissen: We made no changes in either client accounts or in the Encompass Fund. However, we did debate whether to move more to cash in the eventuality of a default on the US debt and the negative impact that would have on the market. We concluded Congress would likely go right to the wire, when the more moderate Republicans would prevail and strike a deal.
Marshall Berol: The client accounts are managed to each client's individual goals and objectives. The objective of the Encompass Fund is long-term capital appreciation. We are not a trading fund. The turnover rate for the Encompass Fund runs around 25%. We don't focus on day-to-day, week-to-week or even month-to-month news developments. We look for industries and companies that will do well over time.
TGR: What are your clients telling you these days?
Malcolm Gissen: I think clients like less risk and less volatility, and we have moved in that direction over the last 12-15 months. We have invested client accounts in more large-cap, domestic stocks. We like the energy, healthcare and technology sectors. We also have added Real Estate Investment Trusts.
We've done the same thing in the Encompass Fund. It was more heavily invested in resource companies, particularly metals. Over the last six months, we've kept the best of the resource companies, but energy is now the largest component represented in the Encompass Fund.
TGR: Your website describes the Encompass Fund as a "go anywhere fund". Geographically, where has the fund gone in the last year that it had not gone previously?
Marshall Berol: It's more a factor of where we've pulled back than where we've gone for the first time. The fund has a number of resource sector investments in Canada, the US, Mexico, South America, Africa and a couple of companies in Europe. We are more wary of jurisdictions that have experienced geopolitical problems, such as Argentina, Bolivia, Ecuador, areas where the governments appear less friendly toward resource operations.
TGR: Marshall, you've invested in resource companies based, in part, on your relationships with company management. How has the downturn in the junior resource space changed those relationships?
Marshall Berol: It hasn't changed the relationships as much as it has focused us even more on company management.
At the end of 2008, we assessed where all of the companies in the Encompass Fund were relative to their projects, finances and management. We reduced or eliminated a number of the companies that were not making the progress we had hoped for and added to those we thought were stronger. That worked out extremely well for the following couple of years, as the markets improved and some of the companies did likewise.
We did the same thing earlier this year, focusing even more on the management teams. In this very difficult environment, strong, knowledgeable managements with successful track records for bringing projects along and raising money are extremely important.
TGR: But you must have to say no to people when they come to you for more financing.
Marshall Berol: Yes, almost every day. This year in particular, companies have needed to raise funds just to keep the lights on, much less advance their projects.
We are being far more selective in what we believe justifies funding. Primarily, that translates to companies that are in production and need funding to increase production, or are very, very near production.
TGR: Do the relationships just dry up when you have to turn down funding requests?
Marshall Berol: I hope not. It's a business decision. Companies are in a position where they need to ask. We're in a position where we can and will say no if it doesn't fit our portfolio objectives. I would hope that the management teams understand our position and our responsibility to our investors.
TGR: What is your current investment thesis for junior mining companies? What do companies you invest in today have to have?
Marshall Berol: It's very good if they're in production or very near production. That means they're generating revenue and cash flow of some kind and are advancing their projects.
Management and the state of the balance sheet are also factors. Companies with significant cash on their balance sheets are a lot more attractive.
With rare exceptions, it is difficult for us to justify investing in very early-stage companies in this environment.
TGR: Regarding other jurisdictions, you've talked about avoiding places like Argentina, Bolivia and Ecuador, but not Brazil. Why are you comfortable investing in Brazil?
Marshall Berol: The Brazilian government seems to be more reasonable, and it is a far larger and broader based economy than elsewhere in South America. Argentina, for example, nationalized a Spanish oil company and changed the tax laws, and the monetary situation is challenging.
TGR: What tricks should investors avoid in today's economic environment?
Marshall Berol: Unfortunately, tricks are most noticeable with hindsight. I think the trick to success is to avoid assuming that when gold or silver prices rise that it will raise all the boats. While we remain optimistic on the price of gold and silver, just having an inexpensive stock doesn't mean it will go up if the price of gold goes up. You have to dig deeper and look at the management, the projects, the location and the finances.
TGR: Indeed. That trick is a real treat. Thanks for your time and insights.
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