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Gold & the Dollar: Rising Together?

Gold was due a rough first quarter in 2010. Yet it rose along with the Dollar...

and precious metals mining analyst with Gordon Capital, BZW and Prudential Bache, Barry Allan joined Mackie Research's Investment Banking Department in 1998 as a mining specialist, and transferred to the Research Department as a Mining Analyst in 2001.

Both a geology and MBA graduate, Barry Allan – always among Canada's top-ranked mining analysts – also has experience of the specialist finance group at CIBC, one of Canada's largest financiers of mining projects. And here, in this exclusive and revealing interview with The Gold Report, Barry Allan says why the European currency crisis and crippling debt problems will push Gold Bullion, as well as the US Dollar, higher through the rest of 2010...

The Gold Report: Barry, the last time we spoke, you told us gold typically has a rough first quarter. Tell us how the yellow metal fared in Q1.

Barry Allan: It's typically the end of the first quarter where Gold gets into problems, and then into the second quarter. We're kind of still in that process. What we did see was a rather good Gold Price relatively speaking; it largely held, and the price went more laterally over the last short while with the whole potential bailout of Greece. By that, I mean it didn't have a sharp correction, but it did go sideways.

TGR: And where do you see Gold heading later this year?

Barry Allan: We will be looking at a better Gold Price environment. I think the variable that we now have, which we didn't have previously in our discussion, is the impact of the potential desegregation of the Euro, and the whole notion of what that will do for gold  vis-à-vis the currency crisis. With the Euro crisis, you're going to get a flocking to the US Dollar and gold. With the rise of the US Dollar, you're also going to get a rise in the Gold Price, which is a bit of an unusual feature – and we've already had that.

TGR: So you think the sovereign bailout of Greece is likely to fail?

Barry Allan: Certainly in my travels – I was just in London, England and New York – there's a general belief that the whole concept of a bailout of Greece is going to fail, and it will take some time, but it will ultimately fail. And that will cause further dislocation of the Euro and hence benefit gold and the US Dollar. So later this year, we fully expect a better price of gold.

Do you see a dramatic rise?

Barry Allan: Certainly, the elements are there. I think we're all dealing with the same hand to a certain extent, in the sense that what will ultimately happen with the Euro remains to be seen. The indications are that Greece is definitely having issues. But there are also other weak parties in the Euro that may show some problems. If that happens, that's just going to accelerate the whole crisis of the currencies, which will be a positive for the US Dollar or other world currencies and for gold.

TGR: In the same way people are talking about Greece, people are talking about Portugal and Ireland; people are even talking about England. If England shows any kind of debt issues, will people really flock back to the US Dollar or look to alternative currencies as a safe haven?

Barry Allan: The practical part of it is that you can move huge amounts of currency in a pretty short period of time, and what typically happens is money will slosh around in different currencies and go from one currency to another as circumstances change. I saw it a while back by virtue of friends of ours in Ireland who were wanting to move money out of Ireland and saying, "Where do we go?" and their first impulse was to go to the US Dollar. I said, "Well, I'm not so sure that is your best place to go. Would you consider putting money into Gold?" Their immediate response to me was, "What you say might all be true, but you don't understand how bad the prospects look for the Irish currency."

TGR: How long can we expect this situation with the Euro to last?

Barry Allan: It will occur until such a time as the situation in Europe stabilizes, and then we will find a more moderate exchange rate. But there will be – and there has already been – a movement to world currencies, and other potential currencies might emerge as world currencies.

TGR: As far as Gold Investment goes, what sort of vehicles are you most likely to recommend to people?

Barry Allan: It really all depends on one's tolerance for risk when it comes what vehicle you choose or how you gain that exposure to gold. On a recent trip through Europe, as well as New York, for the first time ever I found almost no interest in senior Gold Mining stocks. People are saying to me, "If I need that kind of exposure, I will just go to the ETF, thank you very much, and not take on operating risk. If I want to invest in equity, I want something that is going to give me a 20%-30% rate of return; hence I am going to look into the smaller tier of gold stocks where there's something that's got more sex appeal, with exposure to the kind of company as well as gold." That struck me.

TGR: What are the reasons behind it?

Barry Allan: I think there are probably two reasons behind it. One has been the evolution of the ETF as a viable instrument and one that factors in people's thinking; the other is exposure to the Gold Price without taking on operating or political risks. You may have some element of counter-party risk there, but you certainly don't have the operating risk aspect. Until recently, the senior gold stocks had not really distinguished themselves because they were not able to show really good increases in bottom-line performance with this rise in gold. They were largely wrestling with operating costs, the growth in cash flow and earnings as a result of better commodity prices. I think the backlash was people saying, "Fine, if I'm going to buy an equity, I want something that's going to give me good, solid rates of return, and that's something more than just 10%"

TGR: You place gold companies in four groups: senior equities, intermediate equities, junior equities and development equities. Could you explain what differentiates companies in the last three categories?

Barry Allan: When we talk about a junior mining company, we're probably talking something that has a production capacity of less than 500,000 ounces. An intermediate would be 500,000 ounces or more. Typically, the market cap is a $10-billion-market-cap-type company, whereas if you get down into the juniors, the market cap will be more into the $2-$3 billion kind of range. The junior mining company probably has one or maybe two operating assets in its portfolio, whereas the intermediate guys will have more and that provides them with more production base diversity.

TGR: And the risks of each?

Barry Allan: The intermediates probably have a lower liquidity risk. And because they have multiple mines in production, they have a bit more portfolio-type flexibility in managing their production base. So a little bit lower risk there as well.

In the case of the juniors, you tend to be leveraged to a particular mine. So you have a higher degree of operating risk associated with the junior, and you may have an element of political risk, depending on where that mine is located. From our perspective, the risk profiles are a little bit higher on the juniors than on the intermediates.

TGR: There was also a "development" category. Describe those companies.

Barry Allan: Companies in that tier are not producing. They're companies either building mines or at the early stage of mine assessment. They're companies that have advanced beyond exploration but don't have a mine in production.

TGR: And the risks?

Barry Allan: They have incumbent risks associated with them depending on where in the development cycle they are. For companies that are reasonably well advanced as far as having mines under construction, it would typically have a lower-risk profile than other companies that really have just a National Instrument 43-101 resource estimate and are conducting pre-feasibility studies of those resource ounces and trying to get to the feasibility stage. So it is a much higher-risk profile.

TGR: What types of risk?

Barry Allan: There are lots of different types of risks. You clearly have a funding risk because most of these are unfunded projects. You have a construction risk in the sense that if you have a reserve, then you have to start building the mine. In some cases, we don't even have a reserve; we have a resource, and we're not sure how much of that resource is going to convert into reserves, so you have a geological risk. In that tier, you're going to want a much better return to compensate you for the risks.

TGR: Some companies in the development category have been doing quite well. Tell us about those.

Barry Allan: In the development equities, it's about taking those risks that we talked about and removing them from the equation. A company that was our top pick for this year was taken over by another. What the company did – pre-takeover – was de-risk the project to the extent that there was a company out there who felt that this would be a good fit for its asset base. We got a good valuation as a result.

Thanks for your time, Barry; this has been very informative.

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