Gold, Equities and the Flight from Risk

Investors in Gold Mining stocks have become more selective...

WITH THE Gold Price recently poking its nose above $1,900 an ounce and investors abandoning equities for commodities, John McClintock, equity research analyst at Mackie Research Capital, sees Gold Mining companies benefitting from this flight from risk. 

In this interview with The Gold Report, McClintock talks about the risk trade. 

The Gold Report: With the recent performance of the gold market, what expectations do you have for the next 6 to 12 months?

John McClintock: I think nothing is really going to change on the equity side until we see the risk trade coming back on to invest in equities. That risk trade is going to be a function of the US housing market rebounding, as investment is a function of wealth, and the resolution of the debt crisis in Europe. 

We are going to see companies that have shown consistent operating performance continue to outperform the market. Currently, the focus on quality is paramount, and we are likely going to see that continue for at least the next six months. 

TGR: The situation is a little different from past markets when people were jumping into mining stocks because the metals were going up and they were buying almost anything in sight. 

John McClintock: Right.

TGR: So are people now being a lot more selective? 

John McClintock: Yes, in where they are going. People are focused on just the risk trade. If you look at the equities, all the major precious metals in Toronto are down on the year and definitely underperforming the commodity. 

It is not because the companies are themselves poor. Investment Dollars for the equities other than institutions, predominantly retail, are largely going to exchange-traded funds (ETFs). ETFs are competing with the supply of funds for all of equities. People are saying, "I don't want to own Treasuries as much anymore." 

I've already seen a bit of that. Just go to the commodity, be safe right now and then when we get out of this turbulent time, maybe in six months, you're probably going to see stocks run. Maybe by September we'll have more visibility. Going down the market cap, you're going to probably see people start focusing on the intermediates and the junior producers that show consistent execution. 

TGR: A question some investors might have is about political stability in countries like Mali and Burkina Faso.

John McClintock: Absolutely. In 2003 and 2004, West Africa had a big wave of transformation to attract mining investment by changing tax codes and giving exoneration periods for taxes to keep companies there. Now, the prices of commodities, particularly fuel, have caused a dramatic increase in domestic prices, which has had a destabilizing effect on the broader economies. 

People who don't make a lot of money don't have a large propensity to spend. There has been civil unrest, much of it focused at government. People want subsidies for agriculture and fuel. In Burkina Faso, we have seen riots and things get out of hand a little bit. Do we think there's going to be a full civil war or change in government in Burkina? No. But we do think there is an upward pressure on royalty rates and taxes on mining companies that will have to be factored into the valuations. 

Right now, depending on which West African country you are in, there are exoneration periods for taxes for 4, 6, 8, even up to 15 years. Tax rates are generally lower, about 20–30%, and although the governments do get carried interests of 10–20%, the mining companies don't pay out dividends to the government until all capital is paid back. 

So the governments really don't get much of the immediate cash flow from the company. We do believe that the revenues and profits, particularly with the very successful companies, will have to be redistributed to some degree to keep political stability and also to ensure a long-term mining industry there. So investors should be aware that royalty rates will change. A lot of it has already been factored into the stocks, we believe.

TGR: Do you have any closing thoughts you'd like to leave with us as far as the gold market in general and expectations for juniors and mid-tier mining stocks? 

John McClintock: In the general macro scheme, I think gold will be the thing. The US will have to deflate its Dollar and rely heavily on exports. Inflation in the US will not be put away for at least 5–10 years. In the early 1990s, it took the Canadian government about 10 years to get out of it and cut its deficit. Europe will have to print money to get itself out of its current situation. Who knows about the debt and real estate situations in China and other emerging markets worldwide? 

So in the longer term, I'm very bullish on gold and commodities, in particular, hard assets. It has been an investment trend that is likely to continue, particularly in the precious metals. Industrial commodities like copper can be expected to come off with an economic slowdown. People seeking safety and wealth preservation will cause gold to continue to be strong for the near and mid-term, without a doubt. 

TGR: Hopefully that will filter down to the equities?

John McClintock: For sure. It's just a function of the risk trade coming back on. The US will not hit 4% gross domestic product any time soon. We need the housing market to bottom, and people to get back into the equity market and begin to make investments. When people have taken 30–50% haircuts on their biggest asset, they can't afford to lose a lot of money in the stock market anymore. 

So people are very risk averse right now and it is about wealth preservation more than wealth generation. With the long-term commodity price the way it is, people will come back to the market eventually, but it's not going to be tomorrow or next month. We are going to see a volatile market here, but six months from now, I'm optimistic the gold stocks will catch up.

TGR: It looks like we are still in the fear stage. So we need fear to turn into greed.

John McClintock: I'm sure you've heard that one before.

TGR: So your final thoughts?

John McClintock: I'd say just stay focused on quality and on management teams that have executed. If investors want to focus on the development companies, we would suggest again to focus on quality strategic assets for senior and intermediate companies. 

TGR: We greatly appreciate your insights. Thank you very much for joining us today.

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