Gold Mining's Viable Price
The end-game for most Gold Mining juniors is to get taken over by a major...
TWO OF THE FIRST ANALYSTS to point out the disastrous effects of gold hedging and gold loan capital financing on Gold Mining balancesheets back in 1997, Eric Coffin and his brother David have been active in mining exploration for over 30 years in roles spanning prospecting through feasibility studies.
Now co-editors of the Hard Rock Analyst family of publications, David is the "rocks side" – literally logging hundreds of thousands of miles every year visiting exploration sites on six continents – while Eric, with a degree in Corporate and Investment Finance, runs the "financial analysis".
Here Eric Coffin speaks to the Gold Report about the outlook for gold vs. Gold Mining stocks, and the very mixed signals coming out of the copper market...
The Gold Report: Eric, in a recent HRA Journal you wrote that you're not expecting a big gain in the market for 2010. However, you also indicated that it's not required to have big gains in the market to have the mining sector do well. Can you expand on that for us?
Eric Coffin: Well, there are indices and there are indices. We have pointed out several times in the last year that if you look at what we call the "creditor countries" – China, India, Brazil – as well as the "resource supplier" countries such as Australia and Canada, none of those country's bourses are technically in secular bear markets, although plenty of people assume they are.
On long-term charts those markets didn't break their 2000-2001 lows which New York and most European bourses did. And we don't think that is a minor point. It basically reinforces the story about the separation that has been going on in the world economy over the last decade, with developing high growth countries increasingly being the price setters for resources.
Metals prices, in general, are strong enough that companies making and growing real discoveries are going to get rewarded by the market, and we've seen that on our own HRA lists. Some of the companies aren't getting beaten back the way people thought they would. The companies that have succeeded are making discoveries and rapidly increasing their asset values, which the market has been paying up for. We're actually pretty pleased, for instance, with Toronto's Venture Exchange Index. It's got its issues like a lack of large profitable companies to underpin it, but it's the closest thing to a proxy for exploration stocks we can come up with. You would expect the Venture Index to be the worst performing index in a bear market but it was actually one of the best gainers in the world in 2009 in percentage terms.
Granted, the Venture Index got slaughtered in 2008. At the start of 2009 we said, "Strange as it may seem, we expect the junior market to outperform the senior ones, at least in percentage terms," which it did to the tune of about 60%. People thought we were nuts, but if you start with the assumption that we are still in a secular commodity bull market, it makes sense that a resource stock index would have a big bounce, especially after being pummeled so badly. If you go back 10, 15 or 20 years, you could expect the Venture Index to drop by two or three times the percentage amount of the senior indices and to take much, much longer to come back.
One of the most interesting aspects of last year's resource sector performance was that trading volumes remained strong through the year and the overall amount of financings were high. That was surprising and quite encouraging. New money was scarcer in other sectors and most major indices were plagued by light volume, even the ones with good gains themselves. Exploration is a negative cash flow business so it's imperative that companies are able to raise money.
TGR: Let's talk base metals. What's your outlook on copper?
Eric Coffin: Dave and I were more bullish about copper than just about anybody a year ago, but we weren't expecting to see the price go up to $3.50 so rapidly. That was a little bit shocking. That's a measure of demand, but it almost seems like it's a "copper-as-money" story too. Dave has said that for years, and he's only half joking. His point is that everybody thinks of gold as the obvious contender as a currency, but you can make a similar argument for a lot of hard asset commodities and it certainly looks like money is being parked in many metals, not just gold. Copper is an obvious choice for traders because it does high volume.
A lot of the metals are not a bad place to hide and hedge against US Dollar weakness, but we've gotten a bit cautious about base metals again partially because the relationship you're seeing right now between pricing and inventory levels doesn't seem to make a lot of sense. It defies logic.
TGR: Isn't copper sending out a lot of mixed signals out there?
Eric Coffin: It's very mixed; if you look at three, or five, or ten-year copper charts, there's a very strong inverse correlation between the copper price and warehouse inventories for copper. When copper warehouse inventories go up to a certain level, the price will start to drop and vice versa.
That relationship reversed itself about the middle of last year. Copper inventories were drawn down fairly significantly from the middle of 2008 to the middle of 2009. It was part of the reason we weren't bearish. Everybody else was on base metals. We did point out – given the depth of this recession – that a 500,000 tonne inventory in early 2009 was not extreme; it was well over a million tonnes at the start of the decade. The inventory fell rapidly for several months, getting down to 250,000 tonnes, but then reversed again and climbed back to the 550,000 tonne level.
The copper price continued to climb right along with inventory levels and has only backed off about 10% in the past couple of months. Dave and I are sitting there scratching our heads, thinking this is bizarre; the price is awfully strong given the fact that the inventories seem to be climbing fairly quickly again. Because of that we got cautious, though we are still bullish long term.
TGR: So, how do you play the copper market now given that we have all these mixed signals?
Eric Coffin: We stepped back a little bit. We haven't added any copper deals; we are looking at a few of them, and we're hoping to add a couple more to the HRA list. But we want to see if there's going to be more of a pullback. We were really expecting the price to come back to $2.50; it hasn't done that and may not. Shy of that, we may add a couple of copper deals, but I think if we do, it will be deals where we see big exploration upside and we're comfortable the market can give the company some mark-up based on discovery, not just market based on the copper price moving up and down. We tend to stick a little bit more to the exploration end, anyway. We're recommending people just let that stuff sit for now, and if there's really a big dump, then yes, maybe we can accumulate some. But we're not comfortable telling people to buy producers right now. We want to see if there's more of a drop, because although we're not seeing inventory climb any more, we're not seeing it come down either.
TGR: Let's talk gold. What's your latest take on that?
Eric Coffin: In the '90s, when we were first doing the newsletter, we were only lukewarm to gold, partially because of the amount of forward hedging and gold forward sales being used as a financing vehicle by the Gold Mining sector. In the '90s, major mining producers were moaning about how much selling there was in the gold market. Dave and I were responding with "What the hell are you talking about? You're the sells. You're forward selling gold left, right and center to finance mine construction."
That came to an end when Gold Prices got so low that it simply made no sense to start production on many projects and the low interest rate regime last decade made the forward sales less attractive relative to straight debt deals. That and the fact that gold miner's shareholders were telling them in no uncertain terms that the idea of effectively shorting gold to finance gold production was crazy.
The combination of industry de-hedging, an end to central bank sales and secular equities bear market after the Internet bubble turned things around. We thought when Nasdaq tech-stock index collapsed, the US Dollar had probably topped out for all time, and that got us a lot more bullish about Gold.
It's had a great run, and we've gotten a little bit more neutral about it in the last little while, but only neutral. You're seeing a run in the Dollar right now, but I think the jury is still out as to whether the Dollar has actually turned around or we're just looking at a bear market rally.
There is no such thing as trading a single currency really; you always trade pairs. So if you sell the Dollar what do you buy? The saving grace for the Dollar is that the other high volume trading currencies (the Euro and the Yen) have their own issues. It's a question of how relatively bad a particular currency is at a given time.
Politically, I don't see any way out for most of the G-7 frankly, other than printing their way out of this problem, which implies a continued race to the bottom for fiat currencies. And as long as you get a bunch of governments trying to print their way out of the problem I think that there's going to be a place for Gold in people's portfolios.
I sense that there are many, many people who are not gold bugs but who saw that gold performed very well as a safe haven. Nothing succeeds like success in the investment business and gold has been about the best investment around for the past decade. That gets noticed. Gold Prices are going to be strong enough where discovery is going to get rewarded, and that is the important thing for Dave and me. I won't be at all surprised if gold sees new highs this year – $1350 or $1250 or whatever. The main question we ask ourselves is whether the price will be strong enough so that companies that make discoveries will get rewarded. As long as the price is good enough for that, we're happy campers.
TGR: When you look at companies making a discovery, what price of Gold do you use to see if it's going to be economically viable?
Eric Coffin: We tend to be a bit conservative about it. We view a mining scenario as one where you've got to look out 10 or 15 years, and especially when you're looking at juniors. Let's face it, for most of these companies, the end game is – and should be – getting taken out by a major. Finding deposits is what the juniors are good at and the best exit is often selling the discovery for a good price then moving on to try and find the next one. When you're trying to wrap your head around the value for these companies, you've got to look at those companies' potential acquirers. What are they thinking and what are they using as a base price.
I think you're going to see M&A activity increasing because companies that have sat on the sidelines waiting for the perfect number before they bid on a company are finding out that they're just not going to get it, and the company they've got their sights on, somebody else gets there first. So, I think you're going to see improving takeover prices, and in some cases I think these majors are probably gritting their teeth and using a $900 or $950 long-term Gold Price to value things. A lot of them must be using that high a price at least to explain some of the recent bids.
TGR: Right. So, you're looking for juniors who have some type of scale potential with an end-game of selling to majors.
Eric Coffin: Right.
TGR: Great, thanks Eric. Lastly, we understand that you have a new free report to offer our Gold Report subscribers, as well as an HRA subscription deal. Can you please let us know the details?
Eric Coffin: Yes, we have just put together an extensive report for Gold Report readers, which highlight some of the companies that I mentioned above, plus a few others that we think have significant potential for 2010. It also showcases the power of the Alert service, which we think has been particularly valuable for subscribers since it allows them to quickly get our input and opinion when important, trend-changing results are released.
Simply go to www.hraadvisory.com/aureport.html for all the details on this offer. To receive the special discount, use the 'subscribe' links. The 20% off pricing cannot be accessed via our homepage.
TGR: Eric, we appreciate your time.
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