Written by Brian Sylvester of The Gold Report
In this exclusive interview with The Gold Report, Doug Groh, senior analyst with Tocqueville Asset Management, likens the gold price to a mirror that reflects peoples' concerns about global economic and political events. And he likes what he sees in the long-term prospects for gold equities.
Companies Mentioned: ATAC Resources Ltd. - Barrick Gold Corp. - Equinox Minerals Ltd. - Gold Resource Corporation - Kiska Metals Corp. - Minmetals Resources Ltd. - NovaGold Resources Inc. - Osisko Mining Corp. - Teck Resources Ltd.
The Gold Report: The situations in Greece, Ireland, Spain and Portugal are proving the unsustainability of deficit financing and are effectively killing the euro as a safe haven currency. As these worries escalate, have you seen more money come into your fund?
Doug Groh: Yes, we've seen funds flow into our gold fund product, but that's been the case over the last year or so. I attribute it primarily to the rise in the gold price. Some investors see gold as an attractive alternative to other investment vehicles and they're buying the gold ETF (exchange traded fund) and gold equities.
Gold bullion itself has outperformed equities this year. Some people feel there's security in owning gold, but it seems they're reluctant to buy the equities because of the risk. In addition to the market and equity risks, mining companies have risk—whether operational or political—with regard to developing their deposits.
TGR: What's the Tocqueville Gold Fund worth right now?
DG: As of June 27th, the fund is valued at about US$2.4B, with about 6% of the fund in bullion.
TGR: Are you buying bullion now?
DG: No. We've been pretty steady in terms of the number of ounces in the fund for five to six years, although it has appreciated in value over the years. In percentage terms, it can go up or down relative to the equity positions in the fund. We have that position because we feel that, as a gold fund, we should own gold as well as gold mining equities. It's not something we necessarily trade; it's just a core position for us.
TGR: In 1980, about 22% of all financial assets were invested in gold-related instruments. Today, estimates put the current global investment at around 3%. Why aren't more investors buying into the thesis that gold will only go higher as paper currencies or fiat currencies lose value?
DG: We think gold is a unique investment vehicle. You can look at gold as a mirror that reflects concerns about a number of factors around the world: uncertainty in Europe, the Arab Spring, U.S. monetary policy and debt, for example. When you analyze it, you might conclude that there's no real utility to gold. In fact, gold's utility is that investors see it as an alternative asset. Gold collectively expresses the notion that money isn't worth what it used to be.
TGR: People are starting to whisper about contagion, much like what happened in Thailand in the mid- to late-'90s and spread to other Asian economies. Do you see contagion as a real risk?
DG: It seems appropriate that one consider that risk in one's investment analysis. Greek debt is owned by a number of European banks; banks that also own debt from Spain, Portugal or Ireland. If Greece defaults, restructures its debt or cannot meet its obligations, its debt will be worth a lot less. This would put pressure on the balance sheets of those institutions holding Greek debt.
TGR: Would that spread to the United States?
DG: I think it's certainly possible. If there's a problem with debt in any part of the world, people will make comparisons. That's where I think there's a real risk. People would start to say, "If it could happen there, it could happen here." That kind of mentality is what concerns me most. As a result of that mentality, you're going to see the markets start to price that probability into the market. In essence, you're already seeing that. I believe that's why we've had a pretty tough couple of months in the equity market.
TGR: Let's turn back to gold. Does the Tocqueville Gold Fund invest in junior mining companies that are strictly exploring for precious metals?
DG: We have exposure to gold mining equities across the spectrum, from those that are exploring and aren't even mining yet to those that are developing and those that are actually producing gold.
Our approach is to have about a 35% weighting in smaller cap, exploring/developing-type companies. It's a little hard to characterize because some of the explorers are actually developing. We think of them as exploring/developing companies. They comprise about a third of the fund. Others are producing cash flow and trying to become bigger. One can consider those as major producing companies and they account for another 40% to 50% of the fund
TGR: And the fund was up about 58% in 2010, correct?
DG: Net of fees, the Tocqueville Gold Fund was up 53.33% during 2010, which compares to the Philadelphia Gold and Silver Index, which was up 35.94% during 2010.
TGR: That's very impressive. In February, you told us that you were "cautious about investing new funds into gold equities." Is that still the case or has the pullback in gold equity prices created a buying opportunity?
DG: At the end of last year and beginning of 2011, many of the equities that we held had performed very well. It seemed as if the market was well ahead of itself. Year-to-date, however, gold equities in general have not performed well and in particular, since about the time Barrick Gold Corp. (TSX:ABX; NYSE:ABX) announced its plans to outbid Minmetals Resources Ltd. (HKSE:1208) of China for Equinox Minerals Ltd. (TSX:EQN; ASX:EQN). The gold mining equities in general are down relative to gold, which is up. That spread between the rising gold price and the decline in gold equity values, in our view, has created a very good investment opportunity.
At this time of year, you're probably best served by adding more aggressively to your gold equity portfolio, I believe. Seasonally, we generally see a low valuation point this time of year. The second half of the year, particularly September through November, has seen good performance for gold equities over the past several years. In that regard, now may be an appropriate time to get positioned for that.
TGR: Do you still believe in a dollar-cost-averaging approach to buying equities?
DG: Yes. If you're not working full time on the gold space, the best way to invest, I think, is to average the cost of the investment over the course of the year. If you're paying close attention to the gold equity market, you can appreciate that these values don't reflect what's going on in the gold price. There can be some good buys in the space. And so, for those that have the time and ability to pay closer attention, it makes some sense to take advantage of the attractive values in the current market. However, the discipline of averaging the investment costs over time is also a good strategy.
The gold price is up over US$100 since the beginning of the year. That US$100 is falling right to the bottom line for gold producers, generating significant cash flow. The gold equities aren't reflecting that cash-flow-generating ability. The margin has expanded, even though costs are up somewhat, but the investor base has lost interest in the cash flow that's being generated.
A number of catalysts are coming into the market that could reinvigorate investors in gold mining equities. First of all, you'll see good earnings and cash flow per share for the second quarter. Companies may increase their dividends. That's an important element to get investors refocused on companies' profitability, I believe. Additionally, in the latter part of the year, we expect to see more acquisitions.
TGR: Let's get to some specific companies in your fund. Seven years ago, you bought Osisko Mining Corp. (TSX:OSK) at US$0.50. It's now trading at around US$14.50. The company recently poured its first gold bar as it entered commercial production at the Malartic Mine in QuÃ©bec. At the end of the first quarter 2011, about 4.3% of your fund was vested in Osisko. What's that percentage now?
DG: Osisko is one of our more important holdings; it's in the top five and is about 5% of the fund. They announced commercial production this week, about a month ahead of schedule. The reports we're getting say that the plant equipment and operations are working better than planned. The new mine at Malartic is only part of the story. Osisko is developing other assets. They made some acquisitions over the last year or so that will add to their growth profile. The Osisko story isn't over, and from our perspective, it's not fully valued.
TGR: One of those assets is the Hammond Reef deposit in northwestern Ontario, which Osisko acquired when it bought Brett Resources in March 2010. Is Osisko going to plow some of the cash-flow from Malartic into Hammond Reef?
DG: That would be the expected business strategy. We believe the Hammond Reef project offers a lot of merit. They're now de-risking the project by identifying the resource and a mining plan. That should be the best use of proceeds for them. I wouldn't be surprised if they announce a property or a project acquisition. I don't see Osisko acquiring another operating company unless it came with a tremendous amount of growth. At this point, I think Hammond Reef is really the next platform for Osisko to grow ounces from.
TGR: Hammond Reef has a 6.7Moz. inferred resource. So that's not a small project.
DG: No, there's good life to that project.
TGR: Another one of your holdings, NovaGold Resources Inc. (TSX:NG; NYSE.A:NG), is developing a mammoth project in the Donlin Creek gold/copper project in Alaska. When is NovaGold going to join Osisko as a gold producer?
DG: I haven't seen their latest timeline. I think it's quite a few years out. NovaGold has some significant engineering projects to complete, such as power facilities and road work and permitting; permitting being the more important element of de-risking that project. The company has been working to revise a feasibility study for Donlin Creek that incorporates a natural gas pipeline. That study is scheduled for completion during the second half of 2011.
It's the type of mining project that major companies wish they had their hands on. Yet, the majors seem to be reluctant to build out assets in that part of the world. They'd rather gain copper and gold exposure in the far-off reaches of Africa and the Middle East as opposed to North America.
TGR: I should mention that Donlin Creek is a 50/50 joint venture (JV) with Barrick Gold. A few years ago, Barrick tried to buy NovaGold outright. Do you think that Barrick might try that again as the project develops? After all, NovaGold has 17 Moz. in the proven-and-probably category.
DG: It would seem to make a lot of sense for Barrick to attempt to acquire NovaGold. But, while it may be logical, it's odd to us that Barrick was divesting its African assets a year ago and is now acquiring African assets to gain copper exposure, when NovaGold's other major asset, Galore Creek, has a significant copper endowment along with gold and silver. Logic isn't always the business principle that's pursued in the mining space.
TGR: Right. The Galore Creek project is a 50/50 joint venture with Teck Resources Ltd. (NYSE:TCK; TSX:TCK.A, TSX:TCK.B), another major. Teck almost went under in the crash of 2008, but it's rebounded nicely and has good cash flow.
DG: Teck likes to be diversified, and I think would rather share the cost of that project with somebody else. So, I don't necessarily see Teck making that bid for all of NovaGold. It would have made more sense for Barrick to gain copper exposure by acquiring NovaGold in Alaska than it does for Barrick to acquire copper exposure in eastern Africa and the Middle East.
TGR: NovaGold's prefeasibility study includes a proposal to build a gas pipeline from Beluga, Alaska to the Donlin Creek project. That would greatly reduce operating costs in terms of fuel and could benefit many projects in the area. Have you begun to examine that as an investment thesis?
DG: The viability of that gas pipeline should be more apparent with the release of the Donlin Creek revised feasibility study; that's something we'll have to check as we go through the study. Certainly development into central Alaska with a gas line and fuel source will open up the center part of the country to mineral exploration and development. Kiska Metals Corp. (TSX.V:KSK) is operating not too far from the proposed natural gas pipeline and they've reported some very good drilling success. We'll probably see them broadening their footprint.
TGR: Do you have a position in Kiska?
DG: Yes, we do have exposure to Kiska.
TGR: Kiska expects another resource estimate in 12 to 18 months and is testing new targets at Island Mountain and Muddy Creek this summer. What are you hoping for from those drill programs?
DG: I'd like to see higher-grade results than we've seen in the past. I also hope that the geometry of the deposit can improve. As Kiska gains more information, they'll have a better understanding of the geology and be able to position their drills to define the geometry at both Island Mountain and Muddy Creek.
TGR: Are there any other companies you'd like to talk about?
DG: One of the companies in our top 10 that doesn't get much coverage is Gold Resource Corp. (NYSE.A:GORO; OTCBB:GORO; Fkft:GIH) in Oaxaca, in southern Mexico. Over the last year, they've had a fair bit of success developing their property and initiating production, finding additional ore on their property and generating cash flow. They've even started to provide a special monthly dividend. That's a unique thing for a gold mining company, to initiate production and issue a dividend in such a short period of time.
TGR: Gold Resource put up guidance of 90,000 oz. (Koz.) in 2011. Is the company still on target for that?
DG: It doesn't seem realistic for this year. Flooding this spring slowed production down. Perhaps by the end of the year they could get to a 90 Koz. per-year run rate.
TGR: The company plans to ramp up to about 150 Koz. in 2012. Is it more likely to achieve that target?
DG: I think the characterization might be at a 150 Koz./year run rate by the end of 2012, as opposed to generating that kind of gold-equivalent oz. during the entire year. It seems reasonable, although I think it's ambitious. Gold Resource management wants to be ambitious. I think investors have to be a little bit cautious with ambitious statements.
TGR: You were going to mention another company; what is it?
DG: It's ATAC Resources Ltd. (TSX.V:ATC). The company had two significant discoveries last year in the Yukon. One was a lead/zinc/silver discovery. More importantly, they came across very sizeable gold intercepts with high-grade gold on the eastern edge of their property. Many suggested that it had the look of the Carlin District in Nevada. ATAC is going back into the property there in the Osiris region to drill it off and see what else they can find. I think you'll hear some good drill results from ATAC in mid- to late-summer.
TGR: Before you go, please leave our readers with a few words of advice on how to play the current market.
DG: One point to keep in mind is averaging costs over time. I think that's the best way to get exposure. Secondly, it's important to assess a company's prospects and to think about a price target before investing. If it reaches that price target, reassess the investment. Third, assess each investment within a certain timeframe. Explorers and developers can take a long time before they realize the value of their assets, whereas producers are not on as extended of a timeline to realize the value of their assets. One has to match one's expectations with the nature of a company's operations.
TGR: Doug, thank you for your time and insights.
Doug Groh has 25 years' investment experience. Before joining Tocqueville in 2003, he was director of investment research at Grove Capital from 2001–2003. Between 1992–2001, as a senior sell-side analyst for JP Morgan and Merrill Lynch, he was recognized as a ranked analyst by Institutional Investor Magazine and The Wall Street Journal for his coverage of basic material stocks in the non-ferrous metals, chemicals and paper and packaging industries. He began his career as a mining analyst and worked as a precious metals portfolio manager at U.S. Global Investors and American Express Financial Advisors in the 1980s and early 1990s. He holds an MA in energy and mineral resources from the University of Texas at Austin and a B.S. in geology/geophysics from the University of Wisconsin—Madison.
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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: NovaGold Resources Inc. and Kiska Metals Corp.
3) Doug Groh: This article reflects my views as of the date or dates cited and may change at any time. The information should not be construed as investment advice. No representation is made, nor is there any guarantee that any projection, forecast or opinion will be realized. References to stocks, securities or investments in this writing should not be considered recommendations to buy or sell. Past performance is not a guide to future performance. Securities that are referenced may be held in my personal portfolio or in portfolios managed by Tocqueville or by principals, employees and associates of Tocqueville, and such references should not be deemed as an understanding of any future position, buying or selling, that may be taken by either me or Tocqueville. I personally and/or my family own shares of the following companies mentioned in this interview: Tocqueville Gold Fund. I personally and/or my family are paid by the following companies mentioned in this interview: as an employee of Tocqueville Asset Management.