The weak gold price is less a function of supply-and-demand and more a function of deflation risk. We see gold as another type of currency. If all the gold mines in the world shut down tomorrow, it would only equate to removing 0.1% of aboveground stocks.
TGR: What’s your projected trading range for gold in 2014?
PL: We’re using US$1,300/oz to value our stocks. If our worries are confirmed and the bond market starts to signal an increased risk of deflation, we could be dealing with a lower gold price deck.
The average all-in sustaining cost number may be the better number to use. That could drop to US$1,000–1,200/oz.
On the flip side, if we see velocity and inflation expectations start to go up and the real rates go negative again, that fair-value number is probably closer to US$1,600–1,800/oz. This is a very difficult time to predict the gold price.
TGR: When NBF calculates all-in cash costs for gold miners it uses a different definition than the World Gold Council. You omit non-cash remuneration and stockpiles/product inventory write-downs. On all-in sustaining costs, you also omit reclamation and remediation at operating and non-operating sites. Would investors be better served if these definitions were the same across the board?
PL: We, and the World Gold Council, are trying to define the true average cost of the industry. We are roughly in the same ballpark. You mentioned what we exclude, but we also include cash taxes. The World Gold Council excludes cash taxes and interest payments.
Remember, we’re tabulating this based on public data. Not every company breaks out its true sustaining capital in a given quarter versus growth capital. We approximate the sustaining capital number by using depreciation, depletion and amortization as a proxy. Of course, it won’t be accurate because it uses depreciated data dollars as a proxy, but it’s a good start.
TGR: Roughly what percentage of the producers you follow make money at today’s level of all-in cash costs or all-in sustaining costs?
PL: From an all-in sustaining cost perspective, the Q3/13 50th percentile is around US$1,050/oz. That means 50% of the industry is losing money, not from a growth perspective, but from a sustaining basis at US$1,050/oz and above. It was US$1,200/oz in Q2/13.
TGR: That’s shocking. Does that make you want to look for a different line of work?
PL: We’re in the midst of a once-in-a-century event. I believe there are two ways out of it. Scenario one: We have a deflationary recession, also called a depression. Scenario two: We repeat what happened in the 1970s and we inflate our way out. But this time it’s on a global scale.
Based on the behavior of the central banks of Japan, the U.K. and the U.S., they seem to be trying to inflate their way out. The question then becomes, when will inflation gain traction?
TGR: A recent NBF research report compared takeover transactions among senior producers, midtier producers, developers and explorers. Where are investors getting the best bang for their buck?
PL: Historic transactions have to be considered in the context of the market at the time. Today’s market resembles 2008. One could argue that this is a great time for free cash flow entities to acquire assets. In a market where cash is king, it’s all about doing bite-size, tuck-in type acquisitions that allow companies to take advantage of a challenging market.
Structurally, some large companies are set up to mine gold at a rate that Mother Nature cannot support. Deposit discoveries are not the size or frequency that can support them. There’s an opportunity for the smaller companies, like B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX), to acquire good assets that can be developed to create tremendous value when the market turns.
TGR: On net asset value (NAV) and enterprise value per ounce, which of those four spaces provides the best return to investors?
PL: There’s a lot of value out there, but investors want to avoid being caught in a value trap. For example, a company may be cheap on a price-to-NAV and price-to-cash flow basis, but it also could have lots of balance sheet risk. If it goes bankrupt before the market turns, investors are caught on the wrong side of the trade, despite the fact that it’s great value.
I would rather buy something that generates free cash flow, like a Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) or a Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX). (Royal Gold is covered by Shane Nagle.) “Be defensive” has been our thesis since early 2013. Free cash flow companies will yield, even if this market lasts four more years; the NAV continues to grow. When the market rerates, investors are actually up.
TGR: NBF’s Oct. 13 report noted that producer transactions were completed at an average of 1.13 times NAV and $155/oz enterprise value. Senior gold producers were 1.2 times NAV and $125/oz enterprise value. Developers were 0.84 times NAV at $102/oz, and exploration transactions were 1.1 times NAV at $55/oz.
PL: No question, there’s tremendous value out there. The questions become: How long does this market last? How does an investor stay solvent? I would buy Franco or Royal Gold, knowing that I’m solvent.