What are some of the most important trends that you’ve observed in today’s precious metals markets?
It has been another frustrating period. For over a year now, the precious metals markets have been more or less range-bound and trading sideways. The surprising thing is, that even though gold is trading at very healthy levels (today, we are around US$1,950 – US$1,960), we have hit US$2,000/oz several times in the last two years, and the gold price trend seems to be flirting with this psychologically important level of somewhere between US$2,000 and US$2,100/oz. At that level, from what we see from our valuation models, producing companies are making a lot of healthy free cashflow, they are generating significant income, some of which they have started distributing back to shareholders by way of dividends. They have sorted out their balance sheets and paid down debt. They’re in a very healthy position to contend with any potential weakness in the market.
If we look at the earlier development stage projects that are being promoted towards production, they too enjoy a fairly healthy valuation outlook, again because of the medium-term environment for gold prices. Most projects have all-in-sustaining cost levels of somewhere between US$1,000 and US$1,200/oz. At around US$1,900/oz of gold, they are making very healthy returns. So, the financiers are quite interested in providing significant financing for development stage projects.
Now, the problem we have, (and the way I have experienced the market for the last year or so) is that the generalist investors are completely apathetic towards gold. They are not interested in gold investments. That’s really what is holding back the market as a whole, because without the volume of capital that can be contributed and brought to the market by generous investors, asset valuations cannot progress.
Why do you think the generalists are not interested in the gold market right now? Have they previously been more involved?
Historically, they have been involved in various periods of the cycle. We are very aware that we operate in a highly cyclical market, which is prone to going into bear and bull markets. But, I think what has held generalist investors back over the last year or so is that the rapid increases of interest rates by the central banks have competed head-on with the gold investment thesis. When investors can buy government bonds (which are considered relatively risk-free and safe), at a yield of around 5% to 5.5%, they are not particularly interested in investing in a non-yielding asset such as gold. It’s only a very small proportion of the market, those who are risk-averse, that are concerned about market instability, and are looking for safe haven assets, that are potentially investing in gold. And even those people are primarily looking to buy into bullion as opposed to mining shares.
Which investors are looking at the precious metals markets and what’s of interest to them in terms of these investments right now?
We’ve seen some interest from the specialist investors, who have always been involved with the marketplace. Some of them are not necessarily “perma-bulls”, as I classify them. They tend to shift their bias in line with the market and move to the sideline when faced with a bear market. They then come back when they feel the conditions are right. These are the types of investors that are picking up the very low valuations we see now in the market. They are buying shares in companies that appear to be extremely undervalued, at least in relation to where the gold price is trading now.
But again, the volume of capital that this segment of investors brings to the market is relatively finite and is unable to promote the valuations of shares in the market on its own. We need a lot more interest from the generalist investor to come back into the market and support higher valuations.
Let’s shift to exploration financing, which is one of the keys to getting more supply into the market. Who is investing in exploration within the precious metals space right now, and what types of projects or regions do you see the financing going to?
Well, that’s the toughest part of the market right now. We have seen difficult conditions in raising capital for exploration stage projects. Most financiers have been turning to specialist investors who are looking to buy into companies at extremely low valuations, in the hope that when the market turns (as we are all fairly optimistic that it will, sooner rather than later) these companies will re-rate the most, and will catch up with developers as well as producing companies. That’s the kind of investment pool that these companies are looking to draw capital from.
The other problem that exploration stage companies are facing is that, because of the low valuations, to raise capital at this level is quite dilutive. So, they are unwilling to raise large amounts to promote a strong drilling campaign, and progress development, because it would be very dilutive for the capital base. They are raising just enough to finance working capital, operating expenses, and a modest amount of drilling to keep developing the work on their projects.
Are you seeing interesting companies or projects coming up? What makes a project stand out so that it would get the financing that is needed?
Yes, there are lots of projects that have significant potential for development, and there should be a lot more interest, at least in my opinion, from the producing companies that are flush with cash. We know that most of these companies are basically producing more than they replenish. Therefore, they are shortening their average mining life and are unable to find new deposits soon enough to fill the void. From a conventional point of view, those management teams should be looking at development stage assets that can be brought into production quickly and provide future growth for the business.
I think the problem is that, if the management teams see that the investment community will not award them for a new acquisition, which could be perceived as a new risk addition to their portfolios, they would rather not do it. They’d rather sit happily on a very large cash balance and wait for the micro conditions to change. It’s going to be a market-driven event that will change this stalemate. We must see gold breaking well above US$2,000, maybe US$2,100, which most people believe would be a very critical level for a new strong bull market to start. Then, the management teams will also sharpen their pencils and look again at the projects that they have been assessing for a while now.
In terms of projects in the marketplace, we believe that the development stage projects that have passed through at least the preliminary feasibility study can establish the economic credentials of the projects and demonstrate that they have a lot of value even at lower prices of gold; would be the first movers and engage in corporate activity. Then of course, depending on the strength of a bull market, the other projects will see the light.
Finally, what makes you want to invest or take notice of a particular company within the precious metals space?
Well, we have historically and traditionally focused on the development stage sector, which we know very well. Typically, we want to see a very strong resource base, something that underpins the long term production capacity of a product. Ideally, that resource base should be relatively high-grade so it is easier to process and is a higher margin material, but also is in a jurisdiction that supports the development of assets. We don’t want to invest in unstable political territories where there can be all sorts of hurdles. It might not be expropriation as such (that’s pretty dramatic and probably now confined to the former Soviet Union countries), but you can have a sort of indirect taxation or punitive moves by the regulatory authorities for environmental reasons. We have seen plenty in Latin America recently, and that has scared investors.
Last but not least, we want to see a very solid management team, not only competent in their sector of expertise, i.e., the precious metal that they’re developing, but in the territory that they engage in. Additionally, we want to see that they have worked for a long period in the country (or in the vicinity) with other projects, so they know all the requirements of the local regulatory authorities, the local taxation authorities, and how to push a project through the approval process.
