Twenty years ago, as the infamous dot. com bubble in the US stock market was rising to a crescendo, I decided that, when the bubble inevitably burst, the greatest beneficiary would be gold bullion and gold mining stocks, both of which had been in a secular bear market for almost twenty years. So, I decided to put all my liquid assets into gold bullion and switch a chunk of my Asian equity investments into a mutual fund invested in gold mining shares. The gold bullion part was easy but, as I reviewed the few gold mining mutual funds that had survived the twenty-year bear market, I quickly realized that they were all heavily invested in platinum stocks or in senior gold miners that had sold forward their production years ahead. I wanted no such companies, for I wanted exposure to companies that, through their operational leverage, would benefit dramatically from a rising gold price. As I reviewed the surviving listed gold mining companies, I discovered that there were scarcely more than 40 in the entire gold mining universe. I’d had little to do with the gold share universe since the early 1970s as I had concentrated my attention on the burgeoning new stock markets of Asia. However, I always remembered the meteoric gains of some of the marginal producers when gold moved from USD 40 an ounce to USD 200. Subsequently, most of the gold mines in South Africa, which had been the dominant force in the industry in the 1970s, had disappeared in a tsunami of consolidation or had simply been closed down as the gold bullion price fell almost 70% during the twenty years following the 1980 high of USD 860. With so few target companies to monitor, I decided it would not be too difficult to run my own gold fund as well as the Asian hedge funds I was already managing. I launched the Phoenix Gold Fund at the end of 2000. I chose the name Phoenix as I expected gold to be resurrected again from the ashes of its 20-year bear market. After a steady, solid start, the Net Asset Value (NAV) appreciated 40% in the first year and 85% in the next. Momentum kicked in and new gold exploration companies appeared like crocuses in spring. Such companies must constantly raise new capital until the time they are acquired by a producer looking to replace depleted resources, or the company undertakes the big capital raise to build the mine.
However, they are usually obliged by the hungry brokers to issue free warrants in conjunction with the equity issue in order to entice clients to sign the cheque. In the event of success in exploration, the shareholders’ reward is doubled as the warrants keep pace, or even outrun, the equity. As a result of several successful investments in exploration plays, the Phoenix Gold Fund celebrated its fifth anniversary with NAV at ten times that of its launch. Then the fears that had driven everyone towards gold and gold stocks began to be realized: Bear Sterns and Lehmann went down and, to the surprise of the gold bugs, everything, including gold and gold stocks, was caught up in the maelstrom of vanishing liquidity.
The gold bullion price fell quickly from USD 1,000 to under USD 700 and dragged all the miners with it. Phoenix, still laden with a good helping of free options, saw those gains vaporize. NAV was slammed from a high of USD 1,432 at the end of February 2008 to a humble USD 382 at the end of October that year. However, the recovery was swift as the market began to realize that the only solution the central bankers had was to balloon the money supply. Gold started to move sharply higher and, within a year of hitting the bottom at USD 382, Phoenix was again over USD 1,200.
I am often asked whether I can reduce the volatility of the fund as it is hard on the nerves of even the most battle-hardened stock market investor. Ten years ago, it was very difficult to hedge exposure to the gold shares as the ETFs that now proliferate were in their infancy. Now one can hedge the general market trend via short sales of ETFs or even put options, but it is impossible to hedge against the volatility of some of the smaller stocks. Three months ago, we participated in a small financing by a junior silver company where the company issued shares at 12.5 cents with a free option to subscribe at 20 cents. The sudden rise in the silver price and the realization that the company was likely to be able to bring its silver mine into production has resulted in the stock trading as high as 49 cents. The small allocation that we made to this financing is now uncomfortably large and we would like to reduce our holding, but under the stock exchange listing rules the shares are in escrow for four months and borrowing is not available. Continuing volatility, therefore, is almost guaranteed, so I always tell potential investors to put 5% or 10% of their portfolio into gold mining stocks and hope that it does not work out. Gold mining investment is the ultimate hedge against economic chaos and stock market crashes, as the below chart of the Dow Jones (expressed in ounces of gold) confirms.
Gold shares have performed abysmally since 2011, falling every year until the gold price hit bottom against the USD in 2015. In 2016, prices celebrated the end of the agony by surging 180% in eight months but then soon gave back 80% of those gains as the speculative money opted instead for the thrills offered by the cannabis stocks. This year gold has made an all-time high against most currencies with only the USD-linked currencies and the CHF yet to sink to new lows. However, in a world of zero, or negative, interest rates, it can only be a matter of time, for there is only one way that the world can deal with the massive debt levels that are consuming all cashflow. That way is to devalue the fiat currencies in which these debts are denominated and accept that Mr. J.P. Morgan was correct when he testified that “gold is money; everything else is just credit”! The central bankers will not lead us there, but the market almost certainly will.
The surging gold price in all currencies other than US dollars has meant that the best gains enjoyed by Phoenix in recent years have been in the Australian producers. Northern Star Resources (ASX: NST) has been an extraordinary performer, rising 1000-fold since 2009. Alas we were too late to catch onto the trend of resuscitating and expanding the old abandoned mines, and we missed Northern Star completely. We did enjoy Saracen Mineral Holdings (ASX: SAR) but took our profits far too early. We also did well with Echo Resources (ASX:EAR) which brought the old Bronzewing mine back into play and has recently been acquired by Northern Star. However, perhaps our most satisfying recent success has been Red 5 Limited (ASK: RED) in Australia. Two years ago, the company had a single mine in Mindanao in the Philippines, where they had sought permission to raise the tailings dam wall in order to accommodate the ongoing tailings from the mill. Surprisingly, the recently appointed Minister of Mines refused permission and the company was forced to put the mine on care and maintenance.
” When I look at the above chart and contemplate cycles and the state of the global economy, I feel there is a very good chance that we are again heading towards the situation where an ounce or two of gold will buy the Dow Jones Index”
When I look at the above chart and contemplate cycles and the state of the global economy, I feel there is a very good chance that we are again heading towards the situation where an ounce or two of gold
will buy the Dow Jones Index!
In such circumstances, most management teams would have concluded that it was game over, and gone off to seek employment elsewhere. However, the company still had some cash reserves and obviously management still had some resilience from Mark Williams. He and his team went back to Australia and approached Goldfields, who owned the Darlot mine, and Saracen, which still held the King of the Hills mine 80 kilometers north of Darlot in the Eastern Goldfields. Darlot was operating at 65% of capacity and struggling, while King of the Hills had moved its mill elsewhere and was all but shut down. Red 5 agreed to buy both mines, partly financed by the vendors accepting Red 5 new shares, and the company took over the operation of the two mines in October 2018. The stock price then was under 5 cents, a fraction of what management thought it should be worth. The company was fairly tight for cash as the all-in-sustaining cost of production was around AUD 1500 and the gold price only AUD 1650. The company quickly re-opened King of the Hills and started trucking that ore to fill the Darlot mill. Soon it was producing at a rate of 100,000 ounces a year, but the company needed funds for drilling to push forward the exploration. The banks were unwilling to consider a small loan and would have insisted on a large forward sale to cover repayment of any loan, and management was reluctant to force further dilution on the shareholders by issuing stock at what it believed was a fraction of the true NPV. I was able to extend to Red 5 a one-year gold loan from the portfolio of my family company at a handsome interest rate. One year later, the company is able to report a resource well over 3 million ounces, the commencement of a feasibility study to build a new 4 million ton-per-annum mill at King of the Hills, and production of 120,000 ounces per annum, with much better margins now the AUD gold price is north of AUD 2200 and the share price has been as high as 39.5 cents. On top of that, the Philippine government has now granted approval to increase the tailings dam wall, so the company can either restart that mine and immediately add another 60,000 ounces per annum to production, or sell the asset and use the funds to build the new plant at King of the Hills (the NPV of the Philippine mine at USD 1500 gold must be over USD 200 million). Management has turned a basket case into a great growth story, but it seems the stock price still has a long way to go. What does it tell you about our present financial system when one can earn over 10% lending one’s gold bullion but be asked to pay interest to deposit Euros or Swiss Francs?
The larger gold mining companies have seen their share prices perform well but they are perhaps not yet convinced that higher gold prices are here to stay, for there has been very little M&A activity. Despite the recent strength in the gold mining shares generally, the market has continued to show a cold shoulder to most of the exploration companies and, surprisingly, has preferred shares of the high-grade producers such as Kirkland Lake (TSX: KL). If the gold price is going much higher, then there is much more leverage in the producers with low-grade and therefore skinny margins. If the gold price is not going much higher, then why bother with gold mining shares at all? We are convinced that gold prices are going to go higher so are happy to buy those companies that, until recently, have been marginal producers but are now beginning to see their margins multiply. However, the best value today is probably to be found in those small companies that have discovered an economic resource, but have a market capitalization of as little as 20% of the NPV of their project. A producer will either make a bid to acquire them at, say, 50% of NPV or they will be able to raise the capital to build the mine. That is the pool where the Phoenix Gold Fund will be doing much of its fishing.
