-- Posted Sunday, 22 March 2009 | | Source: GoldSeek.com
Consistently ranked as one of the top-10 gold and precious metals mining analysts in Canada, Capital Research's Senior Vice President and Director Barry Allan offers a well-rounded perspective on the mining sector that combines geological fieldwork, equity research and finance. Now, after more than 16 years in the industry, he remains bullish on both gold and silver. In this exclusive interview with The Gold Report, Barry discusses his criteria for evaluating major and junior miners, explains how value price moves in gold are more driven by investors than jewelry demand and offers some risk-based guidelines for investors looking to preserve and build wealth in gold.
The Gold Report: Let's start with your economic overview. Where do you see things going?
Barry Allan: I characterize it as my 35,000-foot view. Generally speaking, right across the board we remain positive on the prospects for gold and silver. We look at silver as really a derivative of gold. If we’re bullish on gold, as we are, we are also bullish on silver.
We have argued, and continue to maintain, that demand for gold is really more driven by investors than it is by jewelry demand. Yes, jewelry demand does put a floor under the price, but jewelers are more price takers than they are price makers. It really has been the investment part of the equation that has continued to demand more gold and set higher prices.
We look at interest rates, short-term rates, particularly like a one-year rate. We want to see a low interest rate. Not only does that make the cost to carry-on bullion trading low, your benchmark of investment comparison is low, but also it erodes any forward gold price in the futures market that would attract forward selling. So we do look at interest rates, and I think we’re seeing rather uniform interest rates at some historical low levels and don’t really see that changing.
We also look at the prospects for the U.S. dollar. What is going to happen with the U.S. dollar? It was recently stated to me in New York more precisely: “Yes, the prospects of the U.S. dollar are probably not good—but, guess what? It’s probably the tallest midget in the room.” What that really means is there is a crisis of currencies worldwide. If we think we’ve got a problem with the U.S. dollar, well, let’s go look at the Irish punt, let’s go look at the English pound. All currencies are in crisis at this point in time, and I believe that has been a driver behind gold and the U.S. dollar moving together—that’s rare.
So you’ve got this phenomenon, which is a bit unusual, of the two moving together. But I think we, in our part of the world at least, still find that the crisis of currencies will persist and that just feeds into investment demand for gold. Therefore, the fundamentals all look good for us. Of course, we also do want to keep our eye on are the technical charts. We always want to be cognizant of what the charts are telling us, and certainly everything that you look at on the technical level, short term or long term, is constructive. The charts look quite bullish.
It all looks very good with one slight caveat. We have 29 years of monthly data, and we’ve looked at seasonality trends in gold. You tend to get some second quarter weakness in volume. Maybe that weakness this year is gold going sideways but, certainly, we are coming into that period now. So we’re expecting a little step back here short term in bullion and, as I say, that step back might just be going sideways. So we’re a little bit cautious, as well.
The one thing that we would be concerned to see is the Central Bank having to defend its currency by selling gold. That could be a wild card. I have never seen that yet and large portions of Central Bank transactions in gold are not cleared through the market. They’re referenced to the market, but cleared Central Bank to Central Bank without that disrupting the price. That could be a bit of a worry. If things really do get dark, perhaps some of the bullion reserves that are held by Central Bank might get liquidated. But as yet, I’ve not seen that.
So we are positive on both gold and silver. What we have had collectively within the senior, junior and intermediate sectors is that they have dramatically outperformed the broad market industries and have been the best-performing sector bar none since, really, the October 30th low. In the second quarter of this year, we do not expect quite as hot a performance but certainly for the second half of the year. Yes, absolutely, we continue to be longer term quite optimistic about prospects for gold and the valuations on gold stocks.
TGR: Barry, if you’re looking for some possible weakness in the commodity or the bullion itself in the second quarter, how does that translate to the stocks in general?
BA: Generally, we’ve looked at a couple of things. We’ve looked at what we call the ‘betas relative’—the movement of gold stocks relative to the commodity. Clearly, there is a very good correlation and you have quite a range of betas relative to gold. But, generally speaking, a 1% drop in gold has translated into a 1-1/2% drop in the value of the sector overall. Still, it tends to be a pretty good long-term average. That’s come down, actually. The correlation or the volatility of a gold equity relative to the commodity has diminished over time.
Anyone who wants gold exposure doesn’t necessarily have to buy a gold equity; they could buy an ETF. Over the past three years, the gold equity companies have not really distinguished themselves. We’ve had higher gold prices, but we haven’t seen it translate into earnings and cash flow the way it should, so I think people have really kind of shied away and looked at the ETF as a nice way of saying, ‘alright, I want gold price exposure without all the operating risk and geological risks that may go along with a gold equity.’
TGR: If we were to get another sell-off, we could see some significant weakness in the gold stocks where the bullion might go sideways, as you said.
BA: We will have, and we have had, decoupling of performance of gold equities and the commodities, and that does happen from time to time. It’s not typically unique for just gold stocks. It generally reflects the fact that a gold equity is an equity—it’s a market instrument. It will react with general market conditions. You know, I saw the exact same thing on October 19, 1987—there were good gold price moves up, but the equities were down. You had a total disconnect with what was going on and that’s because the market was just running over every equity; it didn’t matter what it was. It didn’t run over the commodity as much at that specific date, but it certainly did run over the equities.
TGR: If the price of gold continues to go sideways, because you’ve linked it to interest rates and the value of the U.S. dollar, would you expect gold equities to increase only if gold goes up?
BA: We have always tried to maintain a strategy wherein we try to choose the companies that do not necessarily need the gold price to go up, companies that will do their business well and show progression in earnings and cash flow without the need for higher gold prices. What I’m talking about is probably what I would call a ‘low beta gold stock.’ It’s one where the fundamentals are very, very strong, they have growth in the pipeline, the balance sheet is clean, there’s not a lot of leverage and they’re a low-cost producer. That typically attracts us more than a high beta gold stock, where you’re operating costs are quite high, you’re probably in the high 400s and have a lot of debt on the balance sheet.
So we have tried to focus more on what I’d call the low-risk stocks and the low beta stocks than the higher-risk stocks. But the practical part of it is, for traders and for people who are pushing hard for quarterly performance, which a mutual fund typically does, you can usually go back and forth between a high beta gold stock and a low beta gold stock, depending on your view of where the sector is going to go. For example, we’re at a pretty good high right now on gold and we’ve had good runs in it.
TGR: Given the bounce back in these majors since October, has most of the upside been achieved?
BA: I’ve been in the unfortunate situation of having to go back to holds for the near term. I’ve got to do one of two things. I’ve got to say to myself, I’m a little bit worried about the second quarter. I’m not going to say hugely worried, but certainly maybe some weakness—it’s a historical trend. It works 9 out of 12 times, roughly. I’m in an unfortunate circumstance where most of the gold stocks are trading at my target prices, so I’m in a hold pattern.
TGR: What about moving into the intermediate equities?
BA: The intermediates seem to be where a lot of the focus of attention had been. A lot of these intermediate gold stocks were trading like on the valuations of a senior. I was having a hard time finding decent value within that tier. Even before the recent kind of run that we’ve had, I was saying most of these had already become stretched.
Currently, I’ve capped my gold price for this year at $945 or $940 and I’m really thinking that probably what’s going to happen here come end of the quarter is I’m going to be upping my long-term gold price assumption and my gold price assumption for the second half of the year, which will bring back some of the value into these stocks.
At $940 gold, I’m pretty full valued and I’m going to have to get something much higher on my commodity price, but I’m not prepared to do that until I get through my period of seasonal weakness. That’s the quandary that I’m at currently. I do want gold; I want to exposure to it, so probably where I’d point people is to the ETF or to a low beta gold stock that is fairly strong fundamentally. Or I’d suggest they start looking down into the junior producers, where you’ve got higher-risk tiers but you also have some valuation points that you’re trading below NAV.
TGR: I really appreciate your taking the time today, Barry.
Barry Allan joined Research Capital’s Investment Banking Department in 1998 as a mining specialist, and transferred to the Research Department as a Mining Analyst in 2001. Barry has over 15 years of experience in the mining sector. Prior to joining Research Capital, Barry was a Gold and Precious Metals Mining Analyst with Gordon Capital, BZW, and Prudential Bache. Prior to equity research, Barry was a member of the specialist finance group at CIBC, one of Canada’s largest financiers of mining projects. Barry earned his B.Sc. (Geology) and MBA degrees from Dalhousie University.
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-- Posted Sunday, 22 March 2009 | Digg This Article
| Source: GoldSeek.com
