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The Good, the Not-So-Bad and the Maybe Ugly of Gold Equities



-- Posted Monday, 19 August 2013 | | Disqus

Source: Kevin Michael Grace of The Gold Report  

 

With gold in the $1,300s, Gabelli Gold Fund Research Analyst Chris Mancini recommends performing triage on the gold equity sector. In this interview with The Gold Report, Mancini says that companies with cash and cash flow will survive the crisis, while those with the ability to take advantage of the downturn, like streaming companies, will do the best of all.

 

The Gold Report: Were you surprised by the collapse of the prices of gold and silver?

 

Chris Mancini: Yes, I was very surprised. I thought that the macro backdrop for gold and silver was very positive at the beginning of the year. The Federal Reserve had just begun its process of Quantitative Easing 3 (QE3): printing $85 billion ($85B) a month. Japan announced it would undertake its own QE program, which would be a much bigger percentage of its GDP than the U.S. plan.

 

TGR: And Mario Draghi said he'd do "whatever it takes"?

 

CM: Yes. The president of the European Central Bank said he'd do whatever it takes to ensure that there was a recovery in Europe, implying a willingness to buy bonds with printed money. It seemed that all this liquidity splashing around should have been positive for gold.

 

TGR: What, if any, is the relationship between QE and the price of gold?

 

CM: I think what drives the gold price is the view that gold is the ultimate savings instrument. It can't be tampered with, is not replicable and is nobody else's liability. With QE1 and QE2, that money found its way to the highest-growth economies: China, India, Thailand, Vietnam and other countries in Asia. These countries experienced high rates of inflation because this money was chasing scarce resources. And so the average guy on the street was getting 3–4% interest rates on his savings in a the equivalent of a six-month certificate of deposit versus price increases of goods of more than 10%. In other words, negative real interest rates. Holding cash in the bank is a money-losing proposition. This led to an increased demand for gold.

 

With QE3, we have continued to see a lot of demand from China, India and other countries in Asia, especially as the gold price has come down. But we also heard this steady drumbeat of talk that QE was going to end because the economy was doing really well. And because the economy was doing well, people should be in income-producing investments, like stocks or even bonds. So they started getting into them.

 

This became a self-fulfilling cycle: stocks went up, which meant that the economy was supposedly getting better, which meant that QE was ending, so you shouldn't have any gold. Then we had the crash in April.

 

TGR: Don't some people believe that QE is the only thing keeping us from economic disaster?

 

CM: Over the past three quarters, we've had enormous and unprecedented amounts of fiscal and monetary stimulus, while the U.S. economy has grown on average by less than 1%. What I don't understand is why people expect the economy to grow at 3–4% without any monetary or fiscal stimulus.

 

Interest rates were pushed way down by QE, and so people needed to find yield. They weren't finding any in bonds. So they went into dividend-paying stocks. So you had this enormous rise in the stock market so far this year, which I think has been mostly due to QE and forcing investors out of other assets, bonds specifically.

 

TGR: That's what they say about inflation—the money has to go somewhere, right?

 

CM: What the stock market is showing us is the effect of the creation of $85B every month.

 

TGR: Let's assume there will be a tapering of QE. What effect will this have on the price of gold?

 

CM: I don't think a relatively small tapering of QE would have a meaningful effect because it has already been priced in to a large degree. If QE ends completely, I think the S&P 500, Dow and NASDAQ will correct meaningfully. And then you'll hear a tremendous clamor from the markets for more QE. If that happens, there will be a realization that we're in this for good, and I think that this would be good for gold.

 

TGR: You have probably come across these stories of skullduggery in paper gold. One story heard often these days is that the Comex in London has no physical gold. Another is of tremendous amounts of paper gold being leased in order to drive down the price. Do you put any credence in these stories?

 

CM: I don't know the intricacies of it, so I can't really say. However, the severe drop in gold on those two days in April made very little sense from a pure supply and demand perspective. It just didn't smell right.

 

TGR: Even before the gold price collapse, gold equities were in the doldrums. So with gold in the $1,300s, what is the case for gold equities?

 

CM: The equities are highly leveraged to the gold price. So if the price of gold goes back up to where it was at the beginning of the year, $1,500–1,600/ounce ($1,500–1,600/oz), the profitability for gold miners is going to be highly leveraged on the upside. The other case to be made is that given that the average all-in cost of production is around $1,100/oz and there are plenty of mines that produce at $1,350/oz or above, there will be mines that will come offline. So that supply coming offline should support the gold price. The companies are cutting costs right now, and the cost base should be relatively fixed. With gold at, say, $1,600/oz, the companies will be very profitable given the cost cuts taking place now. I believe they'll then pay down debt, and then they'll hopefully start returning cash to shareholders in the form of dividends. I think there is a very good argument to be made that if you own the miners now and you want exposure to upside movement in the gold price, the miners are a very good way to do it.

 

TGR: You've divided gold companies into three categories "relative to their ability to be able to weather the current storm." These categories are the "Good," the "Not-So-Bad" and the "Maybe Ugly." Which criteria determine the good company?

 

CM: Access to cash, access to cash flow and the ability to take advantage of the current distress in the market. The best example now is a royalty or streaming company.

 

TGR: What characterizes the Not-So-Bad companies?

 

CM: Access to enough cash that they won't need to finance anytime soon or access to capital through cash flow.

 

TGR: How do you rate companies that have financed, but will need to go to the markets again?

 

CM: I would rate them between Maybe Ugly and Not-So-Bad. The true Maybe Ugly companies don't have a defined resource and don't have economics surrounding the resource. They're just exploring and need cash.

 

TGR: If trillions of dollars keep being created to forestall deflation, what does this mean for gold in the long term?

 

CM: I don't think anyone really knows the answer to that. To the degree that we had economic growth over the past 10 years, it's been predicated on increased leverage. After the leverage bubble popped, consumers couldn't borrow any more. The way we avoided deflation was through increased government borrowing and money printing. Eventually, it comes down to people questioning the value of the dollars in their pockets, and when people begin to doubt paper money, gold should be a very valuable alternative and do extremely well.

 

TGR: Chris, thanks so much.

 

Chris Mancini, CFA, is a research analyst at the Gabelli Gold Fund Inc., specializing in precious-metals mining companies. He has over 13 years of investment management experience, including research analyst positions at hedge funds Satellite Asset Management and R6 Capital Management. Mancini earned a bachelor's degree in economics with honors from Boston College.

 

DISCLOSURE: 
1) Kevin Michael Grace conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor.

2) Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Chris Mancini: I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent. 
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer. 
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.

 

Streetwise - The Gold Report is Copyright © 2013 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

 

Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

 

Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

 

Participating companies provide the logos used in The Gold Report. These logos are trademarks and are the property of the individual companies.


-- Posted Monday, 19 August 2013 | Digg This Article | Source: GoldSeek.com

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