-- Posted Wednesday, 18 December 2013 | | Disqus
Source: Brian Sylvester of The Gold Report
The best time to buy gold is when the market hates it, especially when it comes to junior explorers with market caps under $1 billion, asserts Ralph Aldis, senior mining analyst with U.S. Global Investors. In this interview with The Gold Report, Aldis shares his main modeling themes. He also explains the win-win-win advantages of flow-through stock issuance, a technique allowed by some noteworthy Canadian provinces.
The Gold Report: At the New Orleans investment conference, U.S. Global Investors CEO Frank Holmes reminded investors that gold is not a means to get rich quick, but should act as a diversifier in a portfolio, a form of insurance. Do you have to remind investors of that?
Ralph Aldis: We do. We always stress that no more than 10% of a portfolio should be exposed to precious metals. Given gold's poor performance in the last two or more years, the trend has been to chase the market and the S&P 500. This is exactly when investors should be using gold plays to diversify and provide a bit of insurance. If they made good money in the market, they could take 5% or 10% off the table and deploy it in gold plays.
Right now, gold is one of the most hated sectors in the market. That's when investors should buy it—when nobody loves it.
TGR: You and some of your colleagues at U.S. Global Investors pay a lot of attention to the economic data published by the U.S. government. Recent data suggest that the American economy is gathering strength. What's your view?
RA: I think the economy overall is gaining strength. That's what the Federal Reserve has wanted: low interest rates and for the long end of the Treasury curve to go down. The 10-year Treasury note was free money on the table even though it did reflect economic risk; it was crazy not to buy it.
The same thing is true of the S&P 500 these days. The Fed wants inflation, and that starts with inflation of asset prices. Again, it's almost like getting free money.
If we look at Shadow Stats' indexes—which calculate inflation the way the Fed and the government used to—inflation is running close to 8% or 9%.
I would also point out the friction in the economy regarding wages. Wages will likely be the next step on the road to inflation. Worldwide, corporate balance sheets are flush with cash. Organized labor is gaining traction on the idea of a living wage. Not every industry will see wage growth all at once, but we will see a series of wage increases across the board.
Another interesting factoid: A recent report from the Harvard Joint Commission on Housing showed rents are up significantly because of the number of houses that have been bought by investors. In some cases, more than 50% of peoples' income is going toward rent. With rents rising and incomes remaining static, wage inflation will become a real driver.
TGR: Over the last five years, gold has outperformed the bond index, but not the S&P 500 Index. Will that pattern hold over the next five years?
RA: No. In the current economic picture, there is a potential for gold to outperform the S&P 500. If we look at a chart of the last 10 years, it's only in the last 18 months that the S&P 500 started to outperform gold.
TGR: We've seen some dramatic volatility in the gold price over the last few weeks. Should investors expect more volatility in the resource sector as the U.S. moves to exit quantitative easing in 2014?
RA: To the contrary, I think the volatility will subside somewhat. We've been in a period of uncertainty about when the Fed is going to act. There have been lots of big trades taking place at unusual hours of the night, when a billion dollars worth of gold futures hit the market and knock it down. I think the people who are bearish on gold have been hitting the markets at unusual hours when there's actually no liquidity out there.
Players on both sides have been trying to knock the price down. When that happens, China or India comes in and buys to keep the price up. There certainly seems to be a floor under gold right now.
Once we've had sufficient tapering to get people to start reassessing the future, there will be more price direction. Volatility tends to go down during a trending market.
TGR: Janet Yellen is in line to become the next Federal Reserve chair. Will she be better or worse for gold than Ben Bernanke?
RA: From what I've read, Yellen tends to believe that markets are very inefficient and that the Fed needs to have a hand in it. To some people, that means more stimulus is coming.
In my opinion, the more the Fed gets involved, the greater the chances for policy mistakes. That is probably a positive for gold. When the Fed decides to intercede it just causes more dislocations and puts the markets out of whack.
With the Fed wanting interest rates to remain low, Treasury bills are riskless right now, but that has to correct itself. The market has gone up strongly because the Fed wants asset price inflation to create a wealth effect. However, if corporate profit margins don't expand as rapidly because of wage growth, that could be a surprise.
TGR: If there is less volatility in 2014, how will that affect how you manage the World Precious Minerals Fund (UNWPX) and the Gold and Precious Metals Fund (USERX)?
RA: It won't change anything to any major degree. We try to stick with the main themes of our models: growth in resources per share, growth in production per share, growth in the cash flow.
Regarding the volatility of cash flow, we're looking at whether the market will pay a higher multiple for a cash flow that's less volatile. This can be a case of contrarian thinking; some people would advise buying the company that's the most out of the money because it will have the biggest move. That may work in the short term, but it's not sustainable.
We look at management's track record in managing the volatility of cash flow and the margins. Companies with more stable margins tend to outperform for longer; you can sleep at night with those types of stocks in your portfolio.
Another factor we look at is the relative performance of each stock to its peers to see what the market is saying about the stock. We also look at the stock price of each company and judge it against its resource statement. When we look at the resource statement, we monetize it into equivalence, treating all companies the same. We look at the company's actual market capitalization against our proprietary resource statement valuation. That is one way to really understand where there are financing needs. Obviously, if a company needs external money, we have to immediately dilute its current share price down to account for the monetization of the assets.
We're looking for what is catalyst driven. That's where we're trying to get our knowledge about processes and events to actually have that additional value for our stock picking.
TGR: That leads me to think that U.S. Global would buy on the dips in the volatility. And if volatility decreases, you would adjust your strategy. Is that the case?
RA: Well, 18 to 24 months ago, when the markets seemed to be losing momentum, we started thinking about which names we did not want to be in. We weeded out a lot that didn't have the right people, the right project or that would be exceptionally challenged in some way. Now, we have a portfolio of names that we want to own.
We always take advantage of volatility and do a little trading on the margin, but we want a core portfolio of names that we believe will not give us any big surprises.
TGR: How would a hypothetical $10,000 investment in the World Precious Metals Fund have performed versus the New York Stock Exchange's Arca Gold Miners Index over the last 10 years?
RA: On a total price change percentage basis, from November 2003 through November 2013, we would be down 11.91% and our benchmark would be down 21.05%.
We started at the bottom and ran up as high as 175% in 2007–2008. Then both the fund and our benchmark fell. We accelerated again in 2011, outpacing the benchmark, and are now back to just below where we started 10 years ago.
TGR: According to the most recent data, 80% of the World Precious Metals Fund is mining equities with market caps under $1 billion ($1B). Why do you lean so heavily on that space?
RA: Looking at what the companies do over time, you get the best price returns—the tenbaggers—among the micro caps in the less than $100–500 million ($100–500M) range.
It's much easier to grow a production profile or resource statement substantially at that lower peer level. That also is where there are more takeovers by majors.
You won't get the growth in the large-cap space. What you do get is volatility, in the sense that when the gold price moves, money tends to go in and out of the most liquid names the fastest.
TGR: How do you manage the lack of liquidity in the sub-$1B space?
RA: We try to spread our investments out. There are 2,000-odd mining companies listed in Canada. We spread investments across the 100 that are good projects run by good people.
As we do more research and get more comfortable with one company, we may raise its percentage or back off another that's not working out. We don't do a lot of rocket trading, blowing in and out of positions. That kind of trading affects the liquidity cost. When we find something isn't working, the weighting is small enough that we can work our way out of it over time. When we find something that's really good, we'll start to raise our weighting as we increase our certainty as to what's developing with that company.
TGR: You mentioned that the sub-$1B space is where the tenbaggers are. How do you balance that get-rich-quick potential with advising investors to take a long view?
RA: Diversification. In a portfolio of 100 companies, I can't diversify away the gold risk, but I can diversify away some of the company risk by holding a variety of names. Individual investors are often overweight in a single name, thereby increasing company risk. If the risk profiles are structured correctly, the portfolio volatility should be less volatile than our benchmark.
TGR: Could you explain what you mean by flow-through for our readers?
RA: Certain Canadian provinces let companies raise money for exploration by issuing shares at a premium to their share price. For the initial buyers of the shares, who don't hold onto the shares, it's an opportunity to lower their taxes.
It's a win-win-win. The company gets money. The initial investors get tax relief. The company working in that province gets money to explore for new mines. It's a great way for the province to encourage development of its resource base.
TGR: What are you thinking about as we close out 2013 and head into 2014?
RA: I think pessimism has reached a maximum, particularly in the gold space. Historically, when pessimistic consensus is this strong and gold stocks are hated this much, these are turning points.
The opportunity is here; don't get discouraged. I think we are going to see inflation, driven by wages, housing, rents—things that the Fed can't substitute away in its calculations.
I see profit in the pipeline. The S&P 500 will probably do okay, but investors need to remember that in the 1970s, when adjusted for inflation, gold stocks did much better than the overall market.
TGR: Ralph, thank you for your time and insights.
Ralph Aldis, CFA, rejoined U.S. Global Investors as senior mining analyst in November 2001. He is responsible for analyzing gold and precious metals stocks for the World Precious Minerals Fund (UNWPX) and the Gold and Precious Metals Fund (USERX). Aldis also works with the portfolio management team of the Global Resources Fund (PSPFX) to provide tactical analyses of base metal, paper, chemical, steel and non-ferrous industries. Previously, Aldis worked for Eisner Securities, where he was an investment analyst for its high net worth group and oversaw its mutual fund operations. Before joining Eisner Securities, Aldis worked for 10 years as director of research for U.S. Global Investors, where he applied quantitative skills toward stocks, portfolio tilting, cash optimization and performance attribution analysis. Aldis received a master's degree in energy and mineral resources from the University of Texas at Austin in 1988 and a Bachelor of Science in geology, cum laude, in 1981, from Stephen F. Austin University. Aldis is a member of the CFA Society of San Antonio.
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-- Posted Wednesday, 18 December 2013 | Digg This Article
| Source: GoldSeek.com
