-- Published: Monday, 16 March 2015 | Print | Disqus
Source: Brian Sylvester of The Gold Report
Chris Ecclestone, principal and mining strategist at London-based Hallgarten & Co., finds optimism in the most unlikely places. He says that the key reason to be cheerful in 2015 is that the mining sector remains largely ignored. Ecclestone posits that the eventual rotation of broad market money into the sector will float many boats and lead to further M&A, which could start this year. In this interview with The Gold Report, he recommends being long mining stocks and keeping your eye out for M&A activity.
The Gold Report: In the December 2014 edition of the Hallgarten & Co. Model Mining Portfolio, you outlined some reasons for investors to be cheerful. Please share some.
Chris Ecclestone: The first is the oil price. The mining space has been afflicted with capital and operating expenditure inflation for 10 years. One of the most sustained rises on the operating expenditure side has been energy costs; mining companies have been paying massively more for oil than they were 10 years ago. The 40–50% tumble in the oil price has reduced those input costs.
Another factor is that many of the commodity currencies have retreated heftily. The Canadian and Australian dollars, the South African rand, even the Russian ruble, have retreated to levels that essentially provide a "double whammy." It definitely helps the producers in those currencies.
TGR: Are there other positives?
CE: I think there's going to be a merger and acquisition (M&A) surge this year. We've already seen a few transactions. The obvious ones are not happening, yet some surprises are happening. Anything that's out there could be subject to a takeover.
TGR: We've seen several large M&As already this year. What are some takeaways from the deals we've seen so far?
CE: One is the marriage of partners that have not been the subject of speculation. Another is that companies are doing deals with stock in order to preserve cash. And no one is saying that these deals are at ritzy prices. Some management teams have learned not to overpay by offering prices that work for both parties. We certainly haven't seen any bidding wars.
TGR: What are some trademarks of an "Ecclestone-d" mining equities portfolio?
CE: I used to run a hedge fund and I think in terms of long and short. For the first time since 2009 our portfolio does not have any short positions. We cleaned out the last two and they were very profitable. Now every position is a long position. When the market gets going again I expect to restock the short portfolio because there are still badly managed companies out there. In the rest of the portfolio we sell off stocks when they hit target prices. Many of our stocks have fallen a lot and while it may look as if our portfolio is full of negative positions, that's because we've taken profits on the stocks that have risen to targets, while holding those that are still awaiting their upward move. That's the way our portfolio works.
TGR: Take us through the rationale for being long mining equities.
CE: One reason to be cheerful in 2015 is that the mining sector has been one of the few sectors that has not moved. Mining has been in the dumps for about two years. If you want to see where the big money is moving, you have to watch the broad markets. In the broader markets investors rotate in and out of sectors. They rotate out of insurance into energy; out of energy and into retail; out of retail and into banks. Eventually they will move into the mining sector and stocks that are big and have liquidity.
After that they'll move into other stories, like midsize companies. They'll never go into the smaller stocks, but retail investors who have seen their shares of some majors go up will sell those and start buying their favorite juniors that they think are cheap. That's the way it works. And it will work that way forever.
TGR: Will the rally be short lived or sustained?
CE: It depends how steep it is. If it's a really steep rally then it likely won't last long because people will say the market has gone up too far, too fast, and people will take profits. It's far better that support is built gradually.
TGR: What's your timeframe for that rally?
CE: I don't have a timeframe. Maybe we're already in the rally. Rare earth elements (REE) prices moved up a little a few weeks ago and suddenly all the REE stocks doubled or more. People need to get used to the fact that some producers make money at these metals prices. For instance, with silver at $16/oz, a silver producer can make money if its cash cost is $8–9/oz. That's a good reason to buy a silver stock. You don't need $20/oz silver for a silver stock to be attractive. It's attractive at these levels and people should be buying them.
TGR: Would you compare the mining equity business pre-2007 and post-2007?
CE: Was it a business pre-2007, or was it a big casino? A casino is a business for the operators, but it's not a business for the people flinging their coins into slot machines. I don't think most "mining" was a business in 2007. Today there's a lot more focus on margins and costs because there's a gun against everyone's head. In 2007, it really was the Wild West. There were lots of decadent deals, decadent financings and decadent parties. Most producers now realize that it's all about cost control and not doing dumb M&A. The mining sector once believed it could play by its own rules. It can't.
TGR: What are some things that investors have to relearn about the current market?
CE: Open-ended exploration campaigns are gone forever because those were an indulgence in the idea that you could keep drilling and drilling and then someone would buy the resource you had on a piece of paper. The resource in the ground all too likely will stay there. The companies that have done best in the post-2011 environment have been those that have entered production or advanced close to production because production means cash flow and cash flow means you don't have to go back to your investors. One thing is clear: Investors no longer have a bottomless pit of money that they could continue contributing to mining sector largesse. In Australia, the enormous pool of money in individual pension funds has pulled back from mining stocks because too much of that money has evaporated.
TGR: So if you're an investor in the gold space, you want to look at equities with a clear path to production at all-in sustaining costs below $1,000/oz?
CE: Yes, there has to be a decent margin. Anyone producing gold at an all-in cost of $1,300/oz might as well pack up the tent because that company needs $1,600/oz gold to produce a profit. Companies need to produce a profit that generates a dividend. That's a mindset that many companies, particularly in Canada, have not grasped. They believe that a takeover is your dividend. But if takeovers aren't happening, what happens? There might be 30 takeovers in 2015. That's not a lot.
TGR: Would you compare the mining industry to someone who's recovering from a heart attack? Those folks are eating healthier and exercising, much like companies in the gold sector are managing costs and watching margins.
CE: I wouldn't say it's healthier. I'd say it's indulging in better practices. Some producers have had the heart attack and don't want to go back, but the mining sector is hankering for another juicy, fat-ridden steak. I doubt that some of these people won't slide back into bad practices at the first opportunity they get to cash a check from a hefty financing. The sector needs to turn over a new leaf.
TGR: Thank you for your insights, Chris.
Christopher Ecclestone is a principal and mining strategist at Hallgarten & Company in New York. He is also a director of Mediterranean Resources, a gold mining company listed on the Toronto Stock Exchange, with properties in Turkey. Prior to founding Hallgarten & Company in 2003, he was the head of research at an economic think tank in New Jersey, which he had joined in 2001. Before moving to the U.S., he was the founder and head of research at the esteemed Argentine equity research firm, Buenos Aires Trust Company, from 1991 until 2001. Prior to his arrival in Argentina, he worked in London beginning in 1985 as a corporate finance and equities analyst and as a freelance consultant on the restructuring of the securities industry. He graduated in 1981 from the Royal Melbourne Institute of Technology.
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-- Published: Monday, 16 March 2015 | E-Mail | Print | Source: GoldSeek.com