Chris Mancini, an analyst with the Gabelli Gold Fund, spends his days finding value in gold equities-and he thinks he's found a recipe for success. Take a long-term outlook, add excellent management, fold in a great project in a quality jurisdiction with low-cost minable ounces in the ground at a huge discount to the spot price-et voila! Mancini calls this "optionality" and in this interview with The Gold Report he says that equities with optionality will not only survive the downturn but also provide excellent leverage to an inevitable upward move in the gold price. Check out some rising names in the Gabelli Gold Fund.
The Gold Report: Cash has flown out of gold funds and into non-gold equities during this bear run in gold. What's the current Gabelli Gold Fund pitch to investors?
Chris Mancini: Gold should be a long-term allocation to everyone's portfolio. Owning gold is an insurance policy against the malfunctioning of the world's monetary system. The current actions of the world's central banks are unprecedented. Any investor who is unsure of the ultimate outcome of these actions should have a larger percentage of his or her portfolio in gold.
We recommend that investors have a certain portion of that gold allocation in gold stocks. Gold stocks provide income, accretive growth and "optionality." That optionality is gold in the ground at a discount. Right now investors can buy gold in the ground, in some cases, at less than $100 per ounce [$100/oz] and if gold goes to $2,000/oz then they could see that optionality manifest itself in a big increase in the price of the stock.
TGR: So it's possible to have security and performance in the same fund?
CM: If you pick the right stocks and have that optionality and gold goes up, the performance of the fund will be really good. By the same token, if gold goes down and you own some of these stocks, the price of the fund will most likely go down. In owning a gold fund like ours investors are getting exposure to gold and leverage to a move in the gold price.
TGR: Gold witnessed modest safe-haven and inflation-hedge demand in June after U.S. Federal Reserve Chairman Janet Yellen said that low interest rates are here to stay. Should gold investors expect anything more than a temporary upward trend in gold prices?
CM: That depends on the expectation in the markets of where real interest rates are going. Yellen stated that interest rates would be lower for longer but that was coupled with data that showed that inflation in the United States could be accelerating. That shows that real interest rates might become more negative than they are now. And that means that holding cash is a money-losing proposition because cash is losing purchasing power. If interest rates become more negative, that will be positive for gold and it won't be a temporary phenomenon.
TGR: What's your price target for gold through the end of 2014?
CM: We don't have one. Our view is that the price of gold is going to be higher at the end of 2014 than it is now. And it's going to be higher in 2015 than it will be in 2014 and we're positioning the portfolio to take advantage of that.
TGR: What impact have redemptions from gold exchange-traded funds [ETFs] had on the gold price?
CM: Last year 900 tons came out of gold ETFs and it was a huge contributing factor to the price of gold declining by 27%. Total annual gold demand is roughly 4,200 tons so if the supply from ETFs goes to neutral then the supply/demand balance this year should shift in the other direction. This year we've seen a tiny negative outflow from ETFs, but they've been pretty flat. Inflows into ETFs would be a big positive for the price of gold.
TGR: How do the inflows and outflows in your fund compare with 2013?
CM: At the beginning of 2014 we had inflows into the fund, and then they flattened out. When we had the big one-day pop in the gold price in June when gold went up $44/oz, we actually had outflows from the fund. That might be telling us that we have some people who are playing gold for a quick bounce and aren't looking at gold from a long-term perspective.
TGR: A recent Gabelli Gold Fund report suggests that Russia may want to diversify its foreign exchange holdings and could look to gold.
CM: Russia has around $500 billion [$500B] of foreign exchange reserves in the form of U.S. dollar treasuries and euro denominated bonds, largely German, French and some other smaller European country bonds. If there is further geopolitical unrest in or around Russia and increased rhetoric from countries like the United States, Germany, and France meant to impede Russia from taking action in places like Ukraine, Russia might get the sense that the United States and other countries in NATO might impose financial sanctions on Russia.
If broad financial sanctions are placed on Russia, then there could be a question as to whether Russia would be repaid by the countries that they've lent money to. In a new Cold War scenario, you would think that Russia would want to diversify out of the bonds of those countries and into something else. What else is there? Gold is an answer. Gold is no one's liability.
TGR: Where is China in the gold demand picture?
CM: Chinese consumers are the largest buyers of gold in the world. That's related to their fear of holding their currency in the bank or holding it in their mattress. There's a significant amount of inflation in China, so real interest rates are negative. It behooves the Chinese to diversify out of cash, which is losing its purchasing power. Holding gold is a way to insure against inflation or some kind of issue with the Chinese banking system.
China has around $3.7 trillion of foreign currency reserves. The People's Bank of China also might want to diversify. If China were to diversify 10% of its foreign currency reserves, $370B, that would be a huge amount of gold to buy, or roughly 3.5 years of the world's total mined supply of gold.
TGR: A significantly higher gold price would float all boats. But until that happens, what's your method for picking gold stocks?
CM: We try to own the companies that can survive and even benefit from this downturn and then prosper in the upturn. We look for companies that have good assets, good management and a good valuation. Good assets alone should allow the companies to survive; their management teams should help them prosper. We're looking to buy these companies at reasonable prices.
TGR: Do you visit mines and mining projects?
CM: Yes. I was recently in Quebec's Abitibi region where I visited Agnico-Eagle Mines Ltd.'s (NYSE:AEM) Goldex and LaRonde mines, and a couple of others.
TGR: Will Agnico ever recoup its capital costs at Goldex after the mine's underground instability issues?
CM: Probably not its initial capital costs. Agnico should be able to produce 100,000 ounces [100 Koz] a year for a few years at an all-in cost of around $1,000/oz. To get those ounces the company had to spend $80-100 million [$80-100M]. It will more than recoup that incremental investment. The company has done a good job of making the best of a bad situation.
TGR: What else did you visit in the Abitibi?
CM: I also visited AuRico Gold Inc.'s (NYSE:AUQ) Young-Davidson mine. The big thing to take away from the Abitibi is that it is a mining region. There are families there who have been mining for generations.
TGR: What stood out at AuRico's Young-Davidson?
CM: The ore body is similar to Goldex and is amenable to low-cost bulk mining but the grade is a lot better than at Goldex. It's a wide ore body with big stopes, so the company has put the infrastructure in place to allow the deposit to be mined cost effectively. The production shaft has been sunk; development work in the upper mine is mostly complete. AuRico's goal is to go from 2,700 tpd to 4,000 tpd, and then eventually to 8,000 tpd once the lower mine is fully developed.
TGR: Young-Davidson produced about 120 Koz last year and AuRico has issued guidance that could be as high as 160 Koz in 2014. Is that realistic?
CM: Yes, that's realistic. The ultimate goal is to get to around 230 Koz/year on a sustainable basis. Once AuRico gets there unit costs should decline to below $500/oz from around $700/oz because to get that incremental tonnage it won't have to add as many underground miners. The mine should reach full capacity by the end of 2016.
TGR: Do you have other positions in equities with projects in Nevada?
CM: We own Newmont Mining Corp. (NYSE:NEM) and Barrick Gold Corp. (NYSE:ABX). A lot of the value of those two companies is in their Nevada operations. I think Newmont and Barrick should merge and then spin off their combined Nevada operations into what would be one of the biggest gold mining companies in the world. Call it Nevada American. It would be huge. The market would love it.
TGR: Some of your largest positions are in royalty companies. Tell us about those.
CM: We have big positions in Royal Gold and Silver Wheaton Corp. (NYSE:SLW). We also own Osisko Gold Royalties Ltd. (OTC:OKSKF), a spinout from the Osisko takeover by Agnico-Eagle Mines and Yamana Gold Inc. (NYSE:AUY). These companies are perfect examples of being able to survive the downturn and benefit from it.
TGR: What are some royalties that give Royal Gold and Silver Wheaton leverage to a dramatic rise in the gold price?
CM: Both companies have royalties on Barrick Gold's Pascua-Lama gold-silver-copper project on the border of Chile and Argentina. Royal Gold has a sliding scale royalty that at this gold price would be 5.23% on the gold on the Chilean side of Pascua-Lama, whereas Silver Wheaton has a stream on 25% of the silver.
It would cost another $4B for Barrick to build Pascua-Lama, even if it gets the environmental permit and green light from the government, but at $1,300/oz gold and $21/oz silver the project is not viable. Once it's built it should produce 800 Koz/year gold at zero dollar cash costs [after silver byproduct credits] and should have a 20-year mine life. It's a great project at a higher gold price.
TGR: What's one thing a gold investor should know about the current market?
CM: The best thing to keep in mind is that even though this market is extremely volatile, you're in it for the long term. It was very volatile to the downside last year; so far this year it's been volatile to the upside. Don't lose hope or exit on a quick run up. You're getting insurance at a relatively cheap price by owning gold and gold mining companies.
TGR: Buy and hold still works?
CM: Yes, if you have the stomach for it.
TGR: Thanks, Chris.
This interview was conducted by Brian Sylvester of The Gold Report.
Chris Mancini is a research analyst for the Gabelli Gold Fund, specializing in precious metals mining companies. He has over 15 years of investment management experience, including research analyst positions at Satellite Asset Management and R6 Capital Management. Mancini earned a bachelor's degree in economics with honors from Boston College and is a holder of the CFA designation.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.