Global unrest and inflation will play a role in improving fundamentals for gold and silver, Byron King, newsletter editor for Agora Financial, tells The Gold Report. But miners have to control costs and clean up their internal cash flow, too. Meanwhile, investors who have run up gains in traditional investments are looking for new asset classes. King shares the names of a few well-managed companies in the gold, graphite and rare earth space that are husbanding their assets and adding value, sometimes in unexpected ways.
The Gold Report: Byron, gold is above $1,300/ounce [$1,300/oz]-although not by much-and silver topped $20/oz. What was holding their prices down, and what are the fundamentals that will move the prices going forward?
Byron King: The short answer is that, for all its faults, the dollar has strengthened, which holds down gold and silver prices. The longer answer is that gold and silver are manipulated metals. That is, the world's central banks have an aversion to things they can't control, and one of the things that they can't control is elemental metals like gold and silver.
Let's ask why the dollar has strengthened. The U.S. is probably in its weakest geopolitical situation in decades. The Wall Street Journal on July 17 had a front-page story about the confluence of crises across the world-Ukraine, Middle East, Southeast Asia-all of which are profound challenges to American power militarily, diplomatically and economically. But the dollar is still holding up. Why?
I believe the dramatic recent increase in U.S. energy production is what's behind the stronger dollar. With more oil and natural gas from fracking, the U.S. is the world's largest energy producer. In addition, we're importing far less oil and exporting a lot more refined product. It helps the dollar.
Still, when I look at the big picture for gold, I see a resource whose production is challenged on the best of days. Output is declining in the major traditional sources: South Africa is in decline; Australia is challenged; some of the big plays in Nevada are getting long in the tooth.
The majors have their own challenges. Take for example, the on-again, off-again courtship between Barrick Gold Corp. (NYSE:ABX) and Newmont Mining Corp. (NYSE:NEM). It's not that companies can't make money mining gold. But the Barrick-Newmont dance indicates how important it is to cut costs in this environment. This potentially massive gold merger is all about cutting costs, and it hasn't happened because of the corporate politics of whose costs get cut.
TGR: Is there a cycle that builds on itself? As the gold price goes down, companies-especially the majors-spend less on exploration and development, which depletes their reserves, production declines and their costs increase. Are we in that part of the cycle where lower prices are setting the stage for less supply and the need for a higher gold price later?
BK: Yes, exactly. Falling supply and static price makes a classic economic case. We are setting the stage for less supply and higher prices. The market is dancing around the reality, but it's still the reality. Consider that, in the last year or so, gold has been as cheap as $1,200/oz. In late March or early April, the price almost touched $1,400/oz. That's a 16-17% price swing in two months. Is this the sign of a well-balanced market?
Now consider how macro-events drive things. In the first half of 2014, geopolitical events-Ukraine, Syria, Iraq-drove the gold price. And to me, these locales bring it back to that dollar-energy relationship.
Iraq produces 2.5 million barrels [2.5 MMbbl]/day of exportable oil. In June, when it looked as if Iraq might not survive, the idea of those 2.5 MMbbl/day being taken out of the market helped drive the price of gold from $1,240/oz to over $1,300/oz.
Or look at Ukraine. It straddles key gas export lines to Europe, and the situation involves Russia, which is one of the world's largest energy producers. Problems with Russia, let alone sanctions and such, affect perceptions of future energy supply, which tends to benefit the dollar.
All in all, where is the gold price headed? Long-term, the answer is up. Inflation is not going away. I think that the central banks of the world, and the people who run university economic departments and train the leaders of the future, really do believe that we ought to have long-term inflation. If that is indeed where they're coming from, you need to own gold and silver.
I think the long-term prospects for demand-the long-term prospects for gold as money and as backing for money-are much better than they used to be.
TGR: Given the volatility that you discussed and the challenges of the U.S. dollar, is there significant retail and institutional cash on the sidelines waiting to find the confidence to jump back into precious metals, as commodities and mining equities?
BK: There is an immense amount of money waiting for the next step. In the last few years, the big indexes have done incredibly well; everything has gone up, from airlines to consumer electronics, Silicon Valley, aerospace. A lot of people have made a lot of money in the big markets and in traditional investments.
Now, where does it all go? All that recently minted money needs a new home. If you have balance sheet appreciation from the large caps and the big blue chips, you're looking for something else. My sense is that a lot of people are looking at the basic resource sector.
We have already seen some of that money step back into the market in the first half of this year. Some of the highest-quality small and midsized mining plays have seen large moves.
TGR: Which companies are getting the attention or which should get some attention?
BK: I'll start with a large intermediate play that's about 18 months into developing the newest mine in Canada, Detour Gold Corp. (OTCPK:DRGDF) [DGC:TSX]. The company has more than 15 million ounces [15 Moz] of gold in reserves. It is ramping up to about 150,000 oz [150 Koz] a quarter. With guidance of 600 Koz/year, that gives the project a 21-year mine life.
Toward the end of 2013, Detour's shares were mugged. They went down to near $4/share. In H1/14, the stock tripled to more than $12.
Now you might ask, is there still any upside left? I believe there is. The up cycle is going to kick back in. A company like Detour-large, well capitalized, intermediate sized, big production, good life of mine, with its costs under control-has more upside left.
TGR: Detour has focused on improving its operating performance. Did you see the impact of this effort in its recently released first quarter results?
BK: Yes, because it keeps lowering its cost per ounce. In a world of, let's say, $1,300/oz gold, Detour is producing at $950/oz, all-in, with a target of $850/oz. If Detour keeps taking cost out of its equation faster than the market can drive down the price of gold, it will do all right. If the market takes the price of gold up, it's pure gravy for investors.
TGR: What about a company that is just going into production?
BK: I've been following GoGold Resources Inc. (OTC:GLGDF) [GGD:TSX.V]. I've met the management team and found them to be sharp people who know what they're doing. The company is working on a variety of projects in Mexico. One of its big plays is the Parral Tailings project, re-mining old tailings from the heart of the Mexican gold and silver belt in Chihuahua.
Parral is one of its significant success stories: more than 35 Moz of silver equivalent, in a situation where it's very cheap to reprocess the tailings. Instead of building a new mine, GoGold just has to move the tailings as it reprocesses. GoGold keeps adding this kind of low-cost type production, which makes it a nice play in this market.
TGR: Are there companies you think can make money regardless of whether the gold price is $1,400/oz or $1,300/oz?
BK: Well, it takes time to build a mine and work out the operational economics. Every case is different. Still, I'm looking hard at companies that are positioning themselves to come out strong in the next two years.
TGR: The last time we talked, you explained that, in the context of history, we've just entered the early stages of the materials revolution, using advanced forms of graphite and rare elements. Can you give us an update on that revolution?
BK: When you get into the graphite space, you quickly realize that graphite is more of a technology play than a basic resource play. There is a materials revolution going on with carbon, certainly with graphite. It's extremely investable, but you have to have patience, and be willing to learn some complex new science. If an investor doesn't want to become educated on the high-end carbon chemistry that's happening out there, this could become an uncomfortable space in a hurry.
Look at it this way. If I mine gold, silver or copper, I can sell it to pretty much anybody, from dentists to jewelers to wire makers to electronic makers. The end users will buy it as long as there is a basic spec or quality to it.
Graphite is different. Once you mine it, what you do with the graphite depends on who your user is. The end user has a specific use in mind-battery anodes, fire suppression, heat dissipation, high-strength materials-that requires an entire industrial chain that has to happen between the mouth of the mine and the end user.
TGR: Do you have any words of wisdom for investors who are trying to decide when to enter the market?
BK: We've seen several strong investment points for gold and silver in the last six months. Right now, I think we might be due for a summer correction, although geopolitical events seem to be exploding all over the place. Sorry, but I just don't have a subscription to next week's Wall Street Journal. My issue only comes every morning.
Still, we've got tremendous volatility. Just in the time we've been talking, JT, the price of gold dropped $33/oz, which is a bit of an eye-opener. It makes you want to look at the rest of the world and see what's going on, what might have prompted that drop.
The question for the investor is, what are you going to do? Well, if there's a downdraft to gold and silver prices, then you want to be involved in companies that can get their costs down faster than the market can beat down the price. But whatever happens day to day, I think metal prices will go up over the long term, because of inflation.
When it comes to picking companies in which to invest, you need to be willing to diversify across many ideas. While it's great to put a lot of money into a couple of plays and see one or two do really well, that's usually not the way life works. In the small-cap resource space in particular, you need to find 6 to 10 quality plays-or more-and spread your investments around.
Then you need to watch carefully, and be willing to cut your losses. You also need to be ready for surprises on the upside. When a company gets a takeout offer or has a good piece of news from the drill rig, you can see fabulous gains flowing to patient investors. Just remember that, when good things happen, you need to sell some shares and take some of that gain off the table.
TGR: Byron, it's always a pleasure. Thanks for your time and your insights.
This interview was conducted by JT Long of The Gold Report.
Byron King writes for Agora Financial. He edits three newsletters: Outstanding Investments, Real Wealth Trader and Military Technology Alert. He studied geology and graduated with honors from Harvard University, and holds advanced degrees from the University of Pittsburgh School of Law and the U.S. Naval War College. He has advised the U.S. Department of Defense on national energy policy.
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