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  • Thinking Outside The Commodity Box: Benchmark's Investment Primer For Lithium, Cobalt And Graphite

    It's often difficult to understand the global markets for critical minerals so The Gold Report narrowed it to three-lithium, cobalt and graphite-and brought in Simon Moores, managing director of London-based Benchmark Mineral Intelligence, and the firm's analyst, Andrew Miller, to provide insight into minerals that they say need to shed their labels as traditional commodities and embrace their future as niche, raw-material solutions for a growing list of technology manufacturers. As Benchmark prepares to embark on its World Tour, Moores and Miller discuss supply chain visibility and the impact of disruptive technologies on these markets, as well as companies seeking to leverage lithium, cobalt and graphite into investable business models that will lure investors with a long-term outlook.

    The Gold Report: In a recent Benchmark Mineral Intelligence report, "Mineral Supply Chain Visibility: Impact of Disruptive Technologies on Critical Raw Materials," you make the case that supply chain visibility will become increasingly important in the critical minerals space. Please briefly explain why.

    Simon Moores: We've noticed that during the rare earth element bubble in 2010-2011, people didn't know what these niche minerals that go into everyday critical technologies were or where they were sourced. We've seen that knowledge grow in the last five years and downstream companies like Apple Inc. [AAPL:NASDAQ] and Tesla Motors Inc. [TSLA:NASDAQ] are now aware of what the raw materials are and where they come from.

    Awareness in these niche minerals of growing importance, such as graphite, lithium and cobalt, is now occurring throughout the supply chain and not just in the upstream portion with the mining or processing companies. The downstream companies are paying attention and they buy the raw materials to manufacture these disruptive technologies. Supply chain visibility is rising.

    Andrew Miller: Supply chains are going to become increasingly important. As these new technologies rapidly develop, both traditional industrial end users and newer high-tech buyers of these raw materials need to know more about the global supply pattern-factors that can impact their business. It's basic risk management in today's world.

    They can't just rely on their traders or distributors for intelligence. End users are now aware of the need for a more global, independent picture on supply, demand and prices.

    TGR: Is that happening?

    SM: We haven't seen companies completely change their raw materials buying patterns yet, but some are preparing for it. In the U.S., the Conflict Minerals Act was the first time specific political restrictions have been put in place for these minerals in the West for ethical reasons. Europe will introduce similar legislation early next year.

    The industry will have to start thinking about buying from reputable suppliers that meet certain standards. That means that end users may no longer opt for the lowest-cost source of raw materials from places like China and Democratic Republic of the Congo [DRC] if producers in these regions don't fall in line with environmental or ethical rules. And that is key. It's not just about price anymore. It means people will start paying a premium for more ethically sourced raw materials.

    TGR: In the same Benchmark report you suggest that disruptive technologies are the most important new market for critical minerals. What are disruptive technologies and what are two or three specific ways these technologies are changing the markets for critical minerals?

    AM: Disruptive technologies are completely new markets that are creating new value chains, products such as smartphones, electric vehicles and different types of energy storage. Growth in these new markets are affecting not only their own supply chains, but also those of existing industrial markets that rely on the same raw materials.

    In the longer term there will be a real need for new critical mineral supply to come onto the market. In many cases that's also going to require suppliers to become more flexible. It's not just the production out of the ground that's going to have to increase; the refining and processing capabilities have to improve and expand too. The material required by traditional critical minerals markets is quite different and more tailored from the majority of product that is needed in these new high-tech spaces.

    TGR: So companies developing these critical minerals projects not only have to get these elements out of the ground, but then they also have to process them in such a way to meet the specific requirements of these new end users, which can vary greatly.

    SM: That's right. The grades that the critical minerals sector has traditionally served up and that have become industry standards over the past few decades are now changing, and that's why critical minerals like lithium, cobalt and graphite aren't really commodities. They can't be mined out of the ground in large volumes and directly used; they are tailored specifically for the end user.

    With commodities it is more of a logistics game, with critical minerals is a processing game-this is where they are fundamentally different.

    TGR: And that is often without any firm commitment from the end users. Is the traditional offtake deal dead in the critical minerals market, at least in specific cases?

    SM: Offtake deals are familiar financing methods for resource companies, but it's difficult to apply that model to these minerals, which are specialist products. Critical minerals are not usually traded in the volumes that offtake contracts often serve, like, for example, iron ore. If these markets grow to reach huge volumes in the future, perhaps then they will be traded in the same way as large-scale commodities.

    TGR: Lithium supplies appear tight even before Tesla Motors' Gigafactory and similar factories around the world start producing lithium-ion batteries. Please give us a brief lithium market overview.

    SM: A lack of new supply coming onstream over the last three years in the face of steadily increasing demand from the battery sector, especially in Asia, has resulted in a lithium shortage. This lithium demand is not coming from a new megafactory like the Tesla Gigafactory or an expansion from LG Chem Ltd. [051910:KSE; 051915:KSE; LGCLF:OTCPK] or Panasonic Corp. [6752:TYO; PCRFY:OTC]-it is coming from existing plants making more batteries for mobile phones, laptops, and power tools, which are all migrating toward lithium-ion. We're seeing a natural increase in demand with a lack of new supply, which has caused carbonate "spot" prices to increase by 20% on average this year and hydroxide by even more.

    Adding to supply problems are the well-documented political pressures in Chile where the government is revisiting the mining licenses of several operators in the Atacama Desert. It is an issue that Sociedad Química y Minera de Chile S.A. [SQM:NYSE; SQM-B:SSX; SQM-A:SSX] is dealing with at the moment, and one that has been well documented by Bloomberg.

    There is one new plant in the Atacama, a 20,000 tonne per annum carbonate plant owned by Albemarle Corp. (NYSE:ALB), that could provide some lithium to the market in 2015, but probably not enough to correct the market deficit.

    Orocobre Ltd. (OTCPK:OROCF) [ORL:TSX; ORE:ASX] continues to ramp up lithium production at its Olaroz lithium mine in Argentina, but to ask any new plant to reach its full capacity within a 12-month period is probably too tough an ask. But there are not enough new players like Orocobre entering the lithium space; they can't yet get the funding.

    TGR: Has Tesla CEO Elon Musk said where the elements of these batteries are going to come from?

    SM: Musk and Tesla have been very quiet on any deals they may or may not have made with suppliers. I do, however, expect Tesla to announce raw materials deals by the end of 2015 or the beginning of 2016. The Gigafactory will start production in some form in Q1/16.

    I still believe the first phase of the Gigafactory will be a pack assembly plant rather than a battery plant.

    Most of the initial manufacturing work will consist of taking lithium-ion cells from Panasonic and assembling them on a bigger scale in Nevada for Tesla's Model S and the new Model X, which is out in September.

    At Benchmark, we believe the Gigafactory will evolve into a true battery producing plant in 2017 where the anode [graphite] and cathode [lithium, cobalt] components will be produced on-site. Therefore, raw materials suppliers have roughly another year to finish off supply deals, and Tesla will have to make a tough call on which ones to back.

    TGR: Cobalt is a component in lithium-ion cathode for batteries. Tell us about the cobalt market.

    AM: Cobalt is similar to the lithium market in the sense that you have one or two large producers that dominate supply. The DRC is where the majority of the raw material is produced. Outside of the DRC, cobalt is produced in a number of countries, but all of that production is limited and there's little capacity for short-term expansion. The key issue with cobalt is security of supply, particularly with the increased demand from the battery sector. Over the past five years or so, cobalt demand from the battery sector has increased threefold, and 2014 battery demand made up 45-50% of the total market.

    TGR: Cobalt prices have slipped some over the summer. Is that the beginning of a downturn in cobalt prices or a summer dip?

    AM: It is more of a short-term trend than anything. When we look at the macro dynamics for the cobalt market, supply is tightening. In H2/15 and certainly into next year we're going to see the market move into deficit, and that will obviously prompt rising prices.

    TGR: Graphite is probably one of the most misunderstood markets that The Gold Report covers. Please dispel some of the common graphite market myths.

    SM: First, it's not just about volume. Graphite is a niche market, so if a firm is trying to develop a graphite mine, it is going to have to examine the volumes end users use, the growth in those areas and whether it can tailor a specific grade for that customer. Saying that, if a company is going down the volume route and wants to produce in excess of 50 Kt annually, then it needs a unique deposit. Not every graphite deposit can yield 100 Kt per year that can be sold into multiple end-use markets.

    TGR: Is grade overrated?

    SM: High grade obviously helps project economics but grade isn't necessarily king. You can have high-quality graphite at a low grade. A lot of the deposits that are commercially active grade 3-7% graphite. But what we're seeing now in the graphite industry is the result of five years of intensive modern-day exploration that has uncovered some of the best graphite deposits the industry has ever seen. The industry can really choose which one to bring to market-it's a very strong position to be in.

    TGR: Do you believe in graphene from natural graphite?

    SM: Graphene is one micro layer of graphite and isolating that one layer from a flake source is proving too difficult at the moment. Three layers is the accepted standard for now and end users appear to be happy with this new form of nan-graphite. I believe that graphene has great long-term potential. The question is when. I think we're looking at in excess of 10 years.

    TGR: Have batteries overtaken refractories as the major market for graphite?

    SM: The significant demand growth in graphite is all about batteries. For an article in our Battery Special, the second issue of our magazine, Benchmark took production and export numbers from China since 2009, and the average growth rate in battery-grade graphite production has been 27% compounded for the last five years, which surprised us considering that for the majority of that time people have assumed that it's been a down market.

    At Benchmark, we also like to crosscheck our data and analysis with other mineral industries used in batteries.

    If you take cobalt's threefold demand increase in the last five years or the fact that lithium is now in shortage, it's clear that batteries are no longer a prospect but an immature industry that is here now and growing.

    TGR: You're about to embark on the Benchmark Mineral Intelligence World Tour. Tell us about it.

    SM: We will offer a series of free seminars that examine the battery supply chain and the raw materials that fuel it. We start our World Tour in London on Sept. 11 and continue in New York, Toronto, Vancouver, Hong Kong, Tokyo, Sydney and Melbourne. These are the world's mining investment hubs and places that have shown interest in the battery supply chain. People can find more information by visiting Benchmark Minerals and clicking the World Tour tab.

    TGR: Please share one tidbit for investors to keep in mind as they conduct their due diligence on critical minerals equities.

    SM: Don't treat critical minerals like commodities. The basic process of analyzing commodities has relevance to specialist minerals but they're not entirely the same. Critical minerals are niche products at this stage that require a long-term outlook. It is no surprise that the people that invested in the critical minerals supply chain in the past-namely Japanese and Korean companies-are long-term thinkers. These companies now control the majority of these supply chains. A longer-term way of thinking is crucial.

    TGR: Thank you for talking with us today, Simon and Andrew.

    This interview was conducted by Brian Sylvester of The Gold Report and can be read in its entirety here.

    Simon Moores is managing director of Benchmark Mineral Intelligence, an online publishing and consultancy business specializing in critical minerals and metals, disruptive technology and emerging markets. Moores has also worked as a business journalist focusing on non-metallic minerals such as lithium, graphite, rare earths, potash, TiO2 pigment and feedstocks such as rutile and ilmenite.

    Andrew Miller is an analyst at Benchmark Mineral Intelligence and specializes in the first-hand data collection of niche minerals and metals, especially graphite, lithium, cobalt and fluorspar. Miller's primary role at Benchmark is price collection for these industries and creating and maintaining indices including Benchmark's new Graphite Price Index.

    Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.

    Bottom of Form

    DISCLOSURE:
    1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Simon Moores: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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) Andrew Miller: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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.
    5) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    6) 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.

    7) 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. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Gold Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (NYSE: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.

    101 Second St., Suite 110
    Petaluma, CA 94952

    Tel.: (707) 981-8999
    Fax: (707) 981-8998
    Email: jluther@streetwisereports.com

    Aug 10 2:17 PM | Link | Comment!
  • Canaccord Genuity's Joe Mazumdar Tells Gold Investors To Go Underground To Survive

    Unlike many analysts, Joe Mazumdar of Canaccord Genuity does not expect a substantially higher gold price any time soon. So what are hard-pressed gold investors to do? In this interview with The Gold Report, Mazumdar argues that they should seek high-grade resources-usually underground-in stable jurisdictions that benefit from the strong American dollar. And he highlights seven near-term developers that offer exactly that.

    The Gold Report: The price of gold flirted with $1,300 per ounce [$1,300/oz] in January. In July, it fell below $1,100/oz. What happened?

    Joe Mazumdar: Gold began 2015 at $1,184/oz. So, year to date it's down about 8% in U.S. dollars. And one of the primary reasons for that is the strength of the U.S. dollar, underpinned by an economic rebound and the anticipation of an interest rate hike in the latter part of 2015. From January to July 2015, the U.S. dollar as proxied by the trade-weighted index, the U.S. Dollar Index [DXY], was up by the same amount as the U.S. dollar-denominated gold price was down, 8%.

    Gold's sideways to downward trend is underpinned by weak demand fundamentals. Overall Q1/15 demand-1,079.4 tonnes-as provided by the World Gold Council, was in line with the last two-year quarterly average. However, jewelry demand, which represents about 55% of overall demand, was down 6% versus the two-year quarterly average, down 8% quarter-on-quarter and down 3% year-on-year. Investment gold, such as bars and coins, which represents about 23% of overall demand, was down 20% in Q1/15 versus the two-year quarterly average.

    TGR: Are the central banks still buying?

    JM: Purchases in the last documented quarter, Q1/15, were about 119 tonnes, so still positive. However, that is down 18% versus the two-year quarterly average. Of note, there was a positive inflow of ~26 tonnes in exchange-traded funds [ETFs] during Q1/15, the first net inflow in a protracted period of time. The two-year quarterly average for ETF investments was a net withdrawal of about 111 tonnes. So much of the negative demand equation was offset by that net inflow. We don't believe that we will see the same positive impact from ETF investments in Q2/15, however.

    TGR: Is continued gold production threatened by a gold price under $1,100/oz?

    JM: We highlight that the Q1/15 mine supply net of hedging, 734.2 tonnes, according to the World Gold Council, was down 7% versus the two-year quarterly average. The only reason overall demand remained flat-1,089.3 tonnes-versus the two-year quarterly average was a spike in the supply of scrap gold [+17% versus two-year quarterly average, 355.1 tonnes].

    The impact of a lower gold price on mine supply lays the foundation for a healthier gold market in the medium to long term. We highlight that over the next 5-10 years, production curtailments combined with the lack of capital spent on development projects and significant cut backs in exploration expenditures will challenge future mine supply. The paucity of projects may drive future M&A bids for junior companies with quality assets in manageable jurisdictions that are currently well funded to production due in part to the quality of the management team. In our opinion, these are the companies that investors should seek.

    TGR: The gold price has collapsed during a period of burgeoning economic and geopolitical volatility. So is gold no longer a safe haven?

    JM: Gold has recently lost some of its attraction as a safe-haven asset. Normally, a spike in market volatility as proxied by the Chicago Board Options Exchange Volatility Index [VIX] results in an uptick in safe-haven assets such as the U.S. dollar and the gold price. These assets are historically negatively correlated except for periods of high market volatility that generate a bid for safe-haven assets. We observed a spike in the Chicago Board Options Exchange Volatility Index [+40%] from Dec. 28, 2014, to Jan. 16, 2015, with a subsequent lift in the U.S. dollar, the gold price and the Market Vectors Junior Gold Miners ETF [GDXJ:NYSE.Arca], which has a large beta to gold.

    From June 23 to about July 7, 2015, when the Greek crisis was at its peak, the Chicago Board Options Exchange Volatility Index spiked up 60%. But unlike the previous spike, gold was flat to down. Some cite the collapse of the Chinese stock market as a partial reason for the muted response from the gold price. When margins were called, investors had to sell liquid assets and this may have included gold holdings. This selling may have triggered further stop-loss selling in a low liquidity environment [summer market] placing further downside pressure on the gold price. The current sentiment remains pessimistic as investors increased their short positions in gold.

    TGR: The price of gold falls in U.S. dollars even as the U.S. dollar rises against other currencies. So does this mean that Canada and other non-American mining jurisdictions, such as Australia, are riding out this storm?

    JM: Yes. At the start of the year, one U.S. dollar was worth CA$1.16. It's now worth CA$1.30. So the Canadian dollar is down 12-13% in 2015, which means that the gold price in Canadian dollars is actually up 3-4%. So we favor miners with high-grade Canadian assets.

    TGR: Given that Canadian gold producers still make money, and their market caps are discounted by 30%, can we expect a flurry of takeovers?

    JM: Yes, but we suspect that this might be put off while investors and potential merger and acquisition [M&A] suitors wait for the Canadian dollar to fall even further. Note federal elections in Canada are planned for Oct. 19, 2015. The current polls suggest that the right-leaning Conservative party and the left-leaning New Democratic Party are neck and neck. The potential for a minority or coalition government with an economy teetering on recession due in part to a weak commodity complex could place further pressure on the Canadian dollar.

    TGR: Are the Chinese investing in Canadian gold companies with a view to growing China's gold reserve?

    JM: China is the world's leading gold producer and its largest gold mine, Zijinshan gold-copper mine in Fujian province, which produced 331,800 oz [331.8 Koz] in 2014 [Source: SNL], is operated by Zijin Mining. To augment domestic production, Chinese firms are acquiring assets in other countries such as Canada, Africa and Australia, among other jurisdictions. Given current valuations, it may be cheaper for them to purchase assets or fund management teams with an underlying offtake agreement rather than buy gold.

    TGR: We've had innumerable false dawns since the bear market started in April 2011. You told us you don't believe the gold price is going significantly higher in the near future. So what sort of projects should investors in gold equities be in?

    JM: With respect to gold investors, it depends on whether you're a generalist or a goldbug. The latter doesn't need to be persuaded that gold is going much higher, and will tend to bet on highly levered plays. We do not recommend purchasing illiquid companies that are seeking to fund the advancement of a marginal deposit. The fact that our gold price forecast is basically the actual gold price futures curve at the time reflects our acknowledgement of the difficulty in forecasting the gold price with any accuracy. We prefer to recommend companies with quality projects that generate a double-digit internal rate of return at current price levels and reside in stable or manageable geopolitical risk jurisdictions within significant and prospective land packages operated by management teams with relevant experience-technical, execution and financial.

    Finally, as a hedge to a downward trajectory in the U.S. dollar-denominated gold price, we would also focus on assets in jurisdictions with resource-based economies such as Canada, Australia and Brazil. All these currencies have fallen against the U.S. dollar; hence the local gold price is higher than the U.S. dollar quote. Personally, I prefer Canada.

    In the current gold market environment, high-grade underground in Canada represents the best of all possible worlds for me. Investing in a small but profitable producer operating a high-grade underground gold mine on a large land package in Saskatchewan.

    TGR: Joe, thank you for your time and your insights.

    This interview was conducted by Kevin Michael Grace of The Gold Report and can be read in its entirety here.

    Joe Mazumdar is a senior mining analyst focused on the junior gold market at Canaccord Genuity. Prior to that he was at Haywood Securities, where he also was a senior mining analyst. His experience includes director of strategic planning, corporate development at Newmont and senior market analyst/trader at Phelps Dodge. Mazumdar also worked in technical roles for IAMGOLD in Ecuador, North Minerals in Argentina/Chile and Peru, RTZ Mining and Exploration in Argentina and MIM Exploration and Mining in Queensland, Australia, among others. Mazumdar has a Bachelor of Science in geology from the University of Alberta, a Master of Science in geology and mining from James Cook University and a Master of Science in mineral economics from the Colorado School of Mines.

    Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.

    Top of Form

    Bottom of Form

    DISCLOSURE:
    1) Kevin Michael Grace conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Joe Mazumdar: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. Canaccord Genuity disclosures available here. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Gold Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (NYSE: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.

    101 Second St., Suite 110
    Petaluma, CA 94952

    Tel.: (707) 981-8999
    Fax: (707) 981-8998

    Email: jluther@streetwisereports.com

    Aug 06 2:07 PM | Link | Comment!
  • Randall Abramson's Plan For Surviving Gold's Summer Of Discontent

    While Randall Abramson, CEO and portfolio manager with Toronto-based Trapeze Asset Management, freely admits that we are living through the summer of discontent in "Commodityland," he says investors should step back and look at commodities, especially gold, from a macroeconomic and historical perspective. In this interview with The Gold Report, Abramson discusses the magnet he expects to pull gold to around $1,400/oz inside 12 months, and he also offers some of his favorite names in the gold space.

    The Gold Report: July 13-20 was an unusual week in the gold market. In a May newsletter to Trapeze Asset Management clients, you argued that the glass is "half full" for investors given current macroeconomic signals. Much water has traveled under the bridge since. Has your view changed?

    Randall Abramson: Our view has not really changed. We rely on certain macroeconomic tools to show us red flags. One is our economic composite that looks at both the U.S. economy and economies around the world. Our economic composite tool currently forecasts smooth sailing with no red flags.

    From a stock market perspective, our relative indicator momentum, which is our other macro tool, only shows Brazil and Russia on sell. The only other market on our watch list recently was the Chinese market. It came down to the bottom of its TRIM line but didn't break through. In fact, it did a perfect bounce off of the bottom. I'm hoping that indicates that what we've seen recently in commodity prices is overdone.

    That said, we do not like recent action in the Australian and Canadian dollars. Both currencies can portend further economic weakness because both countries are essentially hewers of wood and drawers of water-economies based on the extraction of natural resources-and we are cognizant that the commodity-hungry Chinese economy is clearly slowing, though it is still performing at a significantly higher rate than those in the rest of the world. Perhaps that's causing some of the weakness in "Commodityland." But according to the signals, the glass still seems half full.

    TGR: How do you explain the recent 4% drop and five-year low of the gold price to Trapeze clients?

    RA: That drop happened in a flash-a veritable flash crash, almost 6%-then gold rebounded to be down only half that amount on July 20. The timing and size of the multibillion-dollar order responsible for that drop made it look as if it was designed to spook the market. I'm not sure whether it was forced or orchestrated selling.

    TGR: What's your best guess?

    RA: It looks orchestrated given the timing, but I'm more focused on the second part of your question-the five-year low. What happens on a day-to-day basis is difficult to put into perspective. It's easier to put into perspective where we've come from and where we are today. We came from a place where a number of commodities were overbought in 2011 because they had bounced significantly from their respective lows in 2009. Gold and silver, in 2011, were selling above their marginal cost of production and way above the average cost of production-gold normally sells for its marginal cost of production, which is usually about a 30-40% premium to the average all-in production costs.

    Today, the gold price has fallen back to the average cost of production. That's unusual. That means that on average there is essentially no free cash flow being generated by producing gold. We've overshot to the downside. Could we have a further overshoot? It's possible. If gold broke much below where we are today, it could go to $900 per ounce [$900/oz] or slightly below. I don't believe that's going to happen because it would be virtually unprecedented, especially when we're not living through a major dislocation like a global recession, for example.

    TGR: Do you expect further weakness in the Chinese economy to bring further weakness to Commodityland?

    RA: If there is significant further weakness, the answer is yes. There is still significant physical gold demand in China, both from the central banks and the public. If there was further economic weakness there, perhaps gold demand would further increase.

    TGR: Do you see gold's drop as a U.S. dollar story given that the gold price has fallen 40% in U.S. dollar terms from its 2011 peak versus, for example, a 20% drop in Australian dollar terms over the same period?

    RA: It's a combination of factors. The first factor is that inflation is low. We still have inflation, but each year over the last few years, the inflation rate has declined. So we have disinflation but not outright deflation. Maybe the commodity prices are telling us that we're about to have deflation, but that's something the central banks would fight tooth and nail, so I don't think it's a likely outcome. But that doesn't mean that it couldn't occur, at least for a short period.

    The gold price coming down is a function of low inflation, which affects demand at the margin because there's less hoarding. The other factor is that the gold price went too high too soon in 2011. Financial markets always tend to overshoot and undershoot around the mean. Gold will eventually go back up to about $1,400/oz again because that's where it needs to be to meet yearly demand.

    TGR: How long do you expect that to take?

    RA: I think it's going to happen over the next 6 to 12 months; I just don't know whether it's heading lower first. I suspect not. At the margin, exchange-traded funds have been dumping gold because hoarding has been shunned with the price declining. That's not necessarily a bad thing. That could be a sign of a capitulation. Gold has not really behaved all that differently than oil, which was also above its marginal cost of production, reverted to it and then went down through it. The difference is there was an oversupply of oil in the U.S., which is now being alleviated. The U.S. dollar has clearly been a factor in the low gold price too, but I don't think it's the driving factor.

    TGR: You said gold could hit $1,400/oz in the next 6 to 12 months. Do you see it higher than that in the medium term?

    RA: If history is any guide, the gold price is typically 30-40% above gold's all-in sustaining costs of production. And if the all-in sustaining costs today are somewhere around $950-1,050/oz industry-wide, then $1,400/oz gold is where we should be. In the months to come, that's the magnet that's going to pull the gold price higher. After that, it should rise by the inflation finding costs, which over the last 15 years or so have grown by about 7-8% a year. The main reason for that has been higher energy costs. And there have been few major discoveries, so that alone drives up the cost per ounce.

    TGR: The flash gold sale and some gold reserve numbers out of China seemed to spook the market, but was it part seasonal, too?

    RA: Possibly, yes. But August is almost always the best month for gold. I'm hoping that we get a nice big bounce into next month.

    TGR: The last time gold was this low relative to the S&P 500, it signaled that it was time to buy gold. Do you see the recent gold selloff as another buy signal or do you see further downside risk?

    RA: Unless there's something that's going on that we don't know about like outright deflation, this is the time to be buying gold.

    TGR: Reuters says about $3.2 billion [$3.2B] in mining mergers and acquisitions [M&A] has occurred this year versus roughly $4.4B in all of 2014. Will the drop in gold push the pause button on M&A?

    RA: Probably, because normally boards of directors tend to react when things are going well. That's when business combinations take place. M&A often marks the top, not the bottom, of a cycle in virtually every industry unless a company swallows up somebody in a distress situation.

    TGR: Isn't that what is happening in the gold space? Oban Mining Corp. [OBM:TSX] is buying several juniors and Crocodile Gold Corp. [CRK:TSX; CROCF:OTCQX] is merging with Newmarket Gold Inc. [NGN:TSX.V] to go after distressed gold assets.

    RA: Those are examples of one plus one equals more than two. In the gold sector a 300,000-500,000 ounce [300-500 Koz] producer receives a much higher multiple relative to net asset value [NAV] than a sub-100 Koz producer. It truly is one plus one equals more than two.

    TGR: What is the best strategy for gold equity investors at this point?

    RA: The best bet is always to have low-cost producers with solid balance sheets because both of those items will give you staying power.

    TGR: Some large-cap gold names in Commodityland, like Barrick Gold Corp. [ABX:TSX; ABX:NYSE], are trading at multiyear lows. Should investors believe in higher near-term gold prices to take a position in a major gold producer or is there value there even with gold trading around all-in sustaining costs?

    RA: Our favorite large-cap name is Goldcorp Inc. (NYSE:GG) because it's a lower-cost producer with a reasonable balance sheet and decent production growth, which is unusual among the large producers. It's now trading at a valuation that is probably less than $0.50 on the dollar vis-à-vis its NAV using even $1,300/oz gold.

    The whole group looks cheap; you could almost throw a dart among the large-cap producers because on the low recently, we got to 70% of book value. To put that in perspective, the lowest we had seen in many years was the 2008 low where the large-cap producers as a group stopped at book value. There has to be cheap names in the junior space, too, because the TSX Venture Exchange, our Canadian proxy for small-cap resource companies, just made an all-time low-lower than when it started in 2001.

    TGR: What are your thoughts on the ramping up of the Éléonore gold mine in Québec?

    RA: Goldcorp has incurred start-up issues since the launch of the mine in the spring so it's a slower start than expected, but this particular mine should still hit the low end of the expected production range for the full year. And, regardless, the company is now guiding to the high end of its overall previous production guidance.

    TGR: Do you know what its all-in sustaining costs are at this stage?

    RA: They are around sub-$900/oz, so it still a decent margin.

    TGR: What are some other small names you follow?

    RA: Dynacor Gold Mines Inc. (OTC:DNGDF) [DNG:TSX] is another one that we continue to own. It's predominantly a miller rather than a miner in Peru, though it does have the Tumipampa gold project there that it continues to develop, which could add tremendous value. In the meantime, the company is trading, ex-cash on hand, at about 5x its current earnings power. I use earnings power because this month the company is expanding the production capacity at its mill. Dyancor's earnings power should go up even further from its new plant, which will have double the capacity of the existing one and ultimately be much lower cost. Its earnings power could be about $0.40 a share this time next year or higher. And it is still developing Tumipampa, which could have at least 1 million ounces and potentially more.

    TGR: Is Dynacor considered a reputable brand among the gold millers in Peru?

    RA: Dynacor is certainly trusted in the community.

    TGR: With the growing number of contract miners in Peru, is the competition for milling ore a threat to the Dynacor business model?

    RA: I don't think that many more mills have entered the space. That is the perception because there are two or three companies that are now listed, but I think more capacity has left the space than entered it. It's just not as visible because the capacity that's vanished was from players who'd been there for a number of years but who are now noncompliant with new regulations set by the Peruvian government. In fact, that's why Dynacor's performance has improved so much in the last 12 months; it has been sopping up the ounces that were previously going to other mills.

    TGR: We are in the dog days of gold's summer of discontent. What would you say to the remaining investors in the space?

    RA: Unless we're into something different this time-which could be an outright deflation because I can't think of anything else that would cause everything in Commodityland, not just gold, to suddenly start trading below their respective average costs of production-then we should be seeing the lows right here. It does not appear that we are in a global recession. Au contraire, there are signs of a global acceleration after the mid-cycle slowdown we've been living through.

    August is typically a good month for gold and the U.S. dollar appears set to peak given that it's overvalued, stretched, and the U.S. government and U.S. Federal Reserve probably would prefer a weaker U.S. dollar. The average global all-in sustaining costs to produce gold are always growing and normally support the low in the price of a commodity. We are at or slightly below that mark. If the global economy even slightly picks up here, perhaps that leads to a little more inflation and allows the supply and demand equation to rule the day.

    TGR: Thank you for your insights, Randall.

    This interview was conducted by Brian Sylvester of The Gold Report and can be read in its entirety here.

    Randall Abramson, CFA, is CEO and Portfolio Manager of Trapeze Asset Management Inc., a firm he cofounded in 1999 shortly after founding its affiliate broker dealer, Trapeze Capital Corp. Abramson was named one of Canada's 'Stock Market Superstars' in Bob Thompson's "Stock Market Superstars: Secrets of Canada's Top Stock Pickers" [Insomniac Press, 2008]. Trapeze's separately managed accounts are long/short or long only, and have either an all-cap orientation or large cap-only mandate via the company's Global Insight model. Abramson graduated with a bachelor's degree in commerce from the University of Toronto in 1989, and his career has spanned investment banking, investment analysis and portfolio management.

    Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.

    Bottom of Form

    DISCLOSURE:
    1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. Goldcorp Inc. is not affiliated with Streetwise Reports. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Randall Abramson: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Dynacor Gold Mines Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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.
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