Eric Coffin, long-time editor of the Hard Rock Analyst group of publications, has seen the all-time highs in the junior mining space, and the current three-year bear market has taught him to adjust his expectations. He says the companies that he follows that have performed recently all had a specific event-a bigger resource number, a new economic study or even a discovery-that prompted the market to rerate the stock. Coffin says that, as always, it is about solid management and good projects, but it's no longer about who has the biggest copper or gold resource, it's about which company has a resource that makes sense. In this interview with The Gold Report, he suggests some companies with resources that not only make sense but could make even more sense to larger companies.
The Gold Report: At the subscriber investment summit in Toronto in March 2015, you had a talk titled "Life in a Zero Yield World." What is wrong with that world?
Eric Coffin: A zero yield world is the result of four or five years of central banks essentially buying the hell out of the bond market, which is what the European Central Bank [ECB] is doing right now. And buying those bonds, also known as quantitative easing [QE], drives down yields. QE has helped the U.S. and will probably help the European economies but it creates a lot of distortions. We tend to see a lot of money driven into high-risk areas, like heavily leveraged commodity and exchange-traded funds [ETF] bets and things like art and collectibles, because there are these large money pools that can raise capital at close to zero rates, and that tends to make people take greater risks. How that ends remains to be seen, but central bankers realize that they need to start weaning economies off of QE because when you generate that much risk capital and start creating that many distortions, it quite often doesn't end well.
TGR: Can these economies successfully be weaned off QE?
EC: Maybe. On one side there is the "wealth effect," which is the positive impact on the economy from people seeing their portfolios get larger. And that was always part of the plan. Most economists describe the wealth effect as a side effect of QE, but I don't think policy makers at the U.S. Federal Reserve or the ECB think that way. The problem with the wealth effect is it mainly benefits-you guessed it-the already wealthy. I think that is why it hasn't generated higher growth yet or higher inflation except in "one percenter playgrounds" like the fine art market. The U.S. economy is not doing that great overall and the ECB is trying to climb out of its fourth recession in the last five or six years. In both cases much of the money driving these economies is washing in and out of the equity markets and traders are focused on what central bankers are going to do.
In the last few months we have seen huge market swings based on things said by either U.S. Federal Reserve Chairman Janet Yellen or ECB President Mario Draghi. It's not healthy. If we step back and take a 10,000-foot view of the markets, anybody with a finance background knows that an ECB rate cut or for that matter a Fed rate boost of 25 or 50 basis points is not going to make any difference in the real world. But with so much of the money chasing bureaucratic decisions, it is creating distortions and now the Fed has got to find a way to carefully ease out of QE. But if the Fed surprises the markets, the markets are going to get clobbered. It's a tightrope walk for Yellen.
TGR: Throughout these last few years your job has been to clear up some of the market distortion for mining investors. What are some macro indicators that mining investors should follow and why?
EC: It's a good idea to keep your eye on inflation indicators because metal prices are heavily influenced by inflation expectations. I follow the Treasury Inflation Protection Securities [TIPS]. TIPS are basically inflation-indexed securities and there are ETFs for these that are heavily traded. These get bought as inflation protection; the way the price of those mutual funds and ETFs swings up and down gives us a read on traders' inflation expectations. In the last few months, with collapsing oil prices, the bugaboo in the market has been deflation. But in the last little while we have seen a massive flow of funds into these inflation-protected mutual funds and ETFs. It's a bit of a head scratcher because consumer price index numbers still look flat.
When it comes to the U.S., obviously everybody watches the jobs report. That has a big impact. One thing I've been watching closely is real wage gains. Even though the U.S. has seen its unemployment rate drop from about 12% to 5.5%, wage gains for average American workers-80% of the workforce-remain at around 2% before inflation, so after inflation it was next to nothing. People on Wall Street predict that the economy is going to accelerate by 3-5% but I don't see how that happens unless we start seeing real wage gains because 70% of the U.S. economy is consumer spending. You have to pay people money before they can spend it.
I watch currencies, too, because part of the gold trade is currencies, and until recently, gold has followed the euro fairly closely.
TGR: Yellen recently said U.S. equity markets look "frothy" and recent U.S. dollar weakness seems to back that view. How do you expect gold to perform through the end of the year and perhaps beyond that?
EC: I've been a bit disappointed that gold hasn't traded better in the last few sessions but it seems that gold traders are particularly focused on the Fed raising rates. The consensus seems to be that it is going to raise rates in June and that will not help the gold price. But I was one of the few people who didn't expect the euro to go to U.S. dollar parity or below earlier this year. The euro has instead had a nice bounce and that's largely because many international investors have decided that European stock indexes are the next big thing, so there's been huge fund flows into Europe.
It's market gospel right now that if the U.S. starts raising interest rates, the U.S. dollar has to go higher and higher, and that's seen as negative for gold. In a recent edition of Hard Rock Analyst [HRA] there was a chart [reproduced below] that showed the trace of the U.S. Dollar Index through the last four tightening cycles when the Fed went from cutting rates or neutral to raising rates. In all four cases the U.S. dollar dropped once rate increases started. It was a "buy on rumor, sell on news" situation. In a couple of cases it fell about 10% within four months of the start of tightening. The ECB and Bank of Japan trying to hold their currencies down may complicate things this time but still we may get better action on the currency side than people expect. It's quite conceivable that gold could get through $1,300 per ounce [$1,300/oz] relatively quickly once it dawns on people that the dollar index isn't going to the moon.
We also may see stronger gold demand in China if there is a significant correction in the Shanghai market, which has more than doubled in the previous 12 months. If we look at a long-term chart of the Shanghai exchange going back about 30 years, these big bull runs have happened four or five times, closely followed by equally big drops. I don't know when the top is going to be in, but it looks pretty parabolic; moves like that tend to end badly.
TGR: Against that backdrop, where do you see the light at the end of the tunnel in the junior mining equities market?
EC: A few companies on my list have performed better recently and they all have one thing in common: a specific event-a resource number, a new economic study or discovery-that was significant enough that it allowed the market to rerate the stock. It feels as if we are finally seeing the wheat get separated from the chaff-and that has to happen. Seeing an increased focus on the relatively small percentage of companies that have good projects and good management is not going to give us the mother of all bull markets, but it will give us a decent market with room for gains-in that subset of companies.
We all should focus on the small set of companies that really know what they're doing because until we see a large move in commodity prices, that's the only place where we're going to see gains. This is not one of those markets where it's a matter of who has the biggest copper or gold resource; it's about who has a resource that makes sense or has the discovery potential for one. The other performer has been producers that, after three years of putting up crappy numbers, are finally starting to see their numbers improve. Three years of cost cutting and focusing on margin per ton seems to finally be starting to pay off. If they can do this with a flat gold or copper price, what happens when the commodity prices go up 20-30%? They're going to blow the doors off.
TGR: In several HRA posts you've talked about the all-important funding season for junior miners. How is it shaping up?
EC: It hasn't been great. A few companies on my list have done sizable placements and most of the companies that I follow aren't running on fumes anyway; that's part of the reason I'm following them. In general, the end of May is seen as the end of the financing window until October. We don't have a lot of it left. It would be nice to see even a small move in the gold price to help free up a little cash.
TGR: Please give us one bulletproof call.
EC: Ha! Piece of cake! If you want something bigger and safer, I would look pretty hard at Nevsun Resources Ltd. (NYSEMKT:NSU). You want to buy it on weakness, if you can, but it's a well-run and profitable company. Bisha's a fabulous deposit in Eritrea. Nevsun started production at Bisha when gold was near its all-time high and gold dominated production for almost two years. As gold prices started falling the copper grades were coming up and Bisha has been primarily a copper mine for the last two years, and will be for another 1.5. Then it will shift to being predominantly a zinc operation, which should be just about in time for a couple of large zinc mines to cease production and zinc prices to rise.
The company has over $500M in cash and is generating about $20M/quarter in cash flow. Nevsun is drilling to expand Bisha at depth but also drilling out a nearby deposit called Harena, where it recently had some really nice drill holes. It's one of those companies where either there is some kind of deal to become a multi-mine company or a bigger company is going to make a takeover bid. One of those two things will happen by the end of 2016.
TGR: On May 30 you'll be speaking at the Metals Investor Forum in Vancouver, Canada. The theme of the event is that after a four-year bear, mining markets are poised to rebound. What should attendees expect?
EC: There are four of us speaking: Gwen Preston, Brien Lundin, John Kaiser and myself. For my part, I'm going to focus on companies that are advancing, even in a difficult market. Those are the deals that I think will get the most attention when markets start to improve. There will be presentations by all of the companies in attendance including some of the companies we just talked about. It's a daylong event with a catered lunch break and couple of long coffee breaks. That will give attendees a chance to talk to management one-on-one and ask follow-up questions. Subscribers love it.
TGR: Thank you for your time and insights, Eric.
This interview was conducted by Brian Sylvester of The Gold Report.
Eric Coffin is the editor of the HRA [Hard Rock Analyst] family of publications. Responsible for the "financial analysis" side of HRA, Coffin has a degree in corporate and investment finance. He has extensive experience in merger and acquisitions and small-company financing and promotion. For many years, he tracked the financial performance and funding of all exchange-listed Canadian mining companies and has helped with the formation of several successful exploration ventures. Coffin was one of the first analysts to point out the disastrous effects of gold hedging and gold loan-capital financing in 1997. He also predicted the start of the current secular bull market in commodities based on the movement of the U.S. dollar in 2001 and the acceleration of growth in Asia and India. Coffin can be reached at email@example.com or the website www.hraadvisory.com.
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