When a leading Swiss bank recommended its clients sell all their gold, AgaNola Asset Manager Florian Siegfried knew the precious metal was preparing for an upswing. In this interview with The Gold Report, he discusses what he thinks is the root cause of the stock decline.
The Gold Report: The year started off with quite a lot of volatility. From your perspective in Switzerland, what was the root cause of the stock decline? China, the Middle East, the United States?
Florian Siegfried: In our November 2014 interview, we outlined the notion that the cycling credit markets were undergoing a profound change where typically we see spreads going into widening. That climaxed in December of last year when we experienced a dramatic spike in spreads.
China and the Middle East are more of a catalyst than a cause for the volatility. The root cause is, in my opinion, from the credit side. This is why probably people are nervous. They see yields going up in the high-yield market. It's still a very leveraged market with a lot of marching yields that have to be served now with lower prices, which creates a downside momentum. I think we have been answering the cyclical bear in equities. This should be good for gold on the other side, which is probably forming a bottom here. We are most likely at the late stages.
TGR: What are the indicators you watch to understand these cycles?
FS: In addition to the high-yield bond markets, the other indicator is action in the reverse repo market whereby the Federal Reserve is somehow sucking up liquidity by selling Treasury bonds to the banks. Interestingly, the oil price falling so dramatically goes vis-à-vis with quite an explosive volume in the reverse repo market. This is probably related to underlying oil derivatives of hedges being unbound, and with WTI crude oil now trading below $30 per barrel the situation could get serious for the exposed big banks. In my opinion, that's all related and a cause for concern because it's created this liquidity now.
TGR: At the same time, gold is flirting with $1,100/ounce levels. Is that related as well?
FS: As the economic conditions are deteriorating, oil prices continue to fall, credit defaults are set to rise and currencies are tumbling, I think we are building a floor in the gold price. Nevertheless, the sentiment is still extremely negative in gold and precious metals, which is probably an indicator that we could be at the turning point. A few weeks ago, a leading Swiss private bank was recommending its clients sell all gold. That was days before the equity market started to tank and gold took off. I consider this kind of capitulation by big institutions as a reliable contrarian indicator that the precious metals sector is about to turn around.
TGR: Is $1,100/oz a high enough price that some mining companies can be profitable?
FS: It depends on the company. What is driving earnings for many producers is not the U.S. dollar price but the Canadian gold price or the Australian dollar gold price, which are currently trading at $1,580/oz, up another 8% to 9% alone this year. This is a two- to three-year high price, and it's a good price. The smaller Australian or Canadian producers get the whole benefit from currency depreciation.
Last year Australian miners enjoyed an extremely good market. A basket of six Australian midtier gold producers would have returned between 50% and 70% in the year. I think a $1,100/oz gold price, when you transfer it to local currencies, is a good price. The U.S. producers, which are not getting the same benefit because they have a high dollar, are clearly underperforming in this market. So each company has to be evaluated independently.
TGR: At the Silver Summit, Rick Rule was talking about how he valued "optionality," meaning that management doesn't do anything to waste shareholder value until the market gets better. Others we have interviewed, including Bob Moriarty, have celebrated this as a great time to move projects forward because everything from oil to manpower is less expensive. Which camp do you fall in?
FS: I think it's the perfect time to buy and build a mine. In the last 15 years, costs have never been lower. Oil is collapsing below $30 a barrel, so energy is cheap. There is excess capacity from the base metal players and the contractors. This is the time to bargain on project development and get cheap financing from equipment leasing agents to build a mine. There is also not a lot of competition to acquire new assets. Most companies are very stretched financially and have no cash to pay. That leads to a situation where only the best run companies or the ones that have cash can execute on M&A transactions. It's all part of buying low and selling high. This is the time where value is created.
Regarding optionality, I think this is of utmost importance when it comes to project development. Let's make the simple assumption that a company is building a mine today based on a $1,100/oz gold price and the minable resource in the block model consists of 50% of the total resource. The other 50% of the resource is considered not economical at current gold prices. Let's assume next that when the mine has been built and is up and running, the gold price rises to $1,400/oz and at this level probably 80% of the total initial resource is considered economical. At this point the company would want to mine that additional 30% of the resource because it generates additional cash flow. However, it may only do so if it can expand the mine at a reasonable additional capital expense. Otherwise, the project expansion yields a negative rate of return. This is the kind of project optionality that can potentially add significant project value in the future in a rising gold price environment but is not reflected at current share prices. For investors, this is like a free option without an expiry date on a rising gold price.
For investors, my recommendation would be to watch closely what companies are buying, contact the management team about their plans and how much capital they need to put an old mine back into production, how much time they would require to put out a new feasibility study and what they expect in terms of cost savings. Avoid investing in companies with a "bull market" mentality, where management has not taken the necessary cost cutting measures in the past to preserve cash and continues to operate at a suboptimal efficiency level. That is how you will avoid pitfalls and find the right companies to watch.
TGR: Thank you for your time, Florian.
This interview was conducted by JT Long of The Gold Report.
Florian Siegfried is head of precious metals and mining investments at AgaNola Ltd., an asset management boutique based in Switzerland. Previously Siegfried was the CEO of Precious Capital AG, a Zürich-based fund specializing in global mining investments. Prior to this Siegfried was CEO of shaPE Capital, a SIX Swiss Exchange-listed private equity company that was founded by Bank Julius Baer & Co. Siegfried holds a masters degree in finance and economics from the University of Zürich.
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