Hard assets: Gold makes sense
Selling gold stocks in today’s financial climate should be as easy as selling water in the Sahara. As the world’s money markets imploded, gold should have headed every cautious portfolio manager’s shopping list.
In reality, its price dropped after seven years of steady growth. Colin Sutherland, CEO of Nayarit Gold, a Toronto, Canada-registered exploration company, is trying to get investor attention for his ‘junior’ gold company, which has a concession in the Sierra Madre in Mexico, and he is still puzzled.
‘There have been wild swings in the gold price as a function of the economic environment, but where it’s trading now doesn’t make a lot of sense given that we will probably see even more bailouts from Federal government and the flood of dollars will lead to inflation, a prime indicator for gold to take off,’ he says.
Elaine Ellingham, senior vice president for IR at Iamgold, the world’s fourth-largest gold miner, had to identify quickly what was happening. ‘For a while, we couldn’t figure out why the price wasn’t rising and then we realized: gold is something you buy for a rainy day – and this is the rainy day!’ she notes.
With the financial crisis, funds faced with margin calls are liquidating assets, like gold. In that sense, the gold community feels vindicated. Now, in a move that could help IROs in other sectors, gold firms are using this value proposition in investor pitches.
The World Gold Council, a not-for-profit organization funded by the world’s leading gold companies to promote demand, is almost a collective IR program for the yellow metal and its producers.
‘We explain gold as a portfolio diversifier: how it works in times of financial distress, its performance concerning inflation, which has been a key factor, and how it acts as a hedge against inflation and the dollar,’ says Natalie Dempster, the council’s investment program head. ‘Equities and bonds do badly by comparison.’
Dempster has recently completed an analysis of MOSERS, the Missouri state employees’ pension fund, which has 3 percent of its assets in commodities, including gold. ‘Initially, the board didn’t really understand the concept,’ she recalls. ‘It had visions of truckloads of bullion coming to the door.’
After 10 years, however, the investment has more than met MOSERS’ expectations. ‘For a lot of funds, it’s about enhancing trends and smoothing volatility,’ Dempster explains, pointing out that Harvard, whose endowment’s performance has often been the envy of its peers, held up to 17 percent in commodities last year.
Hard assets are only part of the story, though. Rather than buying investment gold, some say the answer is investing in gold mining. ‘Costs have risen, but while there is a margin between the market price and the price of production, it’s still profitable,’ Sutherland says. ‘And a lot of the factors that have pushed up the gold price since 2001 remain in place.’
Ellingham agrees. ‘We speak to a lot of people buying gold stocks, and they are hesitating, but a gold equity has more leverage than gold itself, because it’s backed by future gold reserves,’ she says. ‘If you buy an ounce of gold, that’s what you get, but if you buy a mining company, it has a cash flow from producing and selling gold and, hopefully, a nice profit margin. For example, we have more than 20 mn ounces that have been defined by drilling, so we have exposure to a far greater amount of future gold.’
Iamgold, with seven operating mines and 3,300 employees producing 1 mn ounces a year, puts its balances where its mouth is: its $300 mn reserves are in bullion as well as cash. ‘Investors who have held gold through this have certainly done a lot better than people who bought indexes, so it has proven to be a better store of value than the equity markets in general,’ Ellingham adds.
Buyers being wary
Interestingly, investors in the countries that buy the most physical gold in the Middle East and southern Asia, such as sovereign wealth funds, have not yet shown much sign of buying back up the value chain. Ellingham’s traditional investors are mostly American and Canadian, with some Europeans.
‘Most people who invest in gold stocks are long term, and have been investing for decades, although there has been a tremendous boom in the last seven years or so,’ she says. ‘But I’m sure there are new investors coming up. After all, gold equities are almost a currency diversification.’
With gold, the conquistadores were looking at the wrong end of the continent. Gold investors and miners meet in Toronto, where, Ellingham points out, the exchange has its roots in mining. Even now Toronto Stock Exchange (TSX) and TSX Venture Exchange (TSXV) have 1,200 listed mining companies, over a third of them gold, representing 57 percent of the world’s miners. ‘We have the largest concentration of mining analysts anywhere in the world,’ Ellingham adds. ‘Even in New York, many of the analysts and mining portfolio managers are Canadians.’
London, Johannesburg and Sydney are also important mining investment centers, but the combination of Toronto’s critical mass of analysts and mineral-savvy investors, not to mention its proximity to New York, make it the epicenter of mining investment. ‘In Canada, there is a commodity-driven community in the local banks that knows what you are talking about, and on the exchanges, the regulators understand the industry,’ explains Sutherland.
In general, ‘senior’ mining companies like Iamgold are on TSX and pay dividends, while juniors are on TSXV, where the bold go to play. While investing in a working gold mine seems sensible, investing in junior gold is more like prospecting in the Wild West. That makes IR a challenge, and companies like Sutherland’s must rely on management’s previous success in finding and bringing gold deposits to market.
For his part, Sutherland used to be CFO of Gammon Lake, which he grew from a junior company into a measure of multibillion ‘seniority’, as it moved its gold finds into production and a $2 bn-plus market value. ‘We’ve made investors a lot of money in the past, so many of them are investing in us again in another success in Mexico,’ he says. ‘They may be buying shares at 50 cents, but if we deliver, proper valuations would be $2 to $3 in a short time, then into production $5, $6 or $7, and then you are off to the races.’
A combination of the anomalously falling gold price and the credit crunch had made investors leery even of the seniors, much less the far more speculative juniors. ‘It takes a lot of work with the analyst community to tell our story,’ Sutherland adds.
Nayarit Gold focuses its IR program on retail, although it also does some investment shows focused on institutional commodity investors. Sutherland visits groups in North America and Europe, on the hunt for ‘people looking for a long-term growth story.’
At the beginning of December he was presenting at the San Francisco Hard Assets Conference, hoping the local history of gold would produce interest. He usually attends three of these a year – Las Vegas and New York being other venues – and characterizes most of the 400-plus attendees as private investors, with some institutions. ‘The gold bugs are still out there,’ Sutherland said at the conference. ‘Everyone is still bullish about gold’s long-term prospects.’
People talk about ‘peak oil’ but peak gold is already with us. Sutherland points out that in the last few years the number of million-ounce deposits found has declined considerably. That could positively affect share prices at companies with prospects. ‘The crisis has restricted access to capital for the juniors in early-stage exploration and development, making it increasingly hard to find major new deposits, so you’re going to have a supply constraint,’ he warns.
But Sutherland’s strongest IR pitch is the strange days on the world’s markets: ‘When nothing else makes sense, gold does.’