Source: Streetwise Reports 05/09/2019
Ralph Aldis, portfolio manager at U.S. Global Investors, in this interview with Streetwise Reports, talks about movements in the gold market, why precious metals producers are doing better than explorers and developers, the funds that he manages and companies on his buy and sell list.
Streetwise Reports: Ralph, gold has been trading within a relatively narrow range around $1,300 over the last several months. What's your outlook for the metal?
Ralph Aldis: Longer term, I do think we're going to see a higher gold price. As for the near-term factors that have been a hindrance, many experts have a fairly positive view that this could be the right time for gold given current global geopolitical conditions where you don't know what could happen, especially with the rise of Populist leaders.
But I think the current overshadowing factor on the gold price has been Venezuela. Recently there was a news story that Venezuela was said to have already sold $400 million in gold in spite of sanctions imposed. When that story hit the wires, there wasn't really any real news out there on gold, but it would be my opinion that the news caused the gold price to drop around $11/oz. I believe it shows that, to some extent, sanctions are not working. Stories like Venezuela moving 8 tonnes of gold from its central bank around April 9-10, when gold was trading at $1,308, immediately preceded gold price declines over the next five days towards $1,275/oz. I don't think it' just a coincidence that gold has seen selling pressure around these headlines.
I believe that longer-term most investors are positive on gold, but it's very clear we have had a distressed seller in the market. In fact we've had a couple in the past year; Turkey also comes to mind as a big seller. Against this backdrop we've seen five months of gold buying from China. Opportunistic buyers, when they see distressed sellers like Venezuela, are not going to rush to give sellers top dollar. So, when you see anything related to Venezuela and selling gold, it seems the bids just drop off. Obviously, Venezuela has been able to sell gold even though there have been sanctions. The U.S. has been trying to stop that, but Venezuela has been able to get gold into the market. I think that has been the biggest recent headwind for gold.
It's instructive to remember that in 2018, Turkey was in a similar position. It had a big currency crisis, and it was selling down its gold reserves. Every week its gold reserves were dropping, using gold sales to defend the Turkish lira. Fast forward to 2019, Prime Minister Erdogan's AKP party suffered defeats in the March 31 elections in big cities like Ankara and Istanbul, the biggest and richest city in the country. Erdogan is already calling for a new election because he didn't get the popular support he was seeking. It's these types of news events that make you nervous since countries like Turkey have been known to sell gold to achieve its political objectives. I think until we get past the current situations in both Turkey and Venezuela the gold price is probably still going to trend sideways. I don't think it's going to drop necessarily because there are too many macro factors that are supporting it. But long-term buyers usually offer forced sellers the cheapest price they can.
SR: Let's go on to precious metals stocks. Do you see any broad trends in this market?
RA: Yes. There are a couple things I would say related to the companies and company management and the way that maybe they're thinking. And it's manifesting itself in some of the decisions we're seeing.
One of the trends that we're seeing is better capital allocation decisions versus just trying to grow production at thinner margins. For the longest time, analysts seemed to play this tune of companies need to increase their production so they'll get a higher rating. Companies would do that, but at thinner margins and weren't making any money doing that.
We've seen IAMGOLD Corp. (IMG:TSX; IAG:NYSE) announce the deferral of Côté, and the stock was up 10%. Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) wasn't going to do the mill at Kisladag, and the stock is up 10%. You had AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) talking about evaluating closing its last mine in South Africa within the next 18 months, and then in South Africa the stock traded up maybe 2%. When that news hit the U.S., the stock traded up 10% and then up another 5% the next day.
It's like investors are saying, "Okay, you're going to make a good capital allocation decision that markets like, so we're going to reward you for that." I think to some extent the companies are beginning to see that.
Now, the flip side, when you look at what's happening along with the precious metal companies, I think the Shareholders' Gold Council that was formed last year has done an excellent job, one on the changes to the board at Detour Gold Corp. (DGC:TSX). But it also did a really good job highlighting actions of the board of Goldcorp Inc. (G:TSX; GG:NYSE) going into the Newmont Mining Corp. (NEM:NYSE) merger. It called them out, and some of these guys are in the Mining Hall of Fame. I think the Shareholders' Gold Council should have like a Miners' Hall of Shame and hang these people's pictures up there. Goldcorp was a great company, but it's gone. None of us was there in the room to know exactly what transpired, but from the outside, it doesn't look pretty.
SR: You manage two funds, the U.S. Global Investors Gold and Precious Metals Fund (USERX:MUTF) and the World Precious Minerals Fund (UNWPX:MUTF). How have the funds been performing?
RA: Like night and day. I say that because one of them is just gold producers; that's the Gold and Precious Metals Fund. And World Precious Minerals Fund is predominantly explorers and developers. There has been a recent divergence in terms of the performance of those stocks.
World Precious Minerals has not done as well because it has exploration and development companies, but Gold and Precious Metals has done much better because it is in the producers. The explorers and developers aren't getting money allocated to them. The producers are always where the money flows first at the start of a gold bull market.
There's a crazy phenomenon that I, and most active fund managers, struggle with. If I chart my performance of Gold and Precious Metals against the GDX (Market Vectors Gold Miners ETF [GDX:NYSE.Arca]), which is the senior producers—I'm looking at 10-year numbers ending April 30, 2019—there are at least ten precious metal equity mutual funds, including our Gold and Precious Metals Fund, that have all beat the GDX over the past 10 years, in some cases by substantial double digit margins. Even for the past five years, the Gold and Precious Metals Fund has outperformed the GDX by double digit margins.
Ten Year Charts:
Five Year Charts:
But people don't care about this outperformance. They just want to buy the ETF (the GDX or another) because it's simple, cheap and easy to buy. By comparison, these ETFs generally have lower fees than the typical mutual fund. However, it is my opinion that basing investment decisions on fee structures alone means investors are not getting the performance that they potentially could be getting from a mutual fund advised by an active fund manager with decades of experience. Albeit, while an investor may only purchase or sell shares from a mutual fund at the end of the day, and an ETF allows for that convenience of buying the product at any time during market hours, in my opinion you're leaving a lot of performance on the table without the experience of an active money manager. There are also the hidden expenses to trading ETFs. You can pay a premium to the NAV to buy the product if the market is moving up or you may get sold out at a discount to the NAV on days where redemptions are heavy. In my opinion, I don't understand why you would put your money into the GDX or GDXJ. Their investors may not be aware of the costs/benefits trade-offs. It's like they put their cloths on backwards in the morning, leave the house and never expect anyone to ask, "Why would you make that choice?"
What is also happening is good fund managers who have long-term experience knowing the assets are not getting the inbound money flows into the sector to allocate to the right companies. What's unusual is the ETFs in the gold space are in some cases three to ten times larger than the biggest mutual fund out there that's actively managing gold stocks. That's not the case in the broader market. The GDX has low expenses, but it just hasn't performed as well as some of the active managers, which is the opposite case when you're dealing with the S&P 500 stocks that are very well researched. In that case, it's very hard to outperform the benchmark. But gold stocks are just a little niche on the side. Investors are arguably not getting the best performance by solely buying the cheapest, easiest-to-use product.
SR: Let's talk about the ETF, the GOAU (U.S. Global GO GOLD and Precious Metal Miners ETF) fund that U.S. Global Investors manages. How is that going?
RA: Our ETF is a great contrast to how ETFs can apply quantitative screens to the gold mining sector, creating our constituent index through more sophisticated metrics that allows us to focus more on quality and value of a stock, versus using predominately market capitalization to determine your ETF index. I'm looking at performance since inception to April 30, 2019, which is close to two years. The U.S. Global GO GOLD Precious Metal Miners ETF (GOAU) has outperformed the GDX by 528 basis points. Thus, our quantitative model that is designed to buy good value stocks with good financial metrics has delivered good relative performance to the GDX. Again, there were 528 basis points more of additional performance by buying something that's focusing on quality and value versus predominately market capitalization and liquidity.
Maybe we'll get a shift where investors will start looking a little deeper. I guess we're lucky that they're even looking at gold stocks at this point in time with the broader market making new highs. But that is exactly why investors should have a diversified portfolio of holdings, including gold-related investments, which have a low correlation to market returns so they can lower their total volatility of returns.
SR: What is the year to date for the Market Vectors Junior Gold Miners ETF (GDXJ:NYSE.Arca)?
RA: The GDXJ is -295 basis points as of the end of April; its older sibling the GDX is -95 basis points. So even in this shorter performance window there are a number of actively managed gold equity mutual funds that are beating the two gorillas in the room. For myself or Dan Denbow of USAA, Stephen Land at Franklin Templeton, or Doug Groh at Tocqueville, and a handful of other people who have done this for years, they have 20 to 30 years of experience under their belt of knowing management and knowing the teams and knowing, "Hey, I've seen this show before, I'm not buying a ticket to this dance." With the GDX or GDXJ, they're just buying on market capitalization and liquidity, and those are not value metrics. So there's a disconnect in the gold space.
SR: You said that the explorers and developers are doing worse than the producers. Do you see any signs of any movement in the producers starting to buy the developers or the explorers for their reserves? Would that be the next natural step?
RA: Yes, it would be. For the past year and a half, the producers have been looking over their shoulder saying, "I'm not going to do a deal," or "I'll get fired if I do a deal," particularly if the stock goes down. So they've been very much not wanting to buy anything. Now, we have seen some transactions that have worked pretty well.
When Northern Star Resources Ltd. (NST:ASX) bought Pogo, the stock was up 10–15%. And then we saw Lundin Mining Corp. (LUN:TSX) buy an asset, Chipada, out of Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE), and the Lundin stock has gone up.
So I think we may be getting closer. I think what will give them the confidence is if we get the gold price moving to that $1,360–1,370 level, which we haven't been able to break out of—and that's probably not going to happen until after Venezuela gets settled unless there is some other conflict that drives it—the senior stock prices will have already appreciated enough, and they'll buy these juniors. With some of these juniors, they can go up tenfold, not overnight but over the cycle, very easily. A lot of them are in lockdown mode to minimum spend mode, trying to add value and keep going. But it's very difficult for those companies to get new money allocated to them if investors are only buying GDX or GDXJ, disrupting the allocation of capital flows by bypassing the gold equity mutual funds that can prudently allocate capital.
So, yes, I do think a wave of consolidation is going to come because we do know a lot of the seniors are going to try to spin assets off, and that could create a lot of interesting opportunities for smaller mining companies.
SR: That's a good segue into what companies are your favorites right now, either for mergers and acquisition potential or natural growth. What is on your Top 10 list?
RA: One for everybody in the gold space is Wheaton Precious Metals Corp. (WPM:TSX; WPM:NYSE). It's kind of funny, its Chief Financial Officer Gary Brown was in here a couple weeks back, and gave us an update. And he told me after he gave a presentation at a conference recently, somebody still came up and asked, "Is that Canada Revenue Agency tax thing really gone, is that really behind your or can they appeal it?" He had told them during the presentation that the CRA issue is all taken care of, that risk is gone, but people still haven't fully digested the good news. So that's a very clear kind of opportunity. Wheaton's probably been on the do not buy list for a lot of people for a while because of this risk of who knows what the government's going to do in terms of taxes. And now it has come out of it, it's settled, it's all cleaned up, and the market still hasn't woken up. On my models, Wheaton is still about 50% undervalued compared to a company like Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) or Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX), which are much closer to their true value right now. Fortunately Wheaton is on a marketing push because it recognizes this, too, and it is getting out and telling the story.
I think Wheaton is one of the royalty companies that's really going to shine because it's undervalued relative to its assets. It's one that a lot of people could buy pretty easily because it's traded in New York and in Canada, and it's a large capitalization gold stock. It's also very diversified in terms of its risk because it has many, many different streams coming in. Just generally, that's a very good, deep value story right now that could be bought, and the risk has been basically cleared up.
Another one, which we may have talked about before, is Wesdome Gold Mines Ltd. (WDO:TSX). It has had very consistent, clean results. It has had people throwing term sheets at it to raise some money. But it has been very disciplined and has not raised any money. Charlie Page did a great job as the chairman. He's stepping away right now, but another very good executive, Brian Skanderbeg, joined the board of Wesdome.
Wesdome has really done everything right. It hasn't raised money just because it could get it. It has delivered both operating and drilling results very consistently. It has mines that are in production. And the Kiena mine on care and maintenance represents a good growth opportunity with their recent resource expansion. Wesdome never really had the money to do enough work down deep, but the drill results we are seeing over the last year have begun to open some eyes, so that's a good asset to be bought. It's probably on a lot of companies' watch lists because it's in Canada, a safe jurisdiction, and it's been run properly. I think Wesdome is a very good candidate for a takeover.
A couple of other names that are all producers right now: K92 Mining Inc. (KNT:TSX.V) picked up an asset in Papua New Guinea, Kainantu, that originally had been a Barrick Gold Corp. (ABX:TSX; GOLD:NYSE) asset that it walked away from because of environmental and social issues at the mine site. My understanding is the community relations weren't right. But K92 acquired the asset and has been really hitting it out of the park in terms of some of the drill results and some of the prospectivity that it is seeing. It recently had some drill results that went into a porphyry. Right now, it has been mining veins, but there were some sniffs in the porphyry. Everything it put in the press release was quite scientific, but it described all the mineral assemblages and such. That was meant to really appeal to major mining companies and geologists around the world, and say, hey, this is what we have, come see it. I think B2Gold Corp. (BTG:NYSE; BTO:TSX; B2G:NSX) has staked a bunch of the land around K92, from what I hear on the rumor side. So I think K92 is another one that has a great deposit, high grade. The CEO spends time at the mine site. It's off on the other side of the world, but he goes there and spends a week there every month working, so it's very much a hands-on management. So that's another one that's in my Top 10 house.
Roxgold Inc. (ROXG:TSX) is solid company that is consistently putting up 20% returns on invested capital since bringing Yaramoko into production. Operationally, they have not run short on putting money in the bank so they don't get a lot of love from the brokers and other naysayers who have inferior mines in the region. They say, "Oh, it's a one mine company, oh it has a short mine life, oh crap their mine is much better than ours." Well, recently Roxgold acquired the Seguela Gold Project from Newcrest West Africa Holdings Pty Ltd. that has 11 exploration permits in Cote d'Ivoire for $20 million in cash. Previous unreleased drill holes by Newcrest show a very promising prospect exists with a 1.2 km long, 30–50 meter wide anomaly with wide spaced RC/DD drilling returning high grade intervals, such as 14 meters at 58.1 g/t gold from surface. I guess those returns on invested capital are going to stay high for Roxgold.
There are a couple of other ones. Barsele Minerals Corp. (BME:TSX.V) is not a producer, but it has a joint venture with Agnico Eagle Mines Ltd. (AEM:TSX; AEM:NYSE). Agnico Eagle is doing all the work. Barsele is not having to put up any money right now until the asset gets to a certain stage. I think Barsele is doing everything right, too. That could basically lead to an acquisition in the next year to year and a half.
In the sleep-walking zombie apocalypse space of exploration, there are numerous opportunities to pick up great projects. Cardinal Resources Ltd. (CDV:ASX) has the Namdini Gold Project with 5.1 million ounces in reserves at 1.13 g/t. There is the flexibility to commission the mine from a higher grade starter pit at surface to pull the first 1 million ounces at a head grade of approximately 1.3 g/t. Namdini is located in Ghana, pretty far away from the terrorist hot spots of West Africa, with a number of majors already operating within the country.
Chakana Copper Corp. (PERU:TSX.V) has the Soledad project in Peru and also carries a substantial gold component to their deposit, which likely explains why Gold Fields just bought a 16% stake at nearly a 40% premium to the prior close. Chakana has drilled 4 of the 17 confirmed breccia pipes at the project and has identified another 12 targets. Bx1 was drilled to a depth of 490 meters; hole 17-18 returned 209 meters of 1% copper, 2.22 g/t gold and 70 g/t silver for a 3% copper-equivalent grade. This is high-grade country, which is what majors want to own.
New Pacific Metals Corp. (NUAG:TSX.V; NUPMF:OTCQX) acquired the Silver Sand Project in Bolivia in July of 2017. It wasn't too long after that when Pan American Silver Corp. (PAAS:NASDAQ;PAAS:TSX) bought about 12% of the company, after all it already operates mines within the country. Silver Sand gives investors exposure to a growing silver deposit with substantial size that is currently flying under the radar of most investors.
Outside-the-box names to own would be MenĒ Inc. (MENE:TSX.V; MENEF:OTCMKTS), which went public in November of 2018. It has a disruptive business model where it sells 24kt gold investment grade jewelry direct to the consumer based on the gram weight of the item at current gold prices, with just a 10% markup for the design. It will also buy back the item at current gold prices less a 10% discount. All of your purchases are tracked and current values of your purchases are viewable with your online account. The jewelry industry is a $250 billion global market that is increasingly going online versus the brick and mortar store. Consumers avoid buying diluted down gold alloys with 200–300% markups that immediately drop in resale value the moment you walk out of the traditional mall-based jewelry store. This is a product that appeals largely to Millennial taste, as it is something you can wear, but also retains its resale value. One of the designers is the granddaughter of Pablo Picasso and if you visit the website you will find lots of modern and novel designs to select from.
Another company that we ran across early in the lithium battery space was Nano One Materials Corp. (NNO:TSX.V). Instead of being a miner of lithium, it is an enabler of technology of producing low-cost, high-performance battery materials with a wide range of advanced nanostructure composites. It has patented a dozen processes through its industry-leading work in the space and has in the last year inked joint development agreements with cathode producer Pulead and French materials juggernaut Saint-Gobain. I've exited most of my lithium names but this one has an edge in the space, so I am holding onto it for a prosperous future.
SR: How about companies that you are divesting?
RA: These ones that I've divested are ones that obviously I don't own right now, I've already gotten out of them or have not owned them in a while and I see problems with them.
I have traded Guyana Goldfields Inc. (GUY:TSX) from time to time because it looked interesting and looked like good value on our model. But it has had a couple of missteps, one where it processed ore from the stockpiles, and the stockpiles were not the grade that it thought they were. It makes you think, okay, what's going on there, maybe an error? But it also seemed to just struggle, just not be hitting it in terms of delivering.
We looked at its resource calculations and some of the statistics around them. It seems like there's a lack of certainty around the grade distribution of the ore. It's not a homogeneous grade across the various zones. It's like there are high-grade areas, low-grade areas, and the way the ore body seems to be laid out just doesn't allow a lot of flexibility for it to have access to the average grade. It might have access to the low grade, maybe it has access to the high grade. Maybe that explains why the stockpile wasn't the grade it thought it was. I think Guyana Goldfields has some shareholder lawsuits against it. Once I start seeing slip-ups like that, I just want to stay away.
The other one that I worry about is New Gold Inc. (NGD:TSX; NGD:NYSE.MKT). I haven't owned it since August of 2013. I know Renaud Adams joined it, and it has had a good first quarter. But when the company put out the financials, the stock tanked. It has just been going sideways. It has viability problems long term with its debt and so on. It may be high leverage, but I don't know if I would want to be waiting there for that factor.
SR: Is there anything else that you'd like our readers to know?
RA: There are a couple things. The broader stock markets right now are charging ahead to some extent. You just saw stories about people redeeming out of the GLD and moving their money into the stock market as it reaches for new highs.
But there's something to think about in a recent Goldman Sachs report by strategist David Kostin. The subject was what the world would look like without stock buybacks, because there's some political scrutiny of this practice.
What it discovered is that Federal Reserve data shows that net buybacks averaged $420 billion annually since 2010, while demand from households, mutual funds, pension funds and foreign investors was less than $10 billion for each category. What that tells you is repurchases have consistently been the largest source of U.S. equity demand. So this is a market that's being driven by stock repurchases; it's not a market being driven by earnings fundamentals. Bridgewater Associates recently noted that widening U.S. profit margins over the last two decades are not likely to last, which creates a valuation problem for the market.
Bank of America Merrill Lynch released a report titled "Peak Plutonomy; The Civilization State and Upside-Down Policy: Implications." It believes the forces that are the driving the income and wealth inequality gap have largely peaked and the victims are likely to be heard at the polls. Identity groups—by religion, gender, rural-urban, race, young/old, etc.—are likely to claim previously denied recognition, dignity and resources. The implications are that 40 years of free global markets are likely to reverse. If we see governments move from away from quantitative easing (QE) to more aggressive fiscal policies to tackle stagnation, this could trigger a rise in rates and inflation. It seems like the macro field is shifting direction and values. It concludes real assets could see higher growth while financial assets will miss the stimulus of QE.
Will the stock market continue to do well if buybacks are curtailed? Remember how the government reacted to U.S. corporations moving abroad to avoid high taxes? Maybe the next wave of politicians see corporations engaged in stock buybacks as just enriching themselves while society, the greater good, would be better served by using that money to rebuild our aging infrastructure. So maybe real assets like commodities and gold (no one's liability) might finally have their day in the sun again.
I guess the finishing line on that would be like this headline, Powell Adopts White-of-the-Eyes Inflation Stance, meaning the Fed won't raise rates until it sees inflation in front of us. It wants to see evidence of it. Remember, the Fed is also discussing average inflation targeting; perhaps there would be a shift to let inflation run above its target for a while considering for most of the past 10 years we have been below target. And if the Fed waits that long, it may be too late. The cat may be out of the bag as far as inflation at that point. Again, it may be good for gold. It may not be good for everybody, but it will be good for those thinking ahead.
My worry is just these markets could be a little bit topsy.
SR: Thanks, Ralph, for your insights.
Ralph Aldis, CFA, portfolio manager of U.S. Global Investors, is responsible for analyzing gold and precious metals stocks for the World Precious Minerals Fund (UNWPX) and the Gold and Precious Metals Fund (USERX). In addition, Aldis serves as co-portfolio manager for the Global Resources Fund (PSPFX), Holmes Macro Trends Fund (MEGAX), All American Equity Fund (GBTFX), Emerging Europe Fund (EUROX), Near-Term Tax Free Fund (NEARX), U.S. Government Securities Ultra-Short Bond Fund (UGSDX), the China Region Fund (USCOX), and the U.S. Global Jets ETF (JETS). In 2011, and again in 2015, Aldis was named a U.S. Metals and Mining "TopGun" by Brendan Wood International. In 2016, he and Frank Holmes were named Best Americas-Based Fund Manager by the Mining Journal. Aldis received a master's degree in energy and mineral resources from the University of Texas at Austin in 1988 and a Bachelor of Science in Geology, cum laude, in 1981, from Stephen F. Austin University. Aldis is a member of the CFA Society of San Antonio.
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