After taking a beating for the past six months, precious metals stocks are recovering in tandem with the gold bullion price.

Bullion recently climbed to about US$835 an ounce, after tumbling to US$745 in August, off its all-time high of US$1,032 this past March. Indeed, fund managers are bullish on gold’s prospects, citing strong physical demand for precious metals and gold’s role as an inflationary hedge. Fund managers expect a flight into gold following the U.S. Congress passing the US$700-billion package to prop up battered U.S. financial services companies.

“Gold is very driven by what’s going on in the macro environment,” says Margot Naudie, manager of TD Precious Metals Fund and managing director with Toronto-based TD Asset Management Inc. “Last March, stress in the financial system culminated in the rescue of Bear Stearns. There was also concern with respect to inflation.”

Naudie notes that gold serves not only as a hedge against inflation but also as a hedge against the U.S. dollar during financial crises.

Over the summer, gold prices fell as inflation expectations slipped in the wake of falling grain and crude oil prices. As that occurred, the US$ rallied against other currencies and U.S. Treasury bonds were perceived as being more attractive. Also, adds Naudie, bullion prices tumbled because the U.S. financial system began to purge its excesses through major writedowns.

“When there is too much leverage, assets have to be sold,” she says. “Gold was a victim of the process.”

Now, the reverse is happening. The latest massive injection of liquidity through the bailout program for troubled U.S. financial services firms has stirred up inflationary pressures once more and revitalized the gold price.

“The U.S. took on the liabilities of Fannie Mae and Freddie Mac, and increased its balance sheet,” says Naudie. “Under that scenario, it’s a very bullish environment for gold.”

At the same time, she argues, the demand and supply fundamentals point toward a higher gold price: “Supply continues to fall. Physical demand for gold has gone up notably during the summer due to the pullback in the price. But from a physical demand standpoint, the outlook is very good. It’s not the end of the bull market.”

Naudie maintains a blend of 50% of assets under management in large-cap companies, 30% in mid-caps and 20% in small-cap firms.

“When I look at the spectrum of companies, I look at where the real value is added,” she says. “The real value is added through the discovery, exploitation and development of mines.”

As a result, the TD fund holds a number of smaller exploration firms that can grow through their drilling programs. Those positions are small, however, because the companies are riskier than large and medium-sized players.

The core of the TD fund is made up of large-caps that have strong management, high-quality properties, stable financing and are in politically safe jurisdictions.

“They have the ability to finance growth so shareholders are not being diluted,” she says, naming Barrick Gold Corp., Goldcorp Inc. and Freeport-McMoRan Copper & Gold Inc.

On the mid-cap side, Naudie likes Redback Mining Inc. The owner of the Chirano mine in Ghana and the Tasiast mine in Mauretania has been successful in ramping up annual production to about 500,000 ounces.

“Redback bought Tasiast at a good price and continues to add value through drilling and moving into production,” says Naudie. “This is a company that has everything I look for: a good growth profile, an excellent management team and operations in good political jurisdictions.”

Acquired two years at less than $1 a share, the stock recently traded at $7.50 a share. Naudie’s 12-month target is $8-$9 a share.



The recent run-up in the gold price is in response to the inflationary impact of the US$700-billion bank bailout, agrees Chris Beer, manager of RBC Global Precious Metals Class and vice president of Toronto-based RBC Asset Management Inc.: “Printing that amount of dollars, you would expect, is inflationary. That’s what gold is reacting to.”

During the summer, Beer adds, the gold price was reflecting a global slowdown: “Gold always reacts to the medicine necessary to prevent a slowdown, which is lowering rates. That happened in the U.S. earlier. When the U.S. Federal Reserve Board rate got down to 2%, people thought that was enough to rejuvenate the economy. But apparently it’s not enough.

@page_break@“With the financial crisis, we still need to stabilize a whole bunch of assets and throw a lot of money out there,” Beer adds. “Assuming the banks take that US$700-billion package, it’s a monetary process. And that’s inflationary.”

Beer argues that in the next six to 12 months, there is a strong possibility that people could lose faith in the US$, the euro and other currencies.

“Interest rates are coming down globally,” he says. “There will be massive dollar printing in the U.S. and massive printing of currencies globally.”

The Russian ruble and Chinese renminbi have also been under pressure, he adds: “But a tangible asset like gold is a legitimate part of your assets.”

It’s hard to determine a price target for gold, Beer says: “If it [had] kept its inflation-adjusted price when it hit a high of $800 in 1980, it should be US$2,300 today. Is that my target? No.”

Adds Beer: “We’ve had a lot of crises so far and gold is where it is. But the trend of subpar growth globally will result in low interest rates. That lowers the opportunity cost for holding gold, which does not bear interest. It’s inflationary, however, and there are a lot of excess dollars in the world. To me, that’s a positive scenario for a tangible asset like gold.”

From a strategic viewpoint, Beer tends to split the RBC fund’s portfolio equally between large-, mid- and small-cap companies. But in an environment in which large-caps offer more liquidity, Beer and co-manager, RBCAM vice president Brahm Spilfogel, favour that segment of the market, combined with about 30% in mid-caps and 20% in small-cap firms.

“When gold rises, smaller and intermediate companies perform better because they have more leverage to the bullion price,” says Beer. “In this cycle, we’ve seen a number of companies that have problems managing their capital and operating costs. Investors aren’t doing a lot of work on small- and mid-caps. They’re going with the liquid names.”

Barrick Gold and Goldcorp are among the top 10 names, which account for almost 55% of the fund’s AUM.

One of Beer’s favourites on the small-cap side is Guyana Goldfields Inc. A long-term holding acquired at 50¢ a share, it peaked at $12 a share in early 2007, when Beer took some profits. Even though it was recently down to around $3 a share, Beer remains a shareholder and sees more upside in the junior miner, which is developing a mine in Guyana that could potentially have five million ounces of gold.

“Guyana Goldfields has a good cash balance,” Beer says. “And it came out with a study that showed, at US$650 an ounce, the project has a 50% rate of return. We believe that either this company will develop the project, or someone else will.”

His 12-month target for the stock is $7-$8 a share.

Another favourite is European Goldfields Ltd., which is in the process of getting permits to re-open two formerly state-owned mines in Greece.

“It’s like an Agnico-Eagle Mines Ltd.,” says Beer, “and could produce upward of 500,000 to 700,000 ounces of gold a year within a couple of years, just shy of where Agnico will be in a few years.”

Bought two years ago, European Goldfields’ stock recently traded at $3 a share. Beer’s target is $7-$8 a share within 12 months.



Equally bullish on gold is Benoît Gervais, manager of Mackenzie Universal Precious Metals Fund and vice president of Toronto-based Mackenzie Financial Corp.

“Last summer, people feared that the [rising gold bullion price] trend was not on,” he says, “that we would go into a depression because there wasn’t new money coming in and we had a lot of debt. Maybe gold wasn’t useful after all. That pushed us back into the bottom of the long-term trend.

“But the trend is moving higher — and the bottom [of the gold price] will be higher next year. These [financial bailout] moves will benefit all real assets, including gold.”

Gervais argues that for the past year, the precious metal has been in a price band ranging from US$750 to US$1,030 an ounce. But, on the back of costly bailout packages in the U.S., that band will move 15% higher, US$850 to US$1,100 an ounce, next year.

“That band is rising as fast as we are printing money. I don’t see a change in that trend,” he says. “The more money there is, the more inflation rises — and the more the gold price goes up.”

Although Gervais is certain that the gold price will keep rising, he admits it’s difficult to pick the right stocks. The gold-mining industry is facing high costs and often makes slim profits.

“The dynamics are not so great that you can buy any company and be all right. You have to be very selective.”

Leading and intermediate-sized companies such as Barrick Gold and Randgold Resources Ltd. dominate the 50 names in the Mackenzie fund. But Gervais and co-manager Fred Sturm, senior vice president of Mackenzie, also have about 25% of the portfolio in smaller companies that show a lot of promise.

One such name is Moto Gold-mines Ltd., which is developing a mine in the Democratic Republic of Congo that has about 20 million ounces of gold deposits.

“That makes it one of the biggest deposits worldwide,” Gervais says. “On top of that, it’s high-grade and more accessible than [deposits in] many other mines.”

He adds that the company could be a takeover candidate by a larger, better-capitalized player. The stock recently traded at $2.30 a share; there is no stated target price. IE