Has the price of gold turned the corner?

One of those in the bullish camp is Charles Oliver, senior portfolio manager with Toronto-based Sprott Asset Management LP and co-manager of Sprott Gold and Precious Minerals Fund: “I believe that we have turned a corner and gold is going back up. My long-term view is that the gold price will continue to rise in the current environment.”

Oliver, who shares portfolio-management duties with Jamie Horvat, senior portfolio manager with Sprott, cites several factors behind his optimism: “Supply seems to be coming down, whether it’s falling output in South Africa or companies reducing production because of capital constraints. Demand continues to be very strong from central banks or investors, and Chinese and Indian buyers. But most important, governments continue to run deficits. And to pay for them they are printing money. As boomers retire, the deficits will get bigger because they will make more demands on health care and social services.”

He also notes that the U.S. monetary base has grown four-fold to US$3.2 trillion compared with US$800 billion in 2008. “You are not seeing a lot of price inflation at this point,” he says, “but you are seeing the currency debased quite dramatically.”

From an historical perspective, Oliver says, gold prices are cyclical in nature: bullion hit US$200 an ounce in 1974, then fell to US$104 in 1976. “Then, it went up to US$850 in about four years. So, we have seen some big pullbacks, followed by explosive moves,” says Oliver, suggesting that the latest decline will be reversed. “Some of these things may sound very aggressive, but they are precedents that we can draw upon from the past.”

Co-managing a fund with about 140 names, Oliver has tended to allocate the portfolio equally among large-, mid- and small-caps. This time, large-caps account for less than 33% of assets under management (AUM), with the balance in the mid- and small-cap space. There is about 10% of AUM in silver bullion, 25% in silver producers and 65% in gold producers.

“All segments are cheap,” Oliver says, “but small-caps are the cheapest; they have been absolutely pummelled. When you have a down period, investors take the riskier bets off.”

One favourite is Pan American Silver Corp., a mid-cap silver firm with mines in Mexico and Peru that produces about 25 million ounces a year. “It has a strong balance sheet, good management and pays a 4.3% dividend,” says Oliver. “But it’s extremely undervalued.”

Pan American’s stock is trading at about $11.50 a share, a fraction of its $40 price in late 2010. If the silver price recovers from the current US$24 an ounce, says Oliver, “there is no reason why we can’t go back to US$40.”

it’s difficult to say with certainty that gold has turned a corner, says Ani Markova, vice president with Toronto-based AGF Investments Inc. and lead portfolio manager of AGF Precious Metals Fund.

“We have seen big drops in the history of gold, but this recent volatility was caused by investors leaving the gold trade,” says Markova, adding that investors have sold 20 million ounces of gold in exchange-traded funds (ETFs). “This gives me the impression that some very large pools of managed money have left gold as an investment.”

Markova points to the uncertainty that affects not only gold but all investment assets: “We are focused on headline news: Will the [U.S.] Federal Reserve [Board] start to taper? What’s happening in Syria? What’s happening in Europe? There’s not a lot of conviction in the market, although with the Fed printing and creating opportunities for investors, we are seeing multiples expanding and companies buying their own stocks and not investing. That creates another leg of uncertainty.”

In the longer term, Markova maintains, gold could reach US$2,500 ounce. But she is not making bets on the timing. “To me, this is a period in which a lot of macroeconomic and geopolitical factors will come into play,” says Markova, who believes that the gold price may stay in a narrow range for the short term. “Even if we don’t have an exogenous event, we are looking for the time when the velocity of money picks up” – referring to the sluggish rate at which money has been turning over in the economy.

It’s only a matter of time, adds Markova, until the massive printing of money spurs asset inflation, including precious metals. In the meantime, she says, it’s important that the bullion price builds a base around US$1,400. “Industry needs higher gold prices to see sustainable production,” she says. “And that doesn’t include new projects. A lot depends on where we find the equilibrium for the gold price.”

About 44% of the AGF fund’s AUM is in small-cap producers, followed by 30% in large-caps, 22% in mid-caps and about 4% in gold bullion. “The mid-tiers and small-caps represent the better proposition,” says Markova. “Our preference is for companies that have the ability to grow at much reduced capital needs.”

A favourite name in the 110-holding portfolio is Regis Resources Ltd., a mid-cap gold producer in Australia with mines in that country and in Africa. Regis is expected to produce about 420,000 ounces of gold in fiscal 2013, ended June 30. “It has a strong balance sheet,” says Markova, “pays a 4% dividend and trades below net asset value [NAV].”

Regis’s share price is about AU$4 ($3.85). Markova’s target is AU$5-$5.50 in about a year.

DIANA RACANELLI, VICE president with Toronto-based TD Asset Management Inc. (TDAM) and lead manager of TD Precious Metals Fund, also is cautious. “Over the next year or two, the gold price will be range-bound,” says Racanelli, noting that gold bullion may fluctuate between US$1,300 and US$1,450.

“There is no clear indication that gold can move significantly, up or down,” she adds. “We get a lot of conflicting information about global economies. Until that settles out, we won’t see any kind of strong rebound.”

One major influencing factor is the Fed’s decision on the pace of tapering its bond-buying program, anxiety about which as of mid-September has dissipated with the Fed’s decision to hold off.

Another factor, Racanelli adds, is the direction of consumer demand for gold materials in Asia: “It’s been positive, year-over-year. But there are now some restrictions in India in gold imports. So, even though gold-buying has been strong, we don’t know how long that will continue.”

In the longer term, things might start to improve for gold equities as companies are focusing more on capital discipline. “Hopefully,” Racanelli says, “margins will expand and they start to make money.

In the meantime, she notes, even though share prices have been slammed, gold stocks are only slightly cheaper than they were a year ago (on a price/NAV basis).

“The seniors are far more expensive than the intermediates and juniors, but there is a reason for that,” says Racanelli. “The [juniors] generally have higher-cost operations and have more difficulty raising funds. And there’s not a lot of opportunity for the junior names because the seniors are focusing more on capital discipline and looking at shedding non-core assets.”

About 66% of the TD fund’s AUM is in gold companies, 8% is in silver producers, 20% is in diversified miners (such as platinum miners) and 6% is in gold bullion. Racanelli, who assumed portfolio-management duties for the fund in April after former TDAM vice president Ari Levy left the firm, cut the number of names by half to 75.

“We eliminated a lot of small-cap, higher-cost producers and lowered the fund’s risk profile,” says Racanelli, adding that 51% of AUM is in large-caps and the remainder is in a mix of mid- and small-caps.

One top holding is Franco-Nevada Corp., which derives royalties generated from gold mines that mostly are in North America. Says Racanelli: “It offers a little more upside than an ETF and a little less risk than an operating company.”

Franco-Nevada stock has a 1.7% dividend yield, trades at about 1.4 times NAV and is priced at about $45 a share.

In defence of bonds 26

Product Watch 26

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