Although gold bullion has pushed through US$735 an ounce, its highest level in two decades, precious metals stocks have lagged, victims of market volatility and worries concerning the recent credit crunch. And, although precious metals funds are showing small gains year-to-date or, in some cases, are flat, fund managers argue that fundamentals will soon reassert themselves.

“With the subprime lending debacle, there’s been a lot of fear in the markets, regardless of the fundamentals,” says Robert Cohen, portfolio manager at Toronto-based Goodman & Co. Investment Counsel who oversees Dynamic Precious Metals Fund. “If you owned gold itself, you would have done better. But people have been selling stocks wholesale — it doesn’t matter if it’s a gold stock or what have you. For us, this creates a great buying opportunity.”

In spite of market uncertainty, Cohen maintains that three fundamental drivers remain in place. First, the continuing weakness of the U.S. dollar against other currencies is pushing up the price of bullion. Second, monetary reflation by the central banks remains pervasive so global money supply keeps growing.

“Last year, the gold price finished around US$630 an ounce. Today, it’s at US$739. The thesis is in place,” Cohen says. He expects gold to climb to US$750 an ounce within six to nine months. In about three years, gold could reach US$1,000. “It’s just a question of when. It’s not happening in the next year — but it will happen.”

Third, lower interest rates are supportive of gold. Indeed, the U.S. Federal Reserve Board’s decision to cut the U.S. federal funds rate for the first time in four years is expected to help. “Low real rates are good for gold,” Cohen says. “When you lower rates, you create more liquidity in the system and more activity in gold equities.”

Running a 70-name fund, Cohen prefers smaller and mid-sized players, with the exception of large-cap producers Barrick Gold Corp. and Goldcorp Inc. Together, they account for about 7% of the fund.

A favourite junior firm is Osisko Exploration Ltd. “It’s an exploration story out of Quebec and it owns the Canadian Malartic project,” says Cohen, adding that the project in the Abitibi region includes old underground mines. “Osisko has built up a significant resource of about 8.4 million ounces of gold. The economics of this project should be quite robust. We should see production in about three years.”

Initially acquired in December 2005, when Osisko did a private placement, its average cost in the Dynamic fund is $2.88 a share. Recently, a share was trading at $5.80. Cohen’s target over the next 12 to 18 months is about $10 a share.

“There are some skeptics out there,” Cohen says. “But it has an $800-million market cap. That’s pretty good in my books, and the deposit has the potential to grow. In the next few months, Osisko could add another 1.3 million ounces. Some guess that about three million ounces will be added to the resource. That will make it one of the largest gold projects in the world.”

Another favourite is Agnico-Eagle Mines Ltd. The mid-cap firm has a “fabulous growth profile ahead of it,” Cohen says. “Over the next four years, production will go to 1.2 million ounces a year from just over 200,000 ounces a year.” That growth is attributable to new projects in Finland, Mexico, Quebec and Nunavut. Acquired about a decade ago at an average cost of less than $10 a share, a share recently traded at $49.90. Cohen’s target over the next 12 to 18 months is $66 a share.

Cohen also likes Eldorado Gold Corp. The chief attraction is its Kisladag project in Turkey. But, he argues, Eldorado’s value was not recognized for a long time. “It was an underfollowed name, but has now become quite respectable. It has a $2-billion market cap,” says Cohen, adding that the firm is also active in China.

Originally acquired for less than $1 a share in 2002, Eldorado’s shares recently traded at $5.95. Cohen’s target is $8.38 a share within 12 to 18 months.



Equally bullish is Charles Oliver, lead manager of AGF Precious Metals Fund and senior vice president of Toronto-based AGF Funds Inc. : “All the signs I see continue to endorse my belief that gold will be US$1,000 an ounce — and beyond — within the next three years.”

@page_break@Like Cohen, Oliver points to the weakening US$ as one of the key drivers of bullion’s price. “Because of the [U.S.] fiscal deficit and China’s trade surplus with the U.S.,” says Oliver, “the U.S. dollar will deteriorate further, mainly against the Asian currencies.”

Unlike Cohen, however, Oliver considers inflation another key driver, much like that which occurred in the 1970s. “There was a rise in materials and energy prices then, and we certainly had significant inflation during that period,” says Oliver. “Back then, Japan was one of the drivers of GDP growth and causes of inflationary pressures. Today, we have China — and it is about 10 times bigger, in terms of population.”

Finally, the U.S. Federal Reserve Board’s recent interest rate cut should prove bullish, says Oliver. “Over the past 30 to 40 years, gold usually rallies when the Fed is cutting interest rates,” he says. “As real rates are compressing, the propensity of foreigners to own US$ declines, which supports the gold price.”

Oliver is a value investor who runs the fund with Robert Farquharson, AGF Funds’ vice chairman. AGF Precious Metals Fund holds about 140 names, split roughly even among senior producers, mid-sized companies and junior players.

“We are well diversified across the spectrum,” Oliver says.

About a quarter of the fund on a weighted basis is in diversified firms that produce a variety of metals. One holding is Inmet Mining Corp. “It has about 250,000 ounces of gold a year from mines in Papua New Guinea and northern Quebec,” says Oliver, noting the firm also produces copper and zinc. “Just as gold producers have some flexibility, I look at it in the same way.”

Bought in 2001 at an average price of $6.72 a share, Inmet’s stock was recently trading around $98 a share. “It’s still cheap,” says Oliver. Taking into account $15 a share in cash, the stock trades at about eight times earnings. Oliver has no stated target.

Another long-time favourite is Aurelian Resources Inc. Although initially reluctant to invest in exploration plays, Oliver was impressed with Aurelian’s findings in southern Ecuador and took a small position in September 2003, paying 48¢ a share. But, in time, he says, “Aurelian found the best new gold deposit of the millennium, Fruta del Norte.”

The stock price rose to more than $30 and then recently split three for one. Oliver has subsequently taken profits and cut the fund’s exposure in half, to about 2.5% of the fund. An Aurelian share was recently trading at $7.60.



The reduction in interest rates is critical to bullion’s rise, says Chris Beer, manager of RBC Global Precious Metals Fund and vice president of Toronto-based RBC Asset Management Inc.

“Gold does well when the Fed and the European Central Bank have to act to deal with the credit crunch,” says Beer.

Moreover, bullion does well when real interest rates — nominal interest rates less inflation — become negative. That occurred in the 1970s and in the 1990s, as well as in the early 2000s, when real rates bottomed at 1%. “Bullion has actually done well in the past while, and year-to-date is up 15%,” he says. “But it tends to do best when real rates are negative.”

Some critics have raised concerns that the rate cut could be a way to bail out troubled hedge funds that have suffered losses in the subprime mortgage market. But, Beer maintains, the Fed has broader concerns and wants to ensure the problem does not extend into the overall economy.

“From bullion’s perspective, it is important that rates drop,” he says. “The reality is gold stocks do well at these inflection points, when real rates are less positive.”

Running a 90-name fund, Beer tends to have about one-third in junior players, one-third in mid-caps and one-third in large-caps. Lately, he’s been favouring some large-caps that have underperformed. One name is Goldcorp Inc., the fund’s top holding.

“It has one of the best management teams, the best growth profile and a number of new projects in the pipeline,” says Beer. “Growth is there and it’s visible.”

But last winter’s merger with Glamis Gold Inc. was viewed negatively and it has taken some time to see results. Says Beer: “The market has to understand the new entity.”

A long-time holding that has gone through several mergers (including one with Wheaton River Ltd.), Goldcorp’s stock hit a high of $45 a share in 2006. It recently traded around $30.40 a share.

Currently, the market has priced the stock on a multiple of 1.2 to 1.3 times net asset value, based on bullion at US$600 an ounce. “But it has traded up to twice NAV,” says Beer, “because people believed in the higher gold price and that these were growth companies.”

Lately, however, the industry’s growth has slowed and rising costs have eaten into margins. “We’re at the point at which we’ll see margin improvement,” he says. “And if gold stays at US$700 an ounce in the fourth quarter, earnings could be higher than expected.”

Beer believes Goldcorp can go through the $35-a-share level within 12 months.

Another favourite is Lihir Gold Ltd. of Australia. The world’s eighth-largest gold producer, it operates the third-largest mine in the world in Papua New Guinea. Over the next few years, production is expected to grow to 1.2 million ounces a year from 800,000 ounces currently. Equally important, its costs are also decreasing, pushing up margins. The company has closed its hedge book, Beer notes, so it is fully leveraged to the gold price: “That is a potent combination in a rising gold price.”

Bought in 2005 at an average cost of AUS$2.20 a share, a Lihir share recently traded at AUS$3.90. “If Lihir continues increasing production and lowering costs, and we have this higher gold price,” Beer says, “you could see the stock at AUS$4.50-$5 in about 12 months.” IE