With gold bullion breaking through the US$1,000 per ounce level, gold stocks have been running hard. And as concerns grow about the impact of trillions of public dollars spent to stimulate world economies, precious metals fund managers are bullish about the prospects for both stocks and the shiny metal itself.
\u201cWe see gold in a range of US$1,000-US$1,100 over the next 12 months,\u201d says Robert Cohen, manager of Dynamic Precious Metals Fund and vice president with Toronto-based Goodman & Co. Investment Counsel<\/b>. \u201cbut I\u2019m biased toward the higher end of the range.\u201d
Cohen points to the massive fiscal stimuli and additional money supply that have been pumped into the global economy as some of the chief factors.
For instance, the U.S. monetary base (the sum of its financial liquid assets in circulation held by the public and banks) has jumped to about US$1.8 trillion from US$1 trillion in September 2008.
\u201cThere are other issues, such as monetary reflation [through massive government-spending programs to boost economic growth], central bank buying of gold and foreign-exchange reserves that need to be diversified, such as those in China,\u201d says Cohen, who also runs Dynamic Strategic Gold Class Fund, a newly launched fund that combines bullion holdings with equities positions.
\u201cGold is about to take on an official monetary role again,\u201d says Cohen, \u201cand we expect to see diversification of foreign-exchange reserves into gold bullion.\u201d
The bullion price might be even higher, were it not for the global recession that has created a deflationary environment and the reduced consumer demand for gold jewellery. \u201cWe do not have consumer price inflation,\u201d says Cohen. \u201cHow can you, when you have high unemployment and overcapacity in the system?\u201d
Still, as one who believes in the notion of monetary reflation, Cohen maintains that there is a strong correlation between the rate of change in global liquidity, as measured by U.S. monetary supply and global foreign reserves, and the gold price.
\u201cThey track one another, with the exception that gold can get jerked around by other shocks. But [the correlation] can explain over half the gold price movements,\u201d says Cohen. \u201cIt\u2019s the single, strongest correlated variable.\u201d
Running a concentrated fund with about 40 names, Cohen owns a cross-section of gold companies but tends to favour smaller firms and mid-cap gold producers. \u201cThere\u2019s still leverage and value in those stocks,\u201d says Cohen, a buy-and-hold investor.
One of the largest holdings in Dynamic Precious Metals Fund is San Gold Corp. The mid-cap firm is redeveloping older gold mines in the Rice Lake area of Manitoba.
\u201cIt has also discovered several new gold-bearing veins that are very high-grade. That is transforming the story,\u201d says Cohen, adding that the new discoveries have tripled San Gold\u2019s gold reserves to about 1.6 million ounces. The firm is ramping up production to 240,000 ounces a year from 50,000 ounces a year within the next three years. \u201cIt has massive potential to get bigger and bigger.\u201d
Acquired in late 2005, at about 30\u00a2 a share, San Gold\u2019s stock is now $2.90 a share. Cohen believes it could be worth around $4-$5 a share within 12 months.
Another mid-cap favourite is Alamos Gold Inc. The firm is active in Mexico, where it produced about 150,000 ounces of gold last year.
\u201cIt had a lot of operational headaches a few years ago,\u201d says Cohen. \u201cBut in 2008, management turned things around.\u201d
The company is building a mill that utilizes a so-called mechanical \u201cheap leeching\u201d technique to process high-grade ore. This should result in higher volumes; by 2012, the company could be producing 200,000 ounces a year.
Acquired initially in late 2004 at about $3.75 a share, the stock is now $10.30 a share. Cohen believes it could hit $13 within a year.
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The gold price itself is immaterial, argues Beno\u00eet Gervais, lead manager of Mackenzie Universal Precious Metals Fund and vice president with Toronto-based Mackenzie Financial Corp. <\/b> \u201cYou don\u2019t want to time the gold market, but use gold as a diversifier \u2014 as a form of insurance in tough times.\u201d
Using the Dow Jones industrial average as a benchmark, Gervais notes that the index\u2019s purchasing power relative to the gold price has gradually deteriorated. In 2000, for instance, the index was equivalent to 50 ounces of gold (then US$300 an ounce).
@page_break@By the summer of 2008, the index had slipped to the equivalent of 15 to 20 times the US$800 gold price. It dropped again, to seven to eight times, when the DJIA bottomed this past spring. \u201cYou would have improved your purchasing power by owning gold,\u201d says Gervais.
Besides gold\u2019s superior purchasing power, Gervais argues, there is another issue at play: the massive growth in global money supply.
\u201cThe biggest challenge will be to absorb that extra money supply, as velocity returns,\u201d says Gervais, referring to the rate at which money changes hands in a fixed period. \u201cIt has to be taken out of the system before inflation gets ingrained. Anything that is in limited or declining supply, including gold, will do well [in this scenario].\u201d
Gervais argues that the price of gold bullion moves within a band, noting that in 2009 it will range from US$850 to US1,050 an ounce. Taking into account the growth in money supply, he believes the band will move upward by about 10% in the next year \u2014 meaning gold will range from US$935 to US$1,200 an ounce. \u201cThe price will rise because there is a fixed supply [of bullion].\u201d
From a strategic viewpoint, Gervais and co-manager Fred Sturm, senior vice president with Mackenzie, have not changed the Mackenzie fund\u2019s portfolio mix, which is split roughly equally among large-caps, mid-cap producers and junior plays that look promising but are riskier than the mid-sized and senior firms.
One of the larger senior holdings in the 50-name fund is Barrick Gold Corp. Although the stock has been a market laggard, Gervais likes it because he\u2019s convinced there is some upside.
\u201cIt\u2019s going through a renewal of its legacy assets, which it should complete by around 2011-12,\u201d he says, referring to Barrick\u2019s need to invest in mines such as Nevada\u2019s Cortez mine. \u201cIt looks like it\u2019s spending a lot of money, and not going anywhere fast. But when Barrick will be done with the process, then the free cash flow will start accruing to the balance sheet \u2014 either to shareholders or to make acquisitions. That should make it look like a much better stock.\u201d
A long-term holding, Barrick is $39 a share, unchanged compared with a year ago. Gervais, who has added to the fund\u2019s holding on weakness, has no stated target.
On the mid-cap side, Gervais likes Randgold Resources Inc. \u201cIt\u2019s an exceptional company because it does what very few companies do,\u201d says Gervais, adding that Rangold has made several discoveries in Mali, C\u00f4te d\u2019Ivoire and Senegal. \u201cIt is very good at buying assets cheaply, and turning them into multimillion-ounce projects. It is also self-financing.\u201d
Gervais notes that Randgold is producing 500,000 ounces annually, but could double output over the next five years. Part of this will be attributable to the firm\u2019s purchase of Moto Goldmines Ltd., which has been developing a very low-cost mine in the Democratic Republic of Congo that has 20 million ounces of reserves. The Nasdaq-listed Rangold stock is US$74 a share, compared with US$40 a share a year ago.
Gervais also favours smaller, exploration stocks such as Northern Dynasty Minerals Ltd. The firm has one of the world\u2019s largest copper\/gold projects in Alaska, he says, noting the firm is partnering with Anglo-American Gold Corp. to develop the multibillion-dollar project; within about four years, it could lead to one million ounces of gold a year, plus more than 500,000 tons of copper a year.
\u201cThe value is in knocking down all the technical and financial risks,\u201d says Gervais, adding that Anglo-American is spending $1.5 billion in exchange for its 50% share of the profits. \u201cNorthern Dynasty is getting a free ride.\u201d
The stock is $7.50 a share, compared with $5 a share a year ago.
Gold has remained a safe haven against financial calamity, argues Chris Beer, manager of RBC Global Precious Metals Fund and vice president with Toronto-based RBC Asset Management Inc.: <\/b> \u201cAnd I expect that to continue, going forward. We will probably continue to see the U.S. dollar depreciate vs most other currencies. A certain portion of assets in gold makes a fair bit of sense.\u201d
Beer is reluctant to make a call on the gold price, and instead concentrates on the factors that will drive gold higher. For one, he notes that the trade-weighted US$ will depreciate because the U.S. government is spending US$4 trillion and collecting only US$2 trillion in revenue.
\u201cThat [deficit] has to be funded somehow, not that many other countries are in better shape,\u201d Beer says. \u201cBut this should result in people using gold as a safe haven.\u201d
Given that the U.S. economy is expected to be sluggish, and the U.S. Federal Reserve Board is prepared to keep interest rates low for some time, Beer maintains that in this environment, it\u2019s a good time for gold. \u201cWhether it\u2019s US$950 or US$1,500 [an ounce], \u201che says, \u201cthe market will determine that.\u201d
And although inflation may appear to be almost non-existent, Beer argues that it will inevitably raise its head because of the massive growth in money supply: \u201cInflation is a monetary phenomenon. That\u2019s the argument for gold: a hedge against monetary inflation.\u201d
Beer divides the RBC fund\u2019s 50-name portfolio across the market-cap spectrum, with roughly equal proportions of large-, mid- and small-caps. One of the larger positions in the mid-cap category is Red Back Mining Inc. The firm operates the Tasiast mine in Mauritania, which produces about 200,000 ounces a year, and has about three million ounces in reserves.
\u201cIt\u2019s growing its asset base in two places,\u201d says Beer, noting that the firm\u2019s other operation in Ghana has also expanded. \u201cThis increase in reserves should lead to an increase in production and cash flow. The valuations are still quite attractive.\u201d
Bought at $2 a share during the initial public offering five years ago, Red Back\u2019s stock is now trading at $12.65 a share. Beer has a target of $15-$16 within a year.
Another long-time favourite is Goldcorp Inc. The senior producer is expected to continue growing, as it is investing heavily in the Penasquito project mine in Mexico. \u201cBy the first quarter of 2010, we should see commercial production,\u201d says Beer. \u201cIf all goes well, Goldcorp will add up to 500,000 ounces of gold a year, with some zinc and silver production, too. This should be a major cash-flow generator for the company.\u201d
Although Goldcorp currently produces 2.3 million ounces of gold a year, Beer believes that could rise to about four million ounces over four to five years.
The stock is $44 a share, compared with $38 a share a year ago. Beer has a 12-month target of
$52-$54. \tIE<\/b>
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