Investors expect too much of gold, says Adrian Day in this interview. It’s important to remember its function is to preserve purchasing power.
2018 has brought potentially positive catalysts for gold, but even with trade war concerns and other geopolitical issues the yellow metal has not met some investors’ expectations.
Speaking at the recent Mines and Money conference in New York, Adrian Day, president of Adrian Day Asset Management, explained that he believes “people expect too much from gold.”
He explained, “gold, after all, should be a store of value. It should simply preserve your purchasing power. If you read a textbook or think of a theory, that’s why you invest in gold: to preserve your purchasing power, not to get a double or triple on the price of a commodity. So I think we expect too much from gold, frankly.”
Day also discussed prospect generators and royalty and streaming companies, outlining the advantages and disadvantages of both models.
Overall, he said, his favorite metal right now is copper. Why? “I like copper in particular [because] copper’s supply deficit … four, five, six years out is purely based on the supply. In other words, you do not need the demand to pick up in order to have a supply shortage in copper,” Day said.
Listen to the interview above for more insight from Day on the gold market and more. You can also view the transcript below.
INN: We’re here at Mines and Money in New York, and you’ll be on a panel tomorrow discussing royalty and streaming companies as well as prospect generators. Can you start by telling me what you like about those models?
AD: Both of the models are different, obviously, but from my point of view they share one big feature in the gold space, which is they mitigate the risks of the competitors in their space. So if you look at royalty companies, for example — or let me switch. If you look at mining companies, for example, miners have a lot of risks. We know about huge capital expenses, many years in many cases before you get a return and mines once built can be confiscated by governments or taxes can be raised; and that’s in addition to just things that go wrong with mines. Robert Friedland likes to say that Murphy works overtime in the mining business. So a royalty company mitigates a lot of those risks because you put money in to buy a royalty. Once you put the money in you’re not responsible for what goes wrong in the future.
And in many ways it’s similar with the prospect generators. If you compare a prospect generator with the traditional exploration company — exploration as we know is an extremely high-odds venture. Rick Rule this morning said one in 3,000 anomalies becomes a mine. So the odds are very, very long, and if you invest in a prospect generator you’re giving yourself exposure to multiple opportunities. So you reduce those odds significantly. I like to look at it as buying a little bit, having a little bit of many, many lottery tickets instead of just one lottery ticket.
INN: Lots of benefits there. Are there any disadvantages you would point out for those two types of models? I don’t know if I’ve ever heard any.
AD: Certainly prospect generators have a couple of disadvantages. One obvious but very important disadvantage is that once you’ve done an earn-in agreement with another company who’s spending the money, they are the ones that control to a large degree, they control the pace. They control sometimes where the money’s spent, and they control also things like the release of news, which can be very important for a junior company. Basically you’re no longer in control of your own destiny, and there’s many, many, many stories of companies that have done JVs with large companies — we won’t name names — the company met the terms of the agreement, but [only] just, and five years later after having done a minimal amount of work they gave the project back. And for the junior, that’s five wasted years essentially. Now, I’m making it as extreme as possible because of course you get the work that’s been done. You find out … what’s a good target, what’s not a good target and so on.
People say, “but royalties” — the knock on royalties is that they don’t have the leverage of mining companies, and they certainly don’t have the operating leverage. But in terms of stocks … there’s obviously four big royalties, Franco-Nevada (NYSE:FNV), Royal Gold (NASDAQ:RGLD), Wheaton Precious Metals (TSX:WPM,NYSE:WPM) and Osisko Gold Royalties (TSX:OR,NYSE:OR), and then there’s a bunch of smaller ones from Sandstorm Gold (NYSE:SAND) downwards. I’ve looked at those royalty companies in various times against the Philadelphia Gold and Silver Index (INDEXNASDAQ:XAU). I’ve looked at them in strong markets, I’ve looked at them in weak markets, and the royalty companies tend to outperform over … medium-term periods whether they’re strong markets or weak periods, and I think that’s because they tend to have better balance sheets and the balance sheets help mitigate the risk in the mining business.
INN: You mentioned a number of the key players in the streaming and royalty space. There’s not a huge amount of choice out there. Do you have any favorites, or how should investors go about choosing these kinds of companies?
AD: I mentioned the four big ones, and I’m talking about gold and silver here. Obviously outside of gold and silver you’ve got companies like Altius Minerals (TSX:ALS), but we’re focused on gold and silver here. So if you ask me which are my favorites, I’d say I like all four of them. I often say for people, “if you’re only buying one stock and you don’t know much about gold and silver and you don’t want to follow it too closely … the stock to buy is Franco-Nevada.” That’s the … number one without a shadow of doubt, but its multiple reflects that, frankly. So you’re paying up for quality.
But I like all of them, they all have different attributes, they all have different qualities that could make them succeed over the next year or two. Wheaton, for example, has the dispute with the Canadian tax authorities, and there’s no question that that is acting as a weight on its stock price. Franco and Royal, for example, trade at 1.9 times NAV, Wheaton trades at 1.5 times NAV. So a significant discount. Once that tax dispute is settled — and frankly, I think however it’s settled, once it’s settled I think the stock will rerate. Osisko is the newer, smaller of the big four and its valuation reflects that. So it’s selling at 1.1 times NAV. So if you’re prepared to take a little more risk and wait a little longer you’ll get a much bigger rewriting with Osisko. So I like them all.
INN: Same question for prospect generators. There’s a little more selection there.
AD: There’s a lot more selection, and of course I should say in royalties there’s also some smaller royalties … I think the things to look for in the prospect generators really are the people and the balance sheet. And that matters so much more to me than any particular property they have. Because remember, if you’re buying a traditional exploration company which is putting all of its money into one project, you really want to know the project and like that project. The whole point of a prospect generator is that you’re getting a little bit of a lot of projects. There are some prospect generators I could mention that have as many as 40 different projects. You’re getting exposure to a lot of things. The individual property is less important; the management, their discipline, the whole — again, the whole point of a prospect generator is that they don’t have to continually go to market to dilute themselves. So you want to make sure you invest in a company that has a history of not constant dilution.
INN: Let’s switch gears and talk about gold. Last time I checked the gold price was about flat year-to-date, and I think some people find that surprising given trade war concerns, other geopolitical developments. Why have we not seen more upward momentum from gold this year?
AD: You know, that’s a really good question. I think there’s a couple of things. Number one, if you’re looking at this year in particular, certainly there are some things that we might think would make gold go higher, but we’ve also had recently — we’ve had the prospect of a detente between North Korea and South Korea and the US. That certainly has removed some of that geopolitical concern. Without being too cynical we could say that the Middle East has been a concern for 20 years, so … what’s different now? And of course also recently we’ve had a bit of a recovery in the dollar, which has hurt gold.
But I think generally speaking people expect too much from gold. Gold, after all, should be a store of value. It should simply preserve your purchasing power. If you read a textbook or think of a theory, that’s why you invest in gold: to preserve your purchasing power, not to get a double or triple on the price of a commodity. So I think we expect too much from gold, frankly.
INN: What can investors expect from the gold price as we head into the rest of the year?
AD: I’m extremely positive on gold on a … two- to three-year basis. I think the biggest risk in the near term is the US dollar because gold has a pretty high correlation, or anti-correlation, negative correlation. It has a pretty big negative correlation with the dollar, and that has been very, very true for the last six months … or year. So I think the biggest risk is the dollar. Looking a long ways out, or looking on a medium and longer term, I think the dollar has to come down. It is overvalued relative particularly to the Asian currencies, and the Asian currencies, all of them — the Chinese, Singapore all of them — need to fundamentally revalue, but that’s going to be a slow process. And in the immediate term … if we have a successful summit between President Trump and Kim … if nothing worse happens in Europe with regard to Brexit, if the economy in the US continues to be relatively strong, we could have a series of events that will support the dollar in the near term. So that’s the biggest risk.
INN: Here at Mines and Money you moderated a panel this morning on gold. You asked some good questions about mergers and acquisitions to the panelists — are we seeing enough of it, that kind of thing. What are your thoughts on M&A right now in the gold sector?
AD: The gold-mining companies — mining companies generally — but the gold-mining companies have acted and have always acted in a very pro-cyclical manner when they should be counter-cyclical. So we got a huge amount of money spent in 2011, 2012, 2013. A huge amount of money on marginal properties, most of which has now been written off. And yet when the price of gold is weak — over the last two years we’ve seen … very few companies take advantage of those low prices, and there’s a lot of reasons for that, but we’re beginning slowly to see that turn and it’s turning first among smaller companies. So we’re seeing smaller companies, not even mid tier, but smaller companies, take positions in juniors, doing joint ventures with seniors. We’re definitely seeing a pickup.
I think it has a long, long way to go, because fundamentally the mining companies are not replacing what they’re producing, and that’s been true for a few years now. And we’re going to start seeing that in the production numbers very soon. They’re not replacing what they’re producing, many of them have huge gaps in their pipeline … over the next 10 years. Remember, it takes a long time to build a mine, so many of them have huge gaps in that pipeline, and I think as these become more apparent companies are going to realize they have to … do joint ventures with juniors, they have to buy deposits. They have to buy companies. It’s the only way to stay flat.
INN: How big of an issue is declining gold supply? Would we ever see a gold supply crunch?
AD: No. I mean, it’s all at the margin, however … prices are set at the margin as they say. So we may only see a 5- or 10-percent decline over a couple of years, but that would be very significant on a marginal basis. It would be significant in and of itself, supply/demand, but it would also be significant from a psychological point of view. If we start to see production declining even marginally — 1 percent, 2 percent, 3 percent — that takes on a life of its own in the investor’s mind. So I think it’s very significant. In the 1970s, for example, we saw production decline; there were a lot of other factors of course, but the gold price went crazy.
INN: Any commodities other than gold that you believe have potential this year?
AD: My favorite commodity will be copper right now. The reason — a lot of the commodities; again, the background. In 2011, 2012, 2013, you had a huge surge in production, a huge boost in production in many commodities just precisely at the time that China’s economy was shrinking a bit and consumption was going down, which led to lower prices. So all of the commodities are in that situation. Why I like copper in particular is copper’s supply deficit … four, five, six years out is purely based on the supply. In other words, you do not need the demand to pick up in order to have a supply shortage in copper.
When you think that copper mines take anywhere from 15 to 20 years or longer to come into production, we know what’s going to come into production five years from now. There might be some that are bigger than we thought, and there might be some old mines that last longer than we thought, but there’s not going to be any major source of copper production five years from now that we don’t already know about and that we can’t calculate and do the math. The plain fact is we have a supply shortage in copper … in five years’ time. And so investors are look forward looking, so they start to buy ahead of time.
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Securities Disclosure: I, Charlotte McLeod, hold no direct investment interest in any company mentioned in this article.
Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in contributed article. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.