Sprott Fund Manager: "Gold Stocks Are the Cheapest I've Ever Seen"
Jeff Clark: Charles, I understand you lost a bet predicting the gold price.
Charles Oliver: Yes, I did. I made a bet four years ago at one of my first meetings with Sprott clients. Gold was trading just over $920 an ounce, and I told them it was going to $2,000 in the next four years and that if I was wrong, I would shave the hair off my head. Well, we got close, but a bet is a bet, so on April 16 my hair was shaved on BNN.
Jeff: Very honorable, holding up your end of the deal. I understand you raised money for charity, too.
Charles: Yes, as part of the event I put together a charity program, and we've raised about a million dollars so far. I personally donated $100,000, because if I'm going to ask everybody in the mining industry who's benefited from this rise in gold and silver prices to give, then I have to put up my own money, too. We actually have four different charities - a quarter each to World Vision, Care Canada, UNICEF, and Terry Fox, which people can read about at the link.
Jeff: So how about going on record and making another bet where gold will be four years from now?
Charles: [chuckles] You know, I've just lost all my hair, and I'm thinking before I make any new bets I'll wait until gold actually gets to $2,000. I'm optimistic that will happen this year, though.
Jeff: Gold has been stuck in a trading range since last September. In your view, what's kept the price from advancing?
Charles: I think one issue is that in December the Europeans embarked upon their version of QE. They called it the "long-term refinancing operation," where they effectively put 500 billion euros into the hands of the banks of Europe - and just like quantitative easing, it had a big effect on the markets and all assets rose, including gold. Then on February 29, the Europeans did their second round of the LTRO, and the early expectations were that we'd see between half a trillion and a trillion dollars, but they announced at the low end of expectations, 530 billion euros. We saw a big selloff in the markets, along with the gold price. So although we've seen a major amount of printing - over a trillion euros in the last few months - the market was somewhat disappointed.
That money is getting into the economy, but it's a bit slower than expected and the market wants to see more. They're already asking the Europeans for more actions in terms of printing or other methods of stimulating the economy.
Jeff: It sounds like you're saying the gold bull market might be over if governments don't resume printing - some in the mainstream make this claim. Is that the primary driver for gold now, or are there other factors that will push the price higher?
Charles: I keep hearing the gold bull market is dead, year after year. Certainly one of the biggest themes for gold over the last decade has been the debasement of currencies, so this has been one of the most important factors. And I do think they're going to print again, because there's been no solution to the debt conundrum. It's my belief that it's only a matter of time until they embark upon their next binge of money printing.
That said, if you go back to long-term fundamentals, you'll see that countries around the world continue to run large budget deficits, and this is very bullish for gold, too. You also have to look at supply and demand. There was an uptick in mine production last year, but supply has been fairly flat over the last decade. The more compelling data has been with demand - increasing investment demand and burgeoning demand out of China. Remember that individuals in China were not allowed to own physical gold as recent as a decade ago, and now they just imported about 760 tons, roughly a quarter of mine production. So they've gone from zero to 25% of worldwide demand in a very short period of time. And they're still only a fraction of US GDP, with a population that's more than four times bigger. They have north of $3 trillion of reserves, about two-thirds of which is in US dollars, and they've been saying they don't like the way the US is debasing their currency and are looking to diversify into hard assets. Add it all up and they could very easily add 10,000 tons of gold to their reserves, an amount that represents about four years of the total global mine production.
So I'm expecting this trend into gold to continue for many, many years.
Jeff: You mentioned that gold hits $2,000 this year.
Charles: Yes, I believe that's going to happen. One of the things I've been watching for the last four years is the trend line that started during the financial crisis of 2008... we're near the bottom of that trend line now and $2,000 is squarely in the middle of it. So if we stay within the trend, which I think we will, we'll hit $2,000 by year end.
Jeff: Let's talk about gold stocks. Investors are getting frustrated, discouraged, even angry at the poor performance in gold and silver equities. What's your opinion on why they've been lagging so much?
Charles: I've done some analysis of gold and gold stocks over the last decade, and what I found is that prior to the launch of the ETFs, from 1999 to 2004, every 1% increase in the price of gold was matched by about a 4% increase in the HUI Gold Bugs Index. But we saw a very dramatic change after the launch of the ETF in 2004. In fact, over the last six or seven years, gold has outperformed gold stocks by a ratio of 2:1.
Now, why has this happened? Well, in 2004, it was a no-brainer to sell some of your large-cap gold stocks because many of them had PE ratios between 40 and 50. They were expensive, and it was easy to say, "Let's buy some bullion because it's cheaper." This trend has proliferated - we're seeing strong investment demand for ETFs from pension funds and trust funds, and the general money flows over the last seven to eight years have been primarily into the ETFs.
Now, though, we've gone too far the other way. Look at Barrick; it used to have a P/E of 40-50, and now it's about 7-8. Yet the company has tripled earnings and increased their dividend over the last five years. Next year they should increase their earnings again, and we could say the same thing about Goldcorp, Newmont, etc.
We've seen major price compression over the past couple years and yes, it's been painful to watch. I sometimes bang my head on the wall when I see the disconnect between the price of gold and gold stocks, but at the same time I recognize this is a great time to be buying gold stocks because they're so cheap.
Jeff: So you're saying the demand for gold ETFs has taken away demand for gold stocks?
Charles: It has taken away some of the demand. Keep in mind that until recently, the only way for pension funds to participate in the gold market was through the stocks. They couldn't actually own bullion, so today they've allocated some of what they could have put into the stocks into the bullion ETFs.
Having said that, look at how dramatically earnings and cash flows from the stocks have grown. Margins have gone from a couple hundred bucks an ounce to over a thousand bucks. The stocks are incredibly attractive, and this will eventually bring those investors back to the equities.
Jeff: Other than the attractive valuations, what other catalysts might light a fire under the equities?
Charles: Another catalyst I expect is dividends. They've been increasing dramatically. I think a lot of investors are beginning to recognize that you have to pay a storage fee if you hold the ETF, whereas you actually get paid to hold a gold company. Plus, you'll benefit from increased earnings and cash flow as the gold price rises. A lot of gold stocks haven't yet increased their dividends to the levels that have grabbed the interest of major investors, but I think that will happen at some point.
The other area I think could potentially heat up is mergers and acquisitions. There have been some interesting comments along these lines just last week. One was from Mark Cutifani of Anglo Ashanti (AU), who said he was hoping to expand his business in Brazil and was looking at acquisitions there. He called the juniors "very cheap" and gave a clear impression he would be acquiring some assets. Then Steve Letwin of IAMGOLD (IAG) was quoted in the Globe and Mail as saying he is planning an acquisition in the next three months. He was looking to add something that would cost no more than a half-billion dollars, most likely in the Americas, though they're also active in West Africa.
I think as people say, "Jeez, look at the value in these companies," you'll see interest grow. Gold stocks are looking as attractive as I've ever seen them, certainly in the last decade. We've been in somewhat of a slumber, but as the senior gold miners take an interest in smaller companies the market will wake up.
Jeff: The head of precious metals at GFMS said producers should start hedging their production if gold hits $2,000. Do you agree that would be a good move on their part?
Charles: The simple answer is "no." My near-term target for gold this year is $2,000, but with all the printing I expect to occur in the coming decade, I think the gold price will ultimately go well beyond that mark. I think those companies that hedge will actually be penalized by the market for doing so. Barrick was one of the last holdouts who covered their hedge book in 2009, and some simple math shows they've saved billions of dollars by covering. In my opinion, you're not going to see many companies hedge at $2,000. Some companies will be required by the bank to put on hedges to get financing and put a mine into production, but that will be the exception.
Jeff: Have you heard any producers talk about hedging?
Charles: No.
Jeff: Silver stockpiles at the COMEX warehouse reached their highest level in 10 years, about 141 million ounces. That suggests either demand is low or mine production is up. What do you make of this?
Charles: I'm always concerned when you see an increase in inventories, as that does have some negative impact. However, if you look at inventories 15-20 years ago, you'll see current levels are about half what they were back then.
You're always going to see increases and decreases in inventories with every bull market, so I'm not worried about this.
Jeff: What's your long-term outlook for the silver price?
Charles: We're incredibly bullish on silver. One argument we're making is that the gold-to-silver ratio [gold price divided by the silver price] should be closer to 20:1 rather than its current 50:1. If you look at the last 2,000 years, the long-term gold-to-silver ratio has been 16:1 about 90% of the time. At 16:1 and gold at $1,600, you'd expect the silver price to be closer to $100, which would be roughly a triple from the current level.
Look at history, too: the Roman exchange rates of the time were 16:1. And the United States mandated in the Coinage Act of 1834 that when somebody asked for a dollar's worth of gold or silver for their $1 paper currency, the government would given them metal in the ratio of 16:1. Why 16:1? The reason is because that's the ratio in the earth's crust: for every one ounce of gold there exists about 17.5 ounces of silver.
So if you're a miner, it should cost you roughly the same amount of money to extract an ounce of gold as 17.5 ounces of silver. So if the production costs are about the same, they should have roughly the same price. That's why for most of the last 2,000 years that ratio has been in place. What changed was when the US decided about 130 years ago to leave the silver standard, and in that process they sold down their inventories. Then the European banks sold down their inventories, then the Chinese, and in this process the gold-to-silver ratio went up to the level of 50:1 where it is today.
Jeff: It sounds like you see some explosive potential with silver.
Charles: Absolutely. I would also point out that if you go back to 1980, the silver price briefly touched $50 and gold hit about $850, so for a small period of time we did get close to that 16:1 ratio.
Jeff: To wrap this up, Charles, I'd like to put you on the spot. If I held a gun to your head, what one gold or silver stock would you buy right now?
Charles: You don't have to hold a gun to my head. I'd buy all the gold and silver stocks I can. They are so attractive. It's frustrating, I know, but just about everything I see out there looks attractive.
Here are a couple examples. A company called Colossus Minerals (T.CSI) announced a couple of weeks ago that the metallurgical recoveries of some of their PGMs [platinum group metals] were better than expected - but the stock hit a 52-week low. Then another company, Kirkland Lake Gold (T.KGI), announced they acquired some very valuable property, the other 50% of the South Mine complex, and their stock also hit a 52-week low. Both of these stocks are in our top 10 holdings.
My point is, a lot of companies have good news and are not being rewarded for it. There are bargains almost everywhere in the sector.
Jeff: If you could tell precious-metals investors one thing right now, what would it be?
Charles: Be patient. This is a frustrating time, I know. I see good news and then watch stock prices fall, yet I see P/Es between seven and nine. And this is from companies that have the potential to double their production in five or six years. If a gold company was a tech stock, it'd be trading at a 30-40 times multiples. So there's a lot of ground to make up.
So you've got to be patient. The valuations in gold stocks are incredibly compelling. And every reason to expect printing to continue still exists, so stay tuned; printing will come and gold will fly once again.
