NEW YORK (
) -- As
rise, every investor must own
for growth and dividends, says one analyst.
Caesar Bryan, portfolio manager of the
Gamco Gold Fund
, believes the gold price could rise to $2,000 an ounce and is making a big bet on growth-stage gold companies.
Bryan believes that as gold companies make more money for their gold they will return that profit to shareholders in the form of dividends. His largest five holdings currently are
, but his favorite companies are those that are growing rapidly either organically or through acquisitions.
So far this year his strategy hasn't paid off. The fund has returned 7% year to date while the gold price is up 10%. I recently spoke with Bryan to ask him to defend his commitment to gold stocks in light of his fund's underperformance.
Why do gold stocks make good investments
:They provide leverage to the price of gold and they also provide growth, which gold doesn't provide investors, so with a rising gold price gold stocks general do better.
Now that hasn't been the trend though recently, so what kind of leverage are you looking at and when
Bryan: Well, that's right. I think that maybe reflects a general fear towards all equities but ... they're providing now a pretty good value.
Year to date your fund is up 7%, but the gold price is up 10%, so you are underperforming the gold price right now. When are you hoping that's going to turn around? Are you changing strategies
Bryan: No, we think that in a higher gold-price environment the gold equities will begin to perform very well.
Are you looking at 3:1 leverage
Bryan: I don't know whether it's going to be 2:1 or 3:1, but ... if you look at the valuations of the gold stocks in a $2,000 gold price environment we think they're extremely undervalued.
Do you think the gold price will hit $2,000
Bryan: I don't actually have a target for the gold price, but we're in a bull market. The price is going to, I think, move higher so I just chose that price
to see what the earnings capabilities are of these companies and it's quite impressive.
How else do you pick your gold stocks aside from their valuations
Bryan:There are really three things that we look for. First, the underlying assets; what's the business model; what reserves and assets does the company have?
Second, and this is important because it's quite a difficult business, is management. Who are the managers of the company and what has their track record been?
Third, the financial structure of the company, which will
show how much debt they have and what leverage they have to the price of gold, and do they have any hedging.
One of the interesting aspects of gold equities is their ability to pay a dividend ... If you look back at the gold equity bull markets in the '30s and '70s, the companies were able to pay considerable amounts of money back to investors, and that's one of the factors that drove their share prices.
Of course that hasn't happened yet. These companies do not pay considerable dividends, but with the gold price where it is now, and if it continues to go up from here, these companies will generate significant amounts of cash flow. I would expect part of that cash flow would be returned to shareholders. That will differentiate these companies: the gold producing companies from the exploration companies and from gold bullion, which of course doesn't pay any dividend.
Bryan: This is a company that's really been able to grow its metric on a per share basis, which is unusual ... for gold stocks. It really hasn't been much of a growth industry. And they've really been successful at finding gold: 1.3 grams of reserves in 2003 and went to 5.5 grams in 2009, and I think that'll rise again this year. So it's really a growth story
Now many analysts say that Randgold trades at too much of a premium, what would you say to that
Bryan: Well, a couple of things. First, they're expanding their production very rapidly over the next few years and at $2,000 gold on next year's production using just their unit cash costs ... they're at six times cash flow. They're growing,
and maybe the price is discounting a little of that growth.
Second, the recent takeover offer of
I think puts Randgold almost in the undervalued camp. Kinross paid over $7 billion
Randgold has a market cap of about $8.1 billion and for that they got significantly lower production and also significantly lower reserves relative to Randgold.
Now when I look at gold stocks in general they're pretty volatile, but Randgold in particular is extraordinarily volatile. Why do you think that is
Bryan: I'm not sure I know that answer to that, but you're right, gold shares are volatile, and maybe it's because it has such a high nominal price, but yes it seems to move around quite a bit.
Randgold when it went public, and if memory serves me correctly, our initial cost price was about $6, so that's been a decent investment.
Do you feel like perhaps the stock is overowned? I know a lot of fund managers actually really love Randgold
Bryan: Possibly, but last time I checked there were actually a few gold funds that didn't have exposure to it. ... It's got an enterprise value of about $7.6 billion, so I'm not sure how it gets to be that overowned and on the metrics ... of enterprise value per ounce of reserve and resource, it trades around $300, which is quite a bit less than a company like
and more in line with a company like
Bryan: Well, Agnico-Eagle is similar to Randgold in that it's experiencing rapid growth. Three years ago, this was a one-mine company, and the one mine was based in Canada ... and they've expanded now to have six operating mines. They've had some teething trouble bringing these mines into production, but I think they're getting over that, and meanwhile, the stock has sort of treaded water actually for some time and now provides a good opportunity.
Do you have a price target for this stock
Bryan: No, I don't but ... to give you a couple of numbers on Agnico-Eagle, it has a market cap of about $11.2 billion, and their production is growing rapidly. On a unit cash cost, we have price of cash flow number of 13 times falling to about 10 times in 2010 ... in a $2,000 price environment
it falls to 5.2 times cash flow for 2012.
Now let's go to Newcrest, did you like Newcrest on its own or did you just like Lihir Gold (LIHR)
Bryan: We own both in the portfolio. Newcrest without Lihir actually had a very good growth story in our opinion. They're actually good at finding gold, a little like Randgold, but they're a more established company. With Lihir ... we expect that deal to close at the end of this month ... they'll have a market cap of about 22 billion; that's Australian, so take 10% off for the U.S.
Lihir really gives them just a backup; Lihir was about a $7 billion market cap, and they produce 1 million ounces of gold, and they've got a huge reserve and resource on Lihir island on Papa New Guinea. This company's a cash generator, and following the merger, Newcrest will have a very strong balance sheet because they are paying in stock. Then they will have the cash generation to grow in other areas
and to execute some of their growth projects. So we think that both on an earnings basis but also on a reserve basis, the company is actually very inexpensive, and we think it will attract considerable buying once the deal is closed.
Now I have heard that picking gold stocks like a Barrick Gold (ABX) , for example, that aren't going out and looking to acquire other companies is actually a safer way to play the gold sector because they're not going to have to spend all this money buying another company, and that organic growth is a better bet
Bryan:The problem with the larger gold companies is that if their producing like Barrick 7 to 8 million ounces, they've got to try to replace that every year ... and sometimes it's easier to replace those ounces by making acquisitions, an early stage acquisition, than trying to find gold because it's hard to find obviously.
And so you're not skittish about betting on the companies making those big purchases
Bryan: Obviously the biggest increase in value is when the company can find gold, so we do have a number of smaller development and exploration companies in the portfolio. But that doesn't amount to a huge percentage because it's a much higher risk.
Smaller companies do the exploration but very often larger companies will come in to define that project and then bring it into production, which takes some capital and some expertise.
So do you wind up trying to play that trend, do you want to bet on the small miners that might be takeover targets
Bryan: Yes, to a limited degree ... our idea right now is that in a high gold price environment ... companies in production will start generating a significant amount of cash, and we think when they raise their dividend or return capital to shareholders, we think
these stocks are going to be an attractive proposition.
Do you hedge risk in the fund at all
Bryan: In the prospectus we are allowed to have 30% of the fund invested in bullion, and we have invested in bullion in the past, but to a limited extent. Right now we think there's a great play in the gold equities. Now any investor's gold allocation should contain, we advise, some bullion but also some equities.
Now just as a rule of thumb the
Philadelphia Gold and Silver Index
, at the low end traded around 20% of the gold price. Since the Lehman failure when equities and gold equities were sold across the board, that relationship was bust wide open and went down to about 10%.
There has been some recovery since then but ... with gold at $1,240
at the low end of 20% that's about $246 or so on the XAU and that's about 40% higher than the current level, so the de-rating of gold equities was pretty excessive.
What happens if you're wrong and gold prices fall substantially
Bryan: Gold equities won't be a good place to be then.
Written by Alix Steel in
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