Miners Shrink Capital Expense to Grow Smart: Analysts

Smart companies are beginning to ignore analysts' insistence that production growth is always good, and to focus instead on growing their margins by lowering capital expenses. This is good news to US Global Investors Inc.'s Brian Hicks, co-manager of the Global Resources Fund, and Ralph Aldis, senior mining analyst and portfolio manager of the Gold and Precious Metals Fund and World Precious Minerals Fund. Learn what kinds of companies attract the interest of these active managers in this Gold Report interview.

The Gold Report: The Nov. 1 edition of Frank Talk suggested that gold equities generally perform poorly in a US election year but rebound strongly the following year. Do you expect a better year for gold and gold equities in 2013?

Ralph Aldis: This year has not been a stellar year for gold equities. Most of the gold equity funds have negative returns for the year.

Brian Hicks: We believe gold equities will do well next year, largely due to macroeconomic factors that have been in place for some time, but which will become even more pronounced in 2013. Those factors include central banks expanding their balance sheets and increased concern over deficit spending here in the US. Looking at how cheap gold equities are relative to the bullion price, that spread will continue to be arbitraged in 2013.

TGR: Every media outlet in the country is talking about the fiscal cliff. If the US goes over the fiscal cliff, what effect would that have on the gold price and on gold equities?

RA: No one has the stomach to let the country fall off the cliff. A compromise will be reached. The most likely scenario is that the government will have to print money in flight. That will be a very clear signal to own gold bullion, and gold equities will be handed their marching papers to go higher.

BH: Whether we get a compromise or go over the cliff, which is the less likely event, gold will do well. Either way, there will be a lot of uncertainty and concern about financial assets. That will prompt people to see gold as a hedge.

TGR: Gold equity investors have seen more volatility than gains in recent years. Should they expect more of the same over the next four to five years?

BH: The volatility has held true for the markets in general; it has not been specific to gold equities. On a relative basis, gold equities have outperformed the broader market since 2008.

To prepare for volatility, investors should be balanced, not overweight in any particular sector. You want to be able to capitalize on the volatility – to the upside or the downside. Gold equities are somewhat countercyclical; they can diversify a portfolio and be additive to overall risk-adjusted returns.

RA: When silver was hitting close to $50/ounce (oz), the regulators raised margin requirements something like five times in five days. That knocked silver for probably its biggest correction ever in a single week. If you live through that type of correction once, you become gun shy about going long on equities when the metal prices are going up.

More generally, the tech bubble, the credit crisis, the real estate crash and the large number of baby boomers approaching retirement are all causing people to sell equities. They are turning to fixed-income or structured interest-rate products. That provides a great buying opportunity for equities.

BH: Generalists talk about gold being in a bubble, but I agree with Warren Buffett that the real bubble is government bonds. At some point, that money will have to come out. When it does, it will be looking for returns and for yield. Gold stocks will be poised to capitalize on that.

TGR: How should gold equity investors handle common market corrections?

RA: One strategy, if you are certain that you are in a bull market, is to stay long the entire time.

I would say you stick with it.

However, in managing our funds, we always keep some cash on hand so we can buy stocks on these dips. For example, a company releases a good news story and the stock starts moving twice as much as any other stock that day. It is probably prudent to sell perhaps 1% of your position because you will be able to replace it later at a cheaper price.

TGR: Another edition of Frank Talk discussed how companies' margins are being compromised and growing thinner. What must gold companies do to boost investor confidence?

RA: The industry's mantra has been "grow production." That is what the analysts look for and what companies are trying to do, but it is difficult to grow production.

You can grow production through your own organic discovery or through acquisition. Too often, companies overpay or size up a marginal project from say, 30,000 tons (30 Kt)/day to 60 Kt/day. They have tried to grow production at the expense of lowering margins. If they lower their margins, they can no longer pay a dividend. If the gold price corrects, the project may no longer be economic.

Management needs to focus on return on capital, on making a sound investment in something that you can make money on.

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