Gold prices are down in the short term, but the commodity metal is here to stay, says geologist Joe Mazumdar. In this interview with The Gold Report, the Canaccord Genuity analyst assesses the current situation and compares the performance potential of the majors with the mid caps. He backs up his analysis and predictions with a few solid companies that are positioned to weather the storm.
The Gold Report: Where can long-term gold investors look for safety during times of market turbulence?
Joe Mazumdar: Is there safety in the gold market? The short answer is no. Both the equity and gold market have been volatile, lately more the latter. Gold stocks have a good correlation, a beta, to gold, and if the price of gold is volatile, the stocks will be volatile. This leverage to the gold price cuts both ways for gold equities. Year to date, gold is down 10–15% as it has underperformed most commodities including copper, oil and natural gas, while the S&P/TSX Global Gold index is down almost 30–35%.
Other reasons why the gold equities have disappointed investors includes the failure to achieve benchmarks or guidance on costs, both operating and capital, and timelines, among others. The overriding financing risk, especially for the juniors, has continued to weigh on their performance.
Major gold producers provide liquidity, but are not necessarily a safe bet. Over the last few years, the large gold companies have not shown growth at a reasonable price. The amount of reserve repletion they require is their Achilles heel such that they have focused on dividends. This is nothing new, as the project requirements tend to create significant footprints and attract the attention of other stakeholders who want to slow down or cancel mining development. This issue is affecting Newmont Mining Corp.'s (NEM:NYSE) Conga project, Pascua Lama with Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and El Morro with Goldcorp Inc. (G:TSX; GG:NYSE) and New Gold Inc. (NGD:TSX; NGD:NYSE.MKT). If a major's growth is linked to this type of project, it is not necessarily a safe place to invest.
Investors should seek out companies that have strong working capital positions relative to their near- to medium-term business plan needs, while taking into account their leverage to gold price. The chosen firms should be able to generate decent margins at current spot levels. We would be wary of companies that are in the midst of a material capital cycle, especially if a significant proportion of the funding was expected to be sourced from organic cash flow. Gold has bounced back well over $1,400/ounce ($1,400/oz), but the stocks can be stress tested to $1,200/oz. We should anticipate more hedging requirements linked to debt financing facilities.
For intermediate producers, look for decent margins at spot levels and stress test down to $1,200/oz. But be wary of any upcoming capital cycle that the firm is looking to execute in the near to medium term. If a company is trying to manage a 10% compound annual growth rate of production, how much new capital does it need and over what period? What is the cash flow? Will it need to return to the debt markets? Look for well-funded developers that do not need to return to the equity markets over the near term.
Seek management teams that have proven capacity to take the project into production. The amount of multiple mergers and acquisition (M&A) bids for targeted companies is few. While some decent premiums can be had, they tend to be off of 52-week lows. For M&A potential, I look for a team that can accrue value to the project by derisking it—a team that has previously permitted, developed and produced comparable projects in similar jurisdictions.
For explorers, look for companies with working capital positions that can fund at least a two-year business plan, can move the project forward and are not just burning general and administrative expenses. Executives and senior managers must be vested in the success of the project.