By
The Gold
Report
:
Many precious metals mining stocks are now trading at bargain
prices, but the old "buy and hold" strategy no longer applies in
this fluid market environment, says Florian Siegfried, CEO of
Precious Capital AG. In this exclusive interview with
The Gold
Report
,
Siegfried says investors need to do their homework and pick their
entry and exit points carefully as he names some undervalued
opportunities he expects to provide above-average returns in the
next market run-up.
The Gold Report:
This is the first time you are speaking with
The Gold Report
, Florian, so maybe you could give us a brief overview of Precious
Capital AG and its investment focus.
Florian Siegfried:
Precious Capital is an independent, privately held fund-management
company in Zurich, Switzerland, with a team of financial and mining
professionals. Our investment strategy is to identify undervalued
future winners in the precious metals mining space. Often these are
companies that are not yet the focus of the bigger institutional
brokers, have good future expansion potential, have reasonable
market capitalization and are driven by good management teams. We
took over the company in December 2008, and since then, the
business has grown quite consistently, and this year is performing
very well for us.
TGR:
Can you give us your European perspective on the current global
economic and financial situation and where things might be
headed?
FS:
We are long-term bulls on gold because we think that the debt
crisis in Europe has been downplayed for too long and there is no
solution to the problem. Eventually, we expect to see a credit
deflation where most of these bankrupt governments in Europe are no
longer able to repay their debt, which will translate into more
stress in the banking sector. In our view, this will lead to a
deflationary downward spiral, which cannot be manipulated any
longer by printing money, because eventually the insolvent banks
will fail to lend, and then there is no possibility to lift asset
prices anymore. When that happens, the investor community will have
a huge preference for liquidity and unleveraged assets.
We think gold is the most favorable asset class in a time of
credit deleveraging. An investor in gold will make money in real
terms as the credit bubble deflates. Investors who are long in
euros or commodity-based currencies will actually lose in
purchasing power as credit deflation hits. This is our long-term
view and we think that there is no further room to manipulate asset
markets, as they have been in the past. I think that we are at the
triggering event here.
TGR:
How much air do you think can come out of this whole system? And
how much can prices deflate overall?
FS:
That's a difficult question. One has to look at various asset
classes. We would be rather bearish on base metals, such as iron
ore, which has already declined quite dramatically since the
beginning of the year. China has to rebalance its economy, which
largely depends on capital investments and exports and this could
become a real problem now. I wouldn't be surprised if in two or
three years we would see prices off by 30% or so. Oil prices are
still getting some support because of the geopolitical situation,
but as China slows down, consumption is probably going to decline
and we could see oil off 20% over the next few quarters.
In the equity markets, I think earnings disappointment is going
to be a major topic next year. Sooner or later, the market has to
realize that if Europe is in a recession, China is slowing down and
the U.S. is not getting ahead of the curve, where would earnings
growth come from? So, I would expect equity prices, overall, in a
year's time could be lower, probably by 10-20%.
TGR:
In reading through your Precious Capital fund materials, it was
interesting to note the major credit crises over the last 300
years, starting with the South Sea Bubble in 1725 and then the
British Credit Crisis of 1772 and then the panics of 1825 and 1873,
followed by the market crash in 1929 that started the Depression.
Then we had the bad recession in 1973. Now we have this global
financial crisis that started in 2008. If the previous 300-year
pattern holds, it would indicate another severe event around
2025-2030. Do you think the Federal Reserve and foreign central
banks can keep things together and prevent a major collapse in
2025-2030?
FS:
These kinds of cycles have a common characteristic. In each, you
have good times, with real or so-called "prosperity," mostly driven
by excessive use of leverage and debt. 2008 was the same, with too
much credit and debt. Bear Stearns and Lehman Brothers failed to
serve the debt because they were too highly leveraged. Then the
whole system broke down because if one bank failed, many others
would fail.
I think we are still relatively early in this kind of cycle. The
Federal Reserve and the European Central Bank have really acted
ambitiously to solve the crisis and prevent the system from
collapsing by just printing money to loan at 0% to the banking
system. But, eventually, what is it going to change? In the long
run nothing, because it's not just a liquidity crisis. It's also a
solvency crisis. The only solution to too much leverage is less
leverage. Only the market can bring that leverage to a level where
it is actually sustainable. I believe the stimulus, TARPs and LTRO
programs from all the central banks have only pushed the inevitable
credit deflation cycle down the road.
TGR:
So how does all this influence your investment strategy?
FS:
We try to identify industries that actually make money in a
deflationary environment. Lower commodity prices create margin
pressure for most industries and they don't do as well as during
times of inflation. The precious metals industry does well in a
deflationary environment because the gold price goes up against the
whole commodity complex, while input costs such as crude oil or
steel are probably stabilizing or will become less expensive than
they were in years of higher inflation. Eventually, I think it is
the market's desire for liquidity, which will cause gold prices to
continue rising.
So, the long-term view is very bullish, but it's a very volatile
market, and last year, gold stocks really underperformed. This is
mainly explained by a lack of liquidity and investor confidence.
The whole precious metal sector has overpromised and under
delivered, and many M&A transactions did actually destroy
shareholder value. I guess investors have reset their expectations
dramatically after all this frustration. However, this can provide
opportunities, and we try to use some of our technical indicators
to trade these stocks while they are getting into an overbought or
oversold condition. This past April and May, when the market was
really capitulating, we were buyers in most of the stocks we
like.
Right now, we think the market is a bit overpriced, and we've
had a very good run in most of these gold mining shares. Now they
could go into a little correction mode and probably lose another
10% or 15%. So, we sold some of our positions at the end of
September and are waiting for more favorable buying opportunities
in the next few weeks. It's not a buy-and-hold strategy that we
want to apply here. One can really trade swings if you can get the
timing right. We are always invested in the sector, but sometimes
we have 30% or 40% cash.
TGR:
How has your strategy paid off over the last couple of years?
FS:
Since we took over the fund in December 2008, we are up about 140%
in U.S. dollars, and this year, as of end of September, we are up
about 26%. We have some winners in the fund that performed well
based on the discoveries and the operational improvements they
made. We were regularly buying when the markets dried up, which
forced stock prices to go lower. There were actually no signals
that would suggest a long-term fundamental downturn. We see these
corrections as tradable opportunities. I was calling brokers in May
and it was unusual to see how defensive they were, saying to stay
away from gold stocks until gold hits $2,000/ounce [oz]. We got the
feeling that was probably the bottom of the market. Timing is of
the essence. Pick your stocks carefully, especially in the junior
space, because most of these companies will never make money for
their shareholders.
That brings me to our selection strategy. The first thing we
look at is management. The mining business is very challenging,
with a lot of risks. The people with the right experience who have
done it before will attract the money from The Street to bring a
story to reality and attract institutional money in the future. The
next thing we look for is geology. Can a good deposit become
bigger, and can this ever become a mine, and what and how long will
it take? In addition, a solid balance sheet with little leverage
and good networking capital in the bank is key, so they don't have
to tap the equity markets in these volatile times.
We are largely positioned in the mid-tier mining space, because
the industry as a whole has started to change. Many of the large
gold mining companies have grown too big and aren't flexible
anymore. Their strategy was for growth in size, rather than
profitability. As a result, many have failed to make money for
shareholders. Now, the whole industry has started to focus on
smaller projects with lower capital requirements. As a result, we
think the market has shown a preference for companies that run easy
mines, which can be expanded operationally and can be financed by
the market without the risk of significant equity dilution.
Many companies have good assets, but don't have the critical
mass to attract institutional money. We expect to see more mergers
taking place between junior companies or mid-tier producers. It
doesn't make sense to have two companies producing, let's say,
150,000 oz [150 Koz] per year trading at a market cap of $500
million [M]. It would be an enormous task for them to get into a
league where they could attract institutional money. Growing to a
$1 billion [B] market cap internally is probably going to be a
tough task. With smart merger and acquisitions [M&A], becoming
a 200-300 Koz producer by combining two businesses can get it into
the $1B market-cap range more easily. We think that M&A among
junior producers is going to be a major topic in the next few
quarters.
TGR:
So, let's talk about some specifics on companies you're currently
invested in that you think look interesting.
FS:
One company we own that we think was undervalued at the beginning
of the year is OceanaGold Corp., which is a 250 Koz producer in New
Zealand. It has transitioned from a company that only operated
there, to a more internationally based one. Its Didipio project in
the Philippines is well advanced and should get into commercial
production next year. We think OceanaGold is going to make a lot of
money as cash costs drop and production increases. It had some cost
issues over the last 12 months or so mainly due to the strong New
Zealand dollar versus the U.S. dollar. The Philippines operation
has a lot of credit from copper, which will lead to ongoing cost
improvements.
The company has good management and its growth is pretty well
financed right now with no need to tap the equity markets in the
near future. The stock has had a good run, up about 68% this year.
I would rather wait for a correction before buying it here. If
management continues to execute its strategy it has the potential
to grow to 400-500 Koz/year of production over the next three to
four years.
TGR:
How about some other ones?
FS:
Another company we were just adding to our portfolio is Keegan
Resources Inc. (
KGN
), which is in a relatively safe jurisdiction in Ghana, West
Africa. It had a sharp price decline from trading at a little over
$9/share, down to around $2.38/share by the middle of May. Its
Esaase project had the classic capital expenditure [capex]
overruns. They underestimated the cost of the project. When
financing requirements changed, the markets became very skeptical
and the shares dropped. We feel the project economics are still
favorable, and that it can operate on a smaller scale than the
planned 300 Koz/year with a $500M capex budget. Management is in
the process of recalculating a smaller plant with a much lower
capex, about $150-200M, rather than $500M.
After the recent rally, Keegan's market cap is now about $270M,
with about $170M in the bank and 6 Moz resource in the ground. The
company is almost trading at cash, which provides good market
support. When the new project economics are published, it will
probably show a 100-160 Moz/year operation with a lower strip ratio
and lower operating costs. The recoveries will be the same, say
92-93%. Many of the long-term shareholders and institutions went in
at $7-9/share. With the stock trading around $3.97/share, we think
it has some real catch-up potential from here. PMI Gold's Obotan
mine is about 10 kilometers southwest of Keegan's Esaase project
and PMI just raised $100M to start construction of the mine. We
originally invested in PMI Gold at $0.10/share back in October
2009.
TGR:
How about companies that are a little closer to home? Certainly the
Yukon has had quite a bit of activity lately. What do you like
there?
FS:
We think the Yukon is a great jurisdiction for mining. With
devolution of resource management responsibilities in April 2003,
the Yukon has its own policy for mining, which we regard as a major
benefit for mining companies. The top part of the Yukon has great
and underestimated potential from a geological standpoint. The main
challenge is the remote locations where you have to bring in all
your equipment by helicopter and the short drilling season, which
goes from about April/May until the snow comes in October.
In the silver space there we like Alexco Resource Corp. (
AXU
), which is producing silver from its Bellekeno mine in the
historical Keno District. It is fully financed by Silver Wheaton
Corp. (
SLW
) with a very tight share structure of about 65M shares
outstanding. We think it has the potential to grow resources and
production through internal cash flow and no debt. Nevertheless,
the company suffered a 27% increase in cash costs in the first half
of the year versus 2011, due to lower base metal credits and mining
of lower-grade material. These factors brought the price down quite
significantly this year by -45%, to about $3.80/share.
What we like about Alexco is that the company is producing now
and has many exploration and development projects in the same
district. Most of the exploration and development money it's
spending will add to future production. It will probably produce
around 2 Moz silver this year. As new projects are added, it will
become a two- or three-mine operator in the next two to three
years, all funded by internal cash flow. The Keno District has very
rich silver grades, historically averaging 50 ounces/ton or so.
It's all underground, which is a big plus, because the mine can
operate year-round with the concentrate being shipped out by road
throughout the year. The management team has a good reputation and
when we visited the mine in May of last year our impression was
that the exploration and development team are all solid and
experienced mining people.
TGR:
Any others you'd like to mention up there?
FS:
Some of these Yukon stocks really fell out of favor over the last
few months. One company we like, especially because the shares are
also still trading at very depressed levels despite good news, is
ATAC Resources Ltd. (ATADF.PK). This is a pure exploration company
with a large land package. All the gold discoveries it released
this year point to a potentially huge system that could be
described as a Carlin-type gold discovery.
We visited the project last year. The company has identified
multiple targets on its so-called Rackla Gold Belt, which is about
185 kilometers long. Every time the company releases results, we
see that this system is potentially growing into something much
bigger. The grades are phenomenal, like 10.24 grams/ton [g/t] over
46 meters, and not very deep. The stock is down to around
$2.36/share, from $10/share in July 2011. The company is well
financed and has a good management team. If one looks for value in
exploration, I think ATAC is a good name to have at these low
levels.
TGR:
Let's turn to some projects and companies that have operations in
the U.S. What do you like there?
FS:
We have a development stage company in the fund called Romarco
Minerals Inc. (RTRAF.PK), which has the Haile project in South
Carolina. This project has been delayed due to the completion of a
full Environmental Impact Statement [EIS]. The stock is therefore
in a penalty box, but the project economics are very favorable. It
will have low costs and gold grades of about 1.8 g/t open pit,
which is rather high. The stock is trading at about $1/share. I
would say that Romarco could be a takeover target for a mid-tier
producer or even a senior, based on the quality of the asset and
the location. Once the EIS issue has been resolved, probably next
year, then we think it will be a very attractive stock to own. The
main risk is permitting and finance, should the company require to
raise more equity, which would be dilutive with the current low
share price.
TGR:
Maybe you can summarize what our readers ought to be doing in the
coming months to take advantage of what you think lies ahead.
FS:
The key is to see the fundamentally positive development of the
industry. Gold mining shares are trading at historically low
valuations, e.g., on a price-to-earnings ratio basis or compared to
the price of bullion. I would stress, however, that these shares
can be very volatile and people can get frustrated if they don't
perform. They sell in a down market and then miss the opportunity
to buy when the market rebounds. One has to be really disciplined.
Never get married to a company, no matter how good it looks. When
things move up and get overbought, always take profits and have
cash on the sideline to buy into the dips.
But, as long as we have these fundamental problems in the world
with money printing and low economic growth, recessions and
depressions, it will be very bullish for gold mining companies. In
order to outperform the gold price, you can't just be long all the
time and not trade these stocks. One really has to be more active
and when the market is capitulating, you have to pick up your most
attractive shares. Always do your own due diligence on these
companies. Check out the management and how it does operationally,
and look at past track records. Once you have identified the right
companies that fit your portfolio, then just try to play the sector
in a little bit more of a contrarian way. That's my advice.
TGR:
Thanks for talking with us today, Florian.
FS:
Thanks for having me.
This interview was conducted by Zig Lambo of
The Gold Report
and can be read in its entirety at
http://www.theaureport.com/pub/na/14610
or on our
instablog.
Florian Siegfried
is the chief executive officer of Precious Capital AG, a
Zurich-based fund specializing in global mining investments.
Siegfried was previously the CEO of ShaPE Capital Ltd., a SIX
Swiss Exchange-listed private equity company, where he was
instrumental in raising more than CHF 50 million in equity
capital. Siegfried is also a board member of GoldQuest Mining
Corp. He holds a master's degree in finance and economics from
the University of Zurich.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
Disclaimer:
1) Zig Lambo of
The Gold Report
conducted this interview. He personally and/or his family own
shares of the following companies mentioned in this interview:
None.
2) The following companies mentioned in the interview are sponsors
of
The Gold Report:
None. Streetwise Reports does not accept stock in exchange for
services. Interviews are edited for clarity.
3) Florian Siegfried: I personally and/or my family own shares of
the following companies mentioned in this interview: OceanaGold
Corp. and Alexco Resource Corp. I personally and/or my family am
paid by the following companies mentioned in this interview: None.
I was not paid by Streetwise Reports for participating in this
interview.
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