Scott Gardner: Europe's Debt Crisis and Its Effect on Gold
Source: Brian Sylvester of The Gold Report (9/30/11)
If you want to know the future, pay attention to the decisions European policymakers will have to make regarding debt, says Scott Gardner, chief investment officer at Verdmont Capital. In an exclusive interview with The Gold Report, he shares his analysis of debt policy investment implications, plus which gold mines Verdmont likes in Latin America and beyond.
Companies Mentioned : AngloGold Ashanti Ltd. - Belo Sun Mining Corp. - Desert Sun Mining & Gems - Lydian International Ltd. - Pershimco Resources Inc. - Red Eagle Mining Corp. - Smash Minerals Corp. - Sunward Resources Ltd.
The Gold Report: In one of your June research reports you wrote, "In the Eurozone, there has been limited political will to really make an impact on the debt side of the equation. With gross domestic product ( GDP ) growth set to slow, things should really get interesting for euro policymakers as they attempt to make their shaky union work." In the Eurozone, there is more than adequate money to take care of the debt situation, but the question remains, is there enough political will to keep all the member countries inside the Eurozone? What sort of impact will pending Eurozone issues have on the gold price?
Scott Gardner: First off, you say that there's enough money, but I think that a lack of money is the primary concern. The European Financial Stability Fund has something like €440B in committed capital and the members haven't agreed upon future funding requirements. Also, the European Central Bank (ECB) itself only has €10B. If you compare that to the three largest banks in France, for example, they own roughly $600B in PIGS (Portugal, Ireland, Greece, and Spain)-related debt. You can see how imbalanced the system is and how undercapitalized some of these organizations are that are meant to be the solution.
TGR: In terms of a percentage of euro GDP, it's a relatively small amount.
SG: I think the overall liability in the banking system has been estimated at about €2.5 trillion, in terms of PIGS-related financing needs over the next few years. This is significant. People talk a lot about the economics behind the crisis, but the issue in the Eurozone is just as much a social one. It's questionable whether or not, for example, the German populace will remain in favor of bailing out some of the peripheral regions' largess. This is where we get into the will of keeping the Eurozone together, and Europe is going to see ongoing pressure there.
TGR: George Soros said we are in a double-dip recession, and he believes that the euro will come apart. Is that your view on both accounts?
SG: People have been focusing largely on the numerator in the debt:GDP ratio and the market has become used to the pressures as they stand now. However, austerity measures and other proposed solutions will put a tremendous amount of pressure on GDP. A double-dip recession cannot be ruled out. Clearly, this will only exacerbate the debt:GDP ratio and further handcuff policymakers in terms of the policy response.
TGR: How will these issues impact gold and silver prices?
SG: During the acute stages of a systemic selloff, all investments typically get punished. We saw that during the correction at the height of the credit crisis in 2008. We're also seeing that today in the current selloff, with gold and silver both down substantially. Over the long run, the crisis in Europe is clearly very bullish for gold and silver because the only way out of the current situation is additional stimulus from central banks. Additional stimulus will put further downward pressure on all the major currencies.
TGR: In one of your June research reports you wrote, "Gold continues to break out in all major currencies despite prevailing concerns in the market that gold is due for a major pullback. Of course, since then, gold has had a dramatic rise, but more recently, it's beginning to look like there is a major correction under way in the gold price." Is the correction for real? If so, what range do you believe it will bottom in?
SG: Nothing goes up in a straight line, and a gold correction from current levels is actually quite healthy as the short-term rise was technically overextended. We remain in a gold bull market and the market usually uses the 200-day moving average as a floor within a long-term uptrend. Therefore, we would be aggressive buyers in and around the $1,600 range, which would bring gold close to its 200-day moving average.
TGR: Do you believe that pullback will inhibit the performance of junior precious metals plays, given that the dramatic uptick in the gold price in August didn't seem to carry many precious metals juniors much higher?
SG: We learned during the selloff in 2008 that junior gold stocks behave like stocks first and gold investments second. If there is substantial risk in traditional investments, gold stocks selloff in sympathy. This time around, we believe investors will look through short-term weakness and see the inherent profitability that gold stocks offer. Arguably, in the current environment, gold stocks are the only game in town, given that they're the only sector that is growing earnings and profitability to the extent that it is.
TGR: In a May research report you wrote, "Despite the recent correction in the base metals complex, it is too early to initiate positions or increase underweight allocations within resource-focused portfolios. Our preferred segments of the commodity market remain energy and precious metals at the expense of agriculture and base metals." Has your position changed?
SG: No. We were lucky enough to advise clients to short copper a few months ago, and we still see continued pressure in base metals-related equities. Many argue that current base-metal stock valuations are reasonable, but we believe overly optimistic commodity forecasts are baked into earnings estimates. Analysts are still forecasting 2012 copper at around $4.30/lb. We'd like to see more conservative copper estimates before we get more enthusiastic on the base metals complex. Meanwhile, gold analysts are forecasting, on average, something like $1,600/oz., which may prove overly cautious.
TGR: You're based in Panama, and you get to regularly visit gold projects in Latin America. What are some projects you visited recently?
SG: We recently visited Sunward Resources Ltd. (SWD:TSX.V) property, which was very exciting. We advised clients to buy Sunward in May of this year, and we've done quite well. We were impressed with how advanced the project was and how quickly management was moving along. The company just came out with an updated resource of 8.2 Moz. of gold, which more than doubled the existing resource of 3.7 Moz. That is very encouraging.
TGR: That's a gold-copper porphyry project in Colombia. Five rigs continue to drill the property; is that right?
SG: It has seven drills currently turning, and it's moving toward nine at the end of the month. There is still tremendous exploration upside at the property, given that the current resource estimate only incorporated two of seven identified anomalies.
TGR: Is the project's metallurgy relatively simple? Is there potential for a bulk-tonnage target?
SG: Given that Titiribi is a low-grade project, it's key for Sunward to really get the tonnage up and it has proven the ability to do that with the recent resource update. One of the main concerns with the project is metallurgy. The company is coming out with some metallurgical testing in October, which we believe is a key catalyst for the stock and will answer a lot of questions concerning profitability.
TGR: Colombia is certainly seeing all kinds of exploration since the government has become more mining-friendly. What other projects in Colombia are you following?
SG: We've been supporting a company by the name of Red Eagle Mining Corp. (RD:TSX.V) for over a year. We were involved in the pre-initial public offering (pre-IPO) financing. The company IPO'd in June of this year. Generally, we're guiding our clients toward developed projects with recognizable assets and advanced-stage projects, but Red Eagle Mining is an example of an early-stage exploration company that people should look to take a small position in. It has two highly prospective projects in Colombia and they have a great management team. Even though the company only recently IPO'd, it already has a team of 15 geologists in place and a 25,000-meter (m) drill program under contract. In this market, we want to focus on companies that have near-term news flow and REM will be coming out with results in mid-October.
TGR: Red Eagle is trading at about $1.05. Is that a good entry point?
SG: Yes. Whenever there's heightened systemic risk in the system, these early-stage plays get hurt. Moving forward, due to the fact that Red Eagle has a sizeable and prospective land package, is drilling and is well capitalized, we think the market will start looking beyond current weakness.
TGR: What other projects in Latin America are you hot on?
SG: We've recently bought Belo Sun Mining Corp. (BSX:TSX.V) . It is an interesting story in the Pará state of Brazil. The company has a 3.4 Moz. resource at its Volta Grande project. It has 11 rigs on site, and the main resource envelope remains open in many directions. The company is due to have an updated resource estimate at the end of October. Analysts are expecting it to boost ounces into the 4 Moz range.
TGR: Peter Tagliamonte is on Belo Sun's board. He was also part of Desert Sun Mining & Gems, which got the Jacobina gold mine up and running, and that spurred a takeover bid from Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE). Does the presence of someone like that, who's been involved with takeovers and successes in the past, hearten your investment choice?
SG: Without question, Belo Sun is a company that a larger-size company would find attractive given the known resource, the exploration upside and its location in a mining-friendly region. The recent takeover of Grayd Resource Corp. (GYD:TSX.V) is a perfect example of what the larger-size companies are looking for. They're looking for an existing resource with decent exploration upside in a mining-friendly region, and Belo Sun fits that bill rather nicely.
TGR: How about one more in Latin America?
SG: We've been actively supporting Pershimco Resources Inc. (PRO:TSX.V) , which is advancing its Cerro Quema project right in our backyard here in Panama. Pershimco has a 500 Koz. deposit, and we see the potential for this to grow considerably. It has two drills on site, and recent results in the easternmost segment of the property expanded the footprint of the mineralization to more than 4 km.
TGR: Pershimco also has a couple of projects in Mexico and one in Canada. Do you like that diversification, or is it spreading resources too thin?
SG: PRO has assembled quite a team, and the focus has been primarily on Panama. I think it's done a tremendous amount with the property here, and we've been very pleased. Things might begin to look up at the Quebec property. The market has been assigning little value to the project, but management has been slowly building up a sizeable land package in the area. As seasonal factors make drilling possible, that might wake people up to the property's merits. Management could always do a joint venture on their other assets if they were concerned about being spread too thin due to their focus on Panama.
TGR: Verdmont invests all over the world. What are some other juniors Verdmont has taken an interest in?
SG: We tend to favor advanced-stage exploration plays in the current market. Lydian International (LYD:TSX) is an attractive prefeasibility, heap-leach gold development story in Armenia. The project has great infrastructure and a strong management team that's led by Timothy Coughlin. He's the former chief geologist with AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) .
TGR: That's the Amulsar gold project. It has outlined about 2.5 Moz. and is working toward a feasibility study and production in 2014. Is that realistic?
SG: We don't have any issues with that. The company has been focused on expanding the known resource. It's currently due to finish 40,000m of drilling over the course of 2011. Even though it's a little bit off the beaten path, Armenia has favorable, Western-style mining policies in place. We don't see anything that makes the project's timeline unrealistic, and we don't see any real permitting issues.
TGR: Name one more strong junior.
SG: With the majors and the advanced-stage gold stories being so cheap, we're focusing a lot of our efforts and investors' capital in those areas. But one pure exploration name that shows up on our radar screen is Smash Minerals Corp. (SSH:TSX.V) . Smash is a relatively advanced exploration company with a sizeable land package in the white-gold district of the Yukon. Smash was put together by Adrian Fleming, the founder of Underworld Resources (UW:TSX), which was sold to Kinross Gold Corp. (K:TSX; KGC:NYSE) in early 2010.
Smash is interesting due to its very prospective and sizeable land package. It has more than 4,000 claims representing something like 800 sq. km. One thing that concerned us before we started investing was that the white-gold district was quite hot, as well as the Yukon in general. We were concerned that with Adrian Fleming and Shawn Ryan (owner of Ryanwood Exploration Inc.) involved, the story might be overly promoted, but in the current selloff, the stock is trading at an enterprise value in the single millions. For a highly prospective exploration company like Smash Minerals, it's a no-brainer at current levels.
TGR: One issue with a number of the Yukon plays right now is that assay labs are backed up at an unprecedented level. These companies can't get the news flow out as quickly as they would like, and that's hurting share prices in some instances. What would you tell investors about that phenomenon?
SG: I think the weakness in Yukon plays is largely due to the fact that they ran so far so quickly, and a lot of them have outstanding paper. The assay lab issue is not a primary concern. That simply creates an opportunity to invest in Smash Minerals, which has been dragged down with the group. It's one of the few early-stage companies that are drilling this summer. Results are due out in October, so there is lots of news in the pipeline.
TGR: Tell us one economic situation that you're going to watch the most closely as Q311 comes to an end and Q411 begins.
SG: All eyes will be on Europe and the pressures there. Generally, the market is trading in sympathy with both European financial stocks and, to a lesser extent, American financial stocks. Policymakers need to find a solution before we get a base and see strength in a lot of these junior mining stocks.
TGR: Thanks, Scott; it's been a pleasure.
Scott Gardner, CFA is the Chief Investment Officer at Verdmont Capital S.A. based in Panama. He is responsible for guiding firm investment strategy and is the head of the company's discretionary investment management program, research and corporate finance operations. Prior to joining Verdmont, Scott was a portfolio manager with an offshore bank in Bermuda, where he managed discretionary investment portfolios, mutual funds and was the bank's lead strategist for commodity-related investment programs. Scott is a CFA charter holder and a member of the CFA Institute.
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1) Brian Sylvester 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: Grayd Resource Corp., Sunward Resources Inc. and Smash Minerals Corp.
3) Scott Gardner: I personally and/or my family own shares of the following companies mentioned in this interview: SWD, BSX, LYD, REM, PRO, SHH. I personally and/or my family am paid by the following companies mentioned in this interview: None.
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