Last week was like a miniature test for gold. US markets gained most of the week, with the S&P 500 and the Dow Jones working their way back up to their 50-day moving averages. The moves slowed the flood of investment dollars heading towards the safe haven of gold – but not completely and not for long. In fact in terms of closing prices gold spent the week almost unchanged at US$1,210 per oz. before jumping up on Friday to close the week at US$1,230.
Sideways and then upwards motion for gold against a strong-looking US equity space and slight gains by the US dollar is very significant for gold. It says the interested eyes – and dollars – turning to the yellow metal have some staying power. A few better days for US markets will not placate their overall concerns about the state of the markets or the economy.
Gold’s move on Friday – up US$21 an ounce – attests to that.
The strength of gold’s rally this year has surprised almost everyone. The way exploration and mining stocks are reacting makes it look like this is the start of a real run.
I have loads to say about that and what it means for investing strategies this year, but I will save such comment for this week’s editorial. Instead, here is a snippet from last week’s Maven Letter. I hope you enjoy!
In The News…
Gold Starts Stepping Up
Gold got hit to start the week. As North Americans celebrated a slew of holidays – Family Day (Alberta, Saskatchewan, Ontario), Presidents Day (US), Louis Riel Day (Manitoba), Islanders Day (PEI), and Valentines Day (date-challenged romantics) – world markets that were open rose sharply Monday after China’s central bank fixed the yuan higher and oil cemented recent gains.
In response, gold slipped 2%.
Fair enough. Gold has been gaining because of safe haven momentum and stronger markets dampen that.
The best part, though, is that gold moved up over the next two days. It didn’t regain US$1,240 per oz., but it moved up.
And it sustained the new pattern: higher highs and higher lows. Gold breaking out of its four-year down-stepping pattern to hit a higher high was very significant. And its low on Monday of US$1,194 did not come close to marking a lower low.
The fact is, you can’t rebuild confidence in an aged bull market or a sluggish economy in a day. That’s especially true when the weak side of world economics is right there as well: as China announced its monetary move, new data showed Chinese exports and imports for January were down 11.2% and 18.8% year-over-year and Japan contracted 1.4% in Q4, year-over-year, a worse result than expected.
Those were the numbers out on Monday. But numbers come out daily that suggest a global economic slowdown.
For example, the company that moves 15% of the world’s shipped manufactured goods reported 15% decline in sales in 2015, resulting in 32% lower profits. A.P. Møller-Maersk laid off 17% of its workforce in October because it sees the slowdown continuing. Sliding shipping volumes are a leading indicator.
Or look at US GDP. In the spring of 2015 it grew at 3.9%, a respectable rate. By the summer growth was down to 2%. In the fall, it eked out just 0.7%. Forecasts, including that from GDP Now, suggest the first quarter of 2016 will be better, but that doesn’t change the fact that 2015 was weak.
Those arguing against US economic weakness often say it is sector specific, that industrial measures are being dragged down by energy but that the rest of the economy is a-ok. Except that it’s not.
Consumer spending is slowing. Retail sales grew at a snail’s pace in the second half of 2015, adding only 0.6%. The full-year growth rate of 2.1% was the lowest since 2009. Car sales are slowing significantly.
And while it is true that services, not industry, are dominant in the US economy, don’t think that services are insulated from an industrial slowdown. How many accountants and lawyers and IT firms and couriers and cleaners and the like are employed by industrial operators? A lot. Given that US manufacturers’ new orders and production stopped growing in July and have been contracting since October, I see a lot of services suffering.
As for the rest of the service sector, it is being fueled by modest increases in US consumer spending. If that continues, US GDP will pick up some in 2016. However, ebbing economic confidence prompts consumers to save rather than spend – and even a small shift in that direction would stamp out the embers.
That’s economic talk. What about the markets?
For what it’s worth, banks are exercising caution. After six bull years of easy returns, most US banks are extricating themselves from the markets – or at least advising such. Citibank downgraded the US stock market to “underweight”, Credit Suisse says “rotate out of stocks”, JP changed from Buy on dips to Sell on rallies, and RBS is simply saying Sell everything.
Here the industrial slowdown shines. Industrial operators represent half the market cap of the S&P 500 and the Dow Jones. That means their successes and failures have outsized impact on market and fixed income performance.
That impact is already playing out in earnings, which (as I’ve mentioned before) have declined year-over-year for two quarters already – and will almost certainly have declined again in Q4 once all the numbers are in. Forecasters are already predicting the same for Q1 of 2016.
The reasons: high dollar, low commodity prices, and rising compensation costs. The ramifications: corporate cutbacks. Less hiring, less capital investment, less pipeline spending, which is a direct hit to the economy.
And yet the markets have moved up the last few days. Why? China’s tightening kicked it off – and we have come to know, over the last eight years, just how much the market loves tightening. China’s move to fix the yuan higher and spend US$96 billion of its foreign reserves in January alone supporting the yuan are tightening, whether the People’s Bank wants to acknowledge it or not.
Investors are addicted to stimulus. China’s move was a reminder of the heydays of the bull market, when anytime things slowed down a bit we just had to wait for a central bank to step in. But realization is creeping in that central banks have almost run out of ammunition.
China is an exception to that statement. With interest rates at 4.35% and US$3.2 trillion in reserves, China has lots of room to move. But not only it is almost alone at that party, it is also spending hugely to support the yuan right now, in the knowledge that a weaker yuan exports deflation to a weak world economy. That would come back to bite.
As for other supportive measures, the few options that remain for other countries might not do a lot.
Consider Japan’s move to negative interest rates. The Bank of Japan made that move to devalue the yen. It did not work. Instead, the yen has now risen 10% against the US dollar since January 30.
More broadly (and there is ample discussion on this available), over the last 6.5 years the nominal GDP of the developed world has grown by just 11%, despite unprecedented stimulus.
So the big picture keeps me convinced that the US economy is not that strong, the global economy is weaker, US markets are turning down, the Fed will not come close to four interest rate increases this year, and that all those things are good for gold.
It will just be a step-wise process. At least gold has taken the first step.
A Heartening Copper Deal
In my copper outlook two weeks ago I was gently optimistic. The supply-demand balance is always tight, supply disruptions are very possible, a supply gap is looming in a few years, and copper is essential in electrifying our world – it all adds up to a positive outlook, albeit one with an uncertain schedule.
A recent deal supports my case.
On Monday Japanese major Sumitomo Metal Mining bought a 13% stake in the Morenci mine in Arizona from Freeport McMoRan for US$1 billion. Morenci is an open pit copper mine that churns out about 900 million lbs. copper annually.
David Fickling of Bloomberg put the deal in context in a way I liked (link here). A 13% stake represents about 1.2 billion lbs. copper, based on current reserves. That means Sumitomo spent about US$0.85 for each pound of copper in the ground.
How does that compare to other copper deals of late? Pretty darn well.
You can see the price per pound paid in copper deals has been falling pretty consistently since 2011, when Barrick and Mitsubishi paid more than today’s market price for pounds in the ground. 2014 saw MMG pay US$0.85 per pound for Glencore’s Las Bambas project and Lundin shell out US$0.59 per pound to Freeport for an 80% stake in two Chilean mines. The only big copper deal in 2015 was also the cheapest in years on a per pound basis: KKR paid just US$0.30 per pound for a 10% stake in OZ Minerals.
In contrast, US$0.85 per pound for a stake in Morenci looks like a pretty healthy number.
As Fickling points out, Japanese firms are usually more concerned with long-term raw material supplies than driving hard bargains. Moreover, Freeport and Sumitomo are already partners at Morenci (the new 13% lifts Sumitomo’s stake to 28%, through several subsidiaries) and the cash will go directly against Freeport’s $20-billion debt load; Sumitomo likely doesn’t want its partner to go under.
Still, an uptick in per-pound copper M&A pricing is yet another sign that we are at the bottom. The copper price will continue to gyrate, but this deal suggests pressure is starting to mount on miners to make deals before prices rise any more.
Major Debt Loads
In an interview earlier this week, I was asked whether I thought gold stocks would respond to a rising gold price in the traditional way: gold majors first, followed by smaller producers, then developers, and finally explorers. My answer: no.
Mining majors are still saddled with high debts and weak balance sheets. Freeport McMoRan is $20 billion in debt. Anglo American has more than half its operations up for sale, in an effort to pay off its burdens. Barrick carries $10 billion in debt, even after paying off $3.2 billion last year.
I see these debt loads having a couple significant ramifications:
- Majors cannot take advantage of cheap valuations and buy assets today. Until debts are under better control, acquisitions are not on the menu.
- Major miners will continue to high-grade their mines in an effort to control costs. The more high grading is done, the more lower grade reserves will be sterilized (rendered uneconomic to mine without contributions from higher-grade areas). Mines will shut earlier as a result.
- Long term, this is bullish for explorers and developers. Years of high grading means majors will run out of economic ore at current operations earlier. The need to develop new mines to replace exhausted ones will spur a run of takeover activity.
- For now, smaller gold producers have the edge. They generally have stronger balance sheets; some offer exposure to specific advantages like forex, which gets lots in large, multi-jurisdiction miners; and many are eyeing potential acquisitions, having strengthened their balance sheets enough during the bear market to capitalize on bottom fishing opportunities.
As an example, let’s contrast Anglo American with a smaller gold producer, like Claude Resources.
Anglo is in pretty dire straits. The miner’s share price slumped 75% in 2015, prompting a December announcement that it would sell three-fifths of its assets. To achieve that Anglo is eyeing $3 billion to $4 billion in deals this year, an effort that would leave the company focused just on copper, diamonds, and platinum.
For sale are Anglo’s suite of coal operations in Australia, South Africa, and Colombia, its iron ore operations in South Africa and Brazil, and its nickel and manganese units.
The company needs cash from these assets to pay down US$13 billion in debt. It’s a big enough burden that Moody’s just downgraded Anglo’s debt and pegged its ratings outlook at negative. The ratings agency said it does not expect Anglo to generate enough operating cash flows in the next two years to reduce debt loads significantly, whether or not it divests a good chunk of the assets it has up for sale. The problem: Moody’s doesn’t think it likely that Anglo could manage deals in the current environment that actually would help its overall situation.
Anglo sees things differently and is in fact forecasting positive cash flow this year. Nevertheless, the focus on divestments and debt means Anglo is not in the market for acquisitions.
By contrast, Claude Resources is trading at a 52-week high.
The Canadian gold miner, which operates two gold mines with a shared mill facility in Saskatchewan, Canada, has $27 million in the bank and less than $20 million in debt. The company churns out some 70,000 oz. gold annually, with all-in sustaining costs last year averaging US$896 per oz. versus an averaged realized gold price of US$1,174 per oz.
Investors are being drawn to Claude because of its:
- Simple assets: two mines with a shared mill is a simple enough operation that costs should not creep.
- Canadian dollar exposure: forex lift is significant.
- Strong balance sheet.
- Takeout potential: 70,000 oz. per year is enough to make a difference to a mid-tier miner and Claude’s operations offer good cost controls and great jurisdiction.
As gold strengthens a range of investors get interested in gold equities. Some of these – institutions and funds – will gravitate to majors because (1) that’s what they’ve always done and (2) they can buy big blocks of ABX or Goldcorp without pushing the price up before they’re done.
For the rest of us, I can’t see the argument for buying Kinross or Barrick when there are smaller producers available with the kinds of advantages Claude offers. I don’t think I’m alone in this.
And in the longer term, the fact that majors are wrestling with debt today bodes well for gold M&A activity in a few years. That is the argument for buying explorers – they are not going to create significant returns in the short term, but the spotlight will shift in time.
First Mining Gets Cash and Quebec Ounces in CFO Takeover
The most active land banker in mining just made another move.
First Mining Finance is a vehicle that Keith Neumeyer (of First Quantum Minerals and First Majestic Silver fame) purpose built to collect mineral properties while they are cheap. The concept is to bank the properties until metals prices rise and make them more valuable, at which point First Mining will put them up for sale.
Since debuting on the Venture in April First Mining has taken over or merged with four companies, creating a portfolio with 7.8 million gold equivalent ounces. Now it is consummating its fifth deal: the takeover of Clifton Star Resources.
Clifton Star has two key assets: the Duquesne gold project and $11 million in cash. First Mining is getting both for 48 million shares, worth $20.5 million given an implied CFO share value of $0.42.
The 130% premium means it is a sweet deal for any recent CFO investors, though there are likely few of those. Clifton Star has been essentially dormant for two years, aside from fighting a few legal battles. One of those battles netted the company almost $6 million, the lion’s share of the current treasury.
The deal will leave First Mining with 350 million shares outstanding. That’s a big count for a company that has only existed for ten months, but from another angle it makes sense: FF is using the capital that is available – shares – to achieve its goal of building a mineral property bank.
First Mining is not the only company working to build a portfolio of mineral properties. What differentiates FF from other similar companies is that Neumeyer and his team are committed to not putting any money in the ground. The idea is to bank properties, not to advance them.