Portfolio Manager Greg Orrell: ‘My Belief in Gold Has Not Wavered’

After the extreme volatility of gold in the last few weeks, OCM Gold Fund Manager Greg Orrell is more convinced than ever of the necessity of owning gold assets. In this interview with The Gold Report, Orrell lays out the rationale for buying these cheap gold stocks around the world, including California of all places.

The Gold Report: How has your bullish view on the gold sector evolved as a series of crises has jolted both the international stock market and the price of gold?

Greg Orrell: First off, my belief in gold as a monetary asset has not wavered. Japan basically admitted that it is bankrupt with its intention to aggressively debase its currency. Normally such actions would invoke, and may still, a race to the bottom as each country engages in economic warfare to deal with its debt issues. At this juncture the fear of global deflation among the G7 crowd remains its worst nightmare, especially as additional stimulus by the Federal Reserve is showing diminishing returns. With high debt levels in both the private and public sectors around the world, stimulating economic growth is proving elusive. These alarming events are setting the stage for the next leg up in the dollar gold price, in my opinion. The fiscal and monetary crisis is ongoing and underscores the necessity of owning gold assets.

Though agonizing, the past 18 months have been nothing more than a consolidation for gold from the September 2011 highs of $1,900/ounce ($1,900/oz). The recent decline in gold prices below $1,500/oz is not the end of the bull market in gold, despite the barrage of negative commentary by those wanting to dance on gold’s grave. The destruction of currencies is in full bloom, but it is not a straight line. The problem for many gold investors is that they can see the endgame. Gold prices rise in a straight line at the end of a monetary system, but we are not there yet. It takes some patience to hold the course while the establishment fights tooth and nail to keep the dollar system from failing.

TGR: The years 2009 and 2010 were better for gold stocks. Can you talk about how things changed after that and how investors can best respond to the precipitous drop in market value?

GO: A number of factors go into the poor performance of the gold shares over the past couple of years besides the gold price. We have seen investor rotation out of defensive posturing and then the gold miners ended up being their own worst enemy. Gold share investors became concerned, and rightfully so, with rising operating and capital costs, poor capital allocation and growing resource nationalization. This in turn made bullion exchange-traded fund (ETF) products more attractive and prompted a trend of shorting the miners versus long gold positions.

Let’s look at the world’s largest producer, Barrick Gold Corp. (ABX:TSX; ABX:NYSE). It incurred cost overruns at the Pascua-Lama project in Latin America. And it overpaid for a copper asset in Africa after spinning off its African gold assets a couple of years earlier. Each of these instances led to contraction of cash flow and net asset value multiples for the whole sector, and set a theme for the industry. At this point, the pendulum has swung too far, with the shares basically discounting everything that could go wrong and more. Therefore, if an investor is not in the gold sector, now is an opportune time to take advantage of the significant decline in share values as there are signs of positive change taking place within the sector.

TGR: Can you provide any insight as to why longer-term investors, and also new gold investors, should buy into the current gold market?

GO: The rationale for owning gold assets remains simple: global deterioration of sovereign credit and a growing need to debase currencies in order to meet future obligations, whether it’s here in the U.S., Europe or Japan. The policy of socializing risk with monetary and fiscal policy has destroyed the balance sheets of the Western world. We are in a phase of experimental central banking, which I believe is going to end badly due to the dislocations of capital it has caused through prolonged periods of negative rates.

In the event economic growth were to take hold, an unleashing of built up reserves in the system would set off inflation with a corresponding rise in rates. Just imagine the effect of a change in the direction of interest rates and the collateral damage that will create in the bond markets and the interest rate derivative markets after all of these years of managing a zero interest rate policy. The cost of funding the U.S. deficit will rise exponentially. More quantitative easing begets more quantitative easing. Investors need to have some type of asset to balance their portfolios. Policymakers who got us into this mess are unlikely to navigate us out of it. History tells us that only gold is a good place to be.

TGR: Is now a good time to be looking at the gold miners, including the juniors?

GO: Absolutely. With current sentiment negative on the miners, it is an incredible opportunity to buy gold shares and recapture lost value. A major problem for the mining industry is that its business model is flawed. Gold investors are not strictly interested in taking money from one hole in the ground and putting it in another. Investors want participation in cash flow through dividends and earnings leverage to higher gold prices along with the potential for increased shareholder value through discovery . Not paying dividends was great for management, geologists, engineers and everyone but the investor who was locked out of the cash flow.

Now falling share prices have put the onus on management to compete with the ETFs for investor dollars. A number of CEOs are being shown the door. Marginal projects are being shelved. Dividends are increasing. Management is beginning to understand that the needs of shareholders must be prioritized. Granted, the decline has been painful, but in my 30 years in the business, this is exactly what needed to happen.

TGR: Has the balance in your portfolio between bullion, large caps, mid caps, small caps, ETFs, royalties and cash changed over the last five years?

GO: Because production is cheap, we are weighting toward the large- and mid-cap producers. They are poised to recapture value as sentiment turns around in that space. The smaller, macro-cap exploration and development companies are bombed out, and a number of companies are trading where market cap per resource ounce is down to $10 or lower. Those companies are interesting as long as they have a balance sheet and they’re not diluting their shares to keep the lights on. Royalty companies have outperformed along with bullion over the last five years because of all the negative factors that I mentioned previously. But I’m not adding to the royalty companies right now because the operating companies offer better value.

TGR: You’re not adding to bullion?

GO: Not at this time. We’re keeping bullion around 5–6%. The miners, in my opinion, offer tremendous value at this point with gold reserves in the ground.

TGR: Who are some of the companies you think are attractive in the middle and small spaces?

GO: Endeavour Mining Corp. (EDV:TSX; EVR:ASX) is interesting right here. The share price has been washed out because it is a higher-cost producer, around $900/oz. Its market cap is down to under $400 million ($400M) with 300,000 oz (300 Koz) of annual production in West Africa, but is slated to grow to 450 Koz over the next couple of years. That’s a 50% increase. Endeavour is driving expansion mostly from internally generated cash flow.

Esperanza Resources Corp. (EPZ:TSX.V) is cashed up with over $70M and with experienced management is developing a couple of attractive heap-leach projects in Mexico. One project can put up 35 Koz/year and another one can do 110 Koz/year. Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) is a major shareholder. Esperanza could be an early day Alamos Gold Inc. (AGI:TSX).

Avala Resources Ltd. (AVZ:TSX.V), 50% owned by Dundee Precious Metals Inc. (DPM:TSX), is trading down at dirt prices. The company has an entire Carlin-style belt tied up in Serbia where it has outlined close to 3 million ounces (3 Moz) so far. The company’s market cap is $12–15M, with $9M in the bank; it’s not a bad option—the market will appreciate the optionality value on the company’s assets at some point.

TGR: Are you a fan of the royalty model?

GO: I am a fan of royalty companies. The revenue comes right off the top so royalty holders have no exposure to increases in costs and typically have exposure to increases in reserves. Royalty companies often acquire the royalties from the original property owners. Another form of royalty is the creation of a gold or silver stream: the royalty firm helps to finance the project and receives gold or silver in return. We have seen a pick up of companies selling either net smelter royalties or streaming deals on projects as a way to finance in a marketplace where equity capital has become expensive.

Source: http://www.theaureport.com/pub/na/15186

Sprott: Why SocGen Is Wrong About Gold’s Imminent ‘Demise’

A Retort to SocGen’s Latest Gold Report

Société Générale (“SocGen”) recently published a special report entitled “The end of the gold era” that garnered far more attention than we think it deserved.  The majority of the report focused on SocGen’s “crash scenario” for gold wherein they suggest that gold could fall well below their 2013 target of US$1,375/oz. It also included a classic criticism that we’ve heard so many times before: that the gold price is in “bubble territory”. We have problems with both suggestions.

To begin, the report’s authors appear to view gold as a commodity, rather than as a currency. This is a common misconception that continues to plague most gold market analysis. Gold doesn’t really work as a commodity because it doesn’t get consumed like one. The vast majority of gold mined throughout history remains in existence today, and the total global gold stockpile grows in small increments every year through additional mine supply. This is also precisely why gold works so well as a currency. Total gold supply can only grow marginally, while fiat money supply can grow exponentially through printing programs. This is why gold’s monetary value is so important – it’s the only “currency” in play that is immune to government devaluation.

Chart A illustrates the relationship between the growth of central bank balance sheets in the US, EU, UK and Japan and the price of gold. This relationship has an extremely high correlation with an R2 of about 95%. As central banks increase the size of their balance sheets through ‘open market operations’ to buy bonds, mortgage-backed securities (“MBS”) and the like, they inject more fiat dollars into their respective banking systems. As gold has a relatively stable supply, if there are more dollars available, the price of gold should rise in dollar terms. It’s really a very simple and intuitive relationship – as it should be.

Global -Central -Bank -Assets -vs -Gold

Source: Bloomberg and Sprott Asset Management LP

This relationship between central bank printing and gold has existed since the beginning of the gold bull market in 2000. In fact, this relationship shows that for every US$1 trillion increase in the collective central banks’ balance sheets, the price of gold has generally appreciated by an average of US$210/oz.

Somewhat surprisingly, it turns out that the collective central bank balance sheets have actually shrunk over the past three months – by approximately US$415 billion. The biggest drop was seen in the ECB’s balance sheet, which shrunk by the equivalent of US$370 billion, while other central banks also experienced small declines. Based on our simple model above, a decrease of US$415 billion should produce a gold price decline of roughly US$87/oz. And as it turns out, gold fell by US$76/oz over the first quarter of 2013. Does this sound like a bubble to you? It certainly doesn’t appear to be. Gold is performing almost exactly as it should – by acting as a currency barometer for the amount of money being injected into or withdrawn from the economy… which leads us to Japan.

Japan’s recent QE announcement is a thing of wonder. It represents an absolutely massive injection of yen relative to the size of the Japanese economy. The Bank of Japan’s US$75 billion equivalent per month of yen printing, coupled with the US Federal Reserve’s $85 billion per month (through its current QE program) will addUS$1.97 trillionto the collective central bank balance sheets over the next 12 months. Given Japan’s considerable contribution, we seriously question how SocGen believes gold can drop to US$1,375/oz by the end of the year. For that to happen, we would need to see a collective balance sheet decline of roughly 15%. Does SocGen seriously believe the US Fed (or any other central bank for that matter) is going to reverse its QE accumulation and then start aggressively selling balance sheet assets over the next year?

The only gold ‘crash scenario’ that makes sense to us at Sprott is if governments begin to balance their budgets and return to sound money practices. There is no question that gold could lose its utility if western governments made a concerted effort to fix their fiscal imbalances, but who honestly believes that’s going to happen any time soon? We certainly don’t – especially in the US. While US deficit spending may diminish in scale, it will remain well above $1 trillion per year after factoring in unfunded obligations. We don’t know of any creditable forecaster who believes otherwise.

We also don’t see a chance of the US Federal Reserve ending its QE programs, despite the continual jaw-boning by various Fed officials of a planned QE exit strategy. There is simply too much risk to the US bond market for the Fed to cut the US$85 billion in monthly Treasury and MBS purchases that the current program employs. After all – remember that those purchases are what keep interest rates close to zero today. If the Fed were to remove that flow of capital, the free market would once again dictate US bond yields and stock prices. There’s not a chance the Fed will take the risk of finding out what US bonds or stocks are worth to the market without a perpetual government-induced backstop. Why take the risk?  Especially since the cumulative QE programs to date have not caused a drastic increase in inflation expectations.

While we expect the Fed to continue to threaten to lower its monthly QE purchases, we believe the chances of even a mild decrease to its current US$85 billion per month rate are negligible. Four years into it this grand QE experiment, money printing has become the backbone of the US bond market, and the unsung driver of the US equity market. In our view, gold cannot become irrelevant for the precise reason that QE is here to stay… and the collective central bank balance sheets will continue to increase over time. We would question any pundit who believes otherwise – unless they can clearly articulate how the Fed can exit QE without causing irreparable harm to the very financial markets the QE programs were designed to assuage.

We believe gold is nowhere close to ‘bubble territory’ today. It is acting exactly as a currency should. Under its current stewardship, we expect the Federal Reserve’s balance sheet to continue to expand along with Japan’s. SocGen’s “crash” scenario would require a complete reversal of this trend, which we do not believe is even remotely possible at this point.

Gold is the base currency with which to compare the value of all government-sponsored money. Investors can incorporate it into their portfolios as ‘central bank insurance’, or ignore it entirely. Either way, we believe gold will continue to track the total aggregate of the central bank balance sheets of the US, UK, Eurozone and Japan. If SocGen believes the aggregate central bank balance sheet will continue to shrink as it did in Q1, then gold should continue its decline. We strongly suspect that shrinkage is over, however. Given Japan’s recent QE decision, we would expect the aggregate to grow a lot bigger, and fast. If there was ever a time for gold to be a relevant currency alternative – it’s now.

Article Source: Zerohedge

Two Seniors + Five Juniors = One Amazing Gold Portfolio: Adrian Day

The Gold Report: John Wilson, a senior portfolio manager with Sprott Asset Management, said recently that investors tend to get more comfortable with equity markets when equity markets are riding high versus when equity markets are riding low. What are your thoughts?

Adrian Day: That’s true; you see that in the broad market and in the gold market. The broad market has been a pretty steady move up from the middle of November until now, and yet all the way through the beginning of January the public was still very heavy sellers, not buyers, of equities. Then they started buying in January.

“Stocks of companies that have good balance sheets and inexpensive or very good projects and are advancing them nicely are doing reasonably well despite the overall negativity in the sector.”

If you look at the gold stocks, you need to be very discriminating about what you buy. A lot of the senior companies have had management shakeups because of bad acquisitions or overpriced acquisitions, capital expenditure (capex) overruns and bad capital allocation decisions; a lot of decisions were made in the last few years simply for the sake of getting bigger. For a few years, the market was indiscriminate, and everything was going up. But for the last six months, the market generally has been a lot more discriminating. Stocks of companies that have good balance sheets and inexpensive or very good projects and are advancing them nicely are doing reasonably well despite the overall negativity in the sector. Some amazing companies are selling at very good prices, and yet nobody seems interested right now.

TGR: Is your gold portfolio mostly equities? Do you dabble in exchange-traded funds (ETFs)?

AD: We buy physical bullion and ETFs. We have been known to buy bonds, although we’re not buying any bonds at the moment. The portfolio is primarily equities.

TGR: You allocate a portion of your clients’ portfolios to juniors, but you also have significant positions in larger-cap gold equities. John Paulson said in late March that he believes that gold companies need to get smaller and spin out some of their mines into other companies and operate on a much smaller scale. Do you think that’s realistic, and do you think that that’s a sound approach to generating shareholder value?

AD: I would flip it around and say that companies need to stop fixating on getting bigger simply for the sake of getting bigger. That doesn’t necessarily mean that companies have to get smaller, but certainly a smaller profitable company is a better company than a larger unprofitable company.

Read More: http://www.theaureport.com/pub/na/15133