The lack of excitement haunting the precious metals and mining shares markets over the past year is expected to change in the next few months, according to Michael Fowler, senior mining analyst with Loewen, Ondaatje, McCutcheon Ltd. In this exclusive interview with The Gold Report, he explains why he expects gold to finally break through the $2,000/ounce barrier in 2013 and how this should affect mining stocks.
The Gold Report: It seems that not much has happened in either the metals or mining shares markets since you last spoke with The Gold Report in March. What‘s it going to take to get people excited again?
Michael Fowler: Talking about gold, the price has been churning sideways. In my opinion, what’s really going to get people excited is that the gold price should actually go up quite strongly into 2013. The other point is a moderation of some of the current cost pressures in the mining business. On the metals side, we’ve seen a lot of softness in worldwide demand but I think that coming into 2013, we’re going to get a better metals market as China continues easing its monetary policy. So I see a pickup in demand coming into 2013.
TGR: We‘ve experienced all sorts of conditions, events and expectations over the past couple of years that probably could or should have taken gold past $2,000/ounce (oz). What do you see on the horizon that will finally get some major money flowing into precious metals or have the rules changed due to some other factors that are not obvious?
MF: Gold essentially reacts to monetary liquidity and to the concept of depreciating currencies around the world. Looking at gold in terms of euros or some of the other currencies, it’s done quite well. It just hasn’t performed in terms of U.S. dollars. The thing that I see on the horizon is potentially a weakness in the U.S. dollar. This could come about from the U.S. having to raise its debt ceiling, or it could have something to do with the Federal Reserve coming up with Quantitative Easing 3, which could happen in the short term and probably within the next six months. So, a de facto weakness in the U.S. dollar is going to be an important factor for gold to go past $2,000/oz. I’m looking for that to happen in 2013.
TGR: It seems that no matter what happens, the dollar ends up being the refuge of last resort. People talk it down and complain about all of the debt problems and everything else. Yet, when they have a choice, they seem to flee into the dollar, which defeats the price of gold going up.
MF: That is the case now. There seems to be a lot of confidence in U.S. treasuries or the U.S. currency but, in a sense, that’s probably a mistake. The debt situation is going to get some attention when the debt ceiling is hit again. It is certainly going to get some attention during or after the election in the U.S. I think people are going to start focusing on the U.S. situation more and more. For instance, the city of San Bernardino in California recently announced it was going bankrupt. These problems are all over the place in the U.S. I just think it’s a matter of time before people are going to focus on it, and then some confidence is going to be taken out of U.S. assets and U.S. treasuries.
TGR: Turning to the mining industry, there have been some real surprises with the rising costs and changing economics with projects being put on hold and that sort of thing. Besides energy prices, what‘s causing these increases and is this temporary or a new built-in factor of concern?
MF: It’s amazing that, although costs have been going up for the past 12 years, suddenly everybody is getting really excited about it. What’s behind the rise, first and foremost, are labor costs, because there is a lack of qualified people in the industry. When the Internet bubble was hot, people were going into the high-tech sector rather than mining and other sectors. There‘s been a big exodus of baby boomers out of the business, such as mining engineers, explorers, etc., and a lack of qualified people to replace them. So it’s a question of supply and demand. Apart from labor, there is power. Power costs have gone up along with reagents, steels, materials and lots of other input costs. Some of these things will abate but the labor issue is big and not just temporary.
TGR: These things eventually sort of self-compensate, but they do cause temporary problems in the short term.
MF: Companies are trying to find solutions here, such as putting into production higher-grade ore bodies, which will lower costs on a per-ounce basis. Also, the mining business probably has to rethink itself like the auto industry where car manufacturers source or even produce modules of cars in countries with a lower cost base. An example would be buying SAG mills and equipment in China or other countries. Companies are going to have to start moderating increasing costs, which are a main reason why gold stocks have done quite poorly compared to the gold price. The gold price really has to start outpacing cost inflation for us to get really excited about the sector again.
TGR: You spoke in the past about companies perhaps over-financing themselves at the wrong time. With most stock prices down, raising money for non-producing explorers and developers must be difficult in this environment. What‘s your perspective on that?
MF: There‘s a two-tier situation out there right now for explorers. Some companies, in my opinion, have raised much more money than they need for their programs over the next two years. I think that’s a very bad situation with blame to go all around. Even the investment funds are over-financing some of these juniors. On the other hand, you have some juniors that don’t have any money and are having a hard time financing their programs or even their overheads. It may take at least six months before they can go back into a market where they can actually finance themselves.
TGR: Would you consider the companies that have over-financed successful or maybe not so smart? I guess it depends on what prices they raised funding.
MF: At the time that they finance, they probably feel very smart and are probably very smug about it. In the past, we would raise money for these juniors for a year or two of exploration work, and then they would come back to the market and get judged on their performance. Now, some have enough money for many years of exploration.
TGR: We’re in the summer doldrums now. When things do pick up, where do you think we’ll get the best action among the different mining groups that you follow?
MF: In the gold sector, I would put the majority of my money in the junior to midtier producers. I’d also put money into some of the interesting turnaround and recovery situations. Our company focuses on the junior producers and explorers and I’d be putting roughly 15% of my money into that group. It’s going to take some time for those companies to turn around, except for specific situations.
TGR: You don’t think that the major producers are going to have the first shot at a little bigger movement?
MF: I think they will have better movement but, unfortunately, I don’t think too much of some of the bigger-cap names. With what you see in their earnings and news coming out recently, they haven’t been good at all. I’d avoid them.
The majority of my money would be in the junior midtier producers, emerging producers and some more or less turnaround producing situations. That would be the bulk of it. Then about 15% would be for explorers and developers.
TGR: There‘s been a real revival in eastern Canada among all these old underground mines that have been around for 50–100 years. The higher gold prices certainly changed the economics.
MF: Yes, they have, but costs have gone up as well. There is some potential for open-pit situations in that area and a lot of the companies are actually focused more on that than they were previously because, as you mentioned, they were mostly underground mines.
TGR: Maybe you can summarize what you’re expecting in the precious metals markets, how that’s going to benefit the mining shares over the balance of the year and what people should be looking at so they can get the biggest bang for their buck.
MF: As I mentioned in March, the industry is on sale. There is an even bigger sale going on right now. The valuations are cheap and it‘s a great time to invest in some good names. The catalyst, to my mind, is going to be a macroeconomic situation, which is ultimately going to weaken the U.S. dollar. We may be seeing that coming up into the fall, with a focus on the debt situation in the U.S.
I believe that the cost concerns in the industry will abate a bit here because energy prices have come down, but inflation is going to be a built-in factor going forward. I’m looking for the gold price to outstrip the cost inflation. So coming into 2013, I’m looking for a $2,000/oz gold price, which should provide some impetus for people to look at gold shares again. I think investors have to look for growth situations. There is a likelihood that some will be taken over. I wouldn’t be despairing too much at the moment. Despair usually means opportunity, and I think the opportunity is right at hand.
TGR: Thanks for joining us today, Michael. We’ll all be eagerly awaiting that $2,000/oz gold price to see where it takes us.
MF: Thank you, Zig.
Michael Fowler, senior mining analyst with Loewen, Ondaatje, McCutcheon Ltd., has worked in the investment industry since 1987 as a base and precious metals mining analyst for numerous high-profile firms. His coverage list included the major North American gold mining companies, but is now focused on small- to mid-sized companies. Previously, Fowler worked as a geophysicist involved in mineral exploration for 10 years. He was involved in the discovery of the high-grade Cigar Lake uranium mine in Northern Saskatchewan in the early 1980s. Fowler holds a Master of Business Administration from Cranfield University, UK; a Master of Science in mineral exploration from Leicester University, UK; and a Bachelor of Science in geology with geophysics from Liverpool University, UK. He is a member of the Institution of Materials in the UK and a member of the Canadian Institute of Mining and Metallurgy.
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