The Gold Report: What is the consensus among Haywood analysts on what 2012 will bring for mine commodities, particularly precious metals?
Joe Mazumdar: Last year, risk aversion was a common market theme. In 2012, some of the same global economic concerns, such as the ongoing Eurozone crisis and the future of the euro, will continue to draw attention. But we also believe there is potential for positive economic indicators, primarily from the U.S., where there have been upticks in manufacturing and GDP growth. Also, unemployment in the U.S. is down to 8.5%, generating some consumer confidence. Recently, GDP growth for Q411 came in at 2.8%, which was slower than consensus forecasts-3%-but still the strongest in over a year.
Political factors will play a role in 2012. There could be a change in leadership among four of the five permanent members of the U.N. Security Council. The presidential election will be a key focus of the U.S. and global market. There are also presidential elections in Russia, France and Mexico. There also may be a changing of the guard in China in the latter part of 2012. The potential for changes in leadership in these key nations will generate a bid to market volatility in 2012.
Beyond gold and silver, our preferred commodity sectors include copper, iron ore and coal. Gold continues to be adversely affected by its own volatility, which continues to tarnish its reputation as a safe-haven asset. We note that during 2011, U.S. Treasury securities, the most liquid safe-haven asset, was a preferred recipient of capital investment, providing a ~10% return, its highest annual return since 2008 when it was 14%.
TGR: Will the strengthening American economy have an adverse effect on the gold price?
JM: Yes, the gold price quoted in U.S. dollars will be hindered by any U.S. dollar strength based on economic growth and increasing consumer confidence. In the current environment, gold, quoted in U.S. dollars, is still holding up well at price levels over $1,700/ounce (oz).
We note that the Federal Reserve said recently that it remains concerned about the “vigor” of U.S. economic growth and pledged to maintain low interest rates until at least 2014. The latter is a positive for gold prices.
In the medium to long term, increasing confidence levels in U.S. economic growth we believe will drive higher capital investments domestically and potentially raise inflation expectations, which would be a positive for gold.
TGR: What about silver and copper?
JM: We see copper on the brink of a rebound in 2012. The London Metals Exchange inventories are at low levels and Chinese imports of refined copper accelerated in the latter part of 2011. Copper is covered by Stefan Ioannou/Kerry Smith of Haywood Securities and they highlight a structural tightness in the copper market as supply growth remains constrained while a portion of future production growth resides in higher geopolitical risk jurisdictions. They note that the GFMS has estimated a deficit of 372 Kt copper in 2011 and forecast yet another deficit for 2012, 101 Kt.
Chris Thompson covers the silver sector for Haywood Securities and has commented that despite the growth in investment demand over the past five years, silver is still very much an industrial metal. Volatility, he believes, will be underpinned by potential contradictory moves by those who see silver as an industrial metal and others who seek it as an investment asset.
TGR: Did the junior mining sector hit bottom in 2011?
JM: Within the current cycle, I think it has hit bottom. For me, the question remains: What are the catalysts that will move individual stocks up within the sector?
For a number of the majors, growth has been increasingly difficult to achieve given the higher amounts of reserves they must replete on an annual basis. Some large companies have been offering higher and more levered dividend payout structures to attract investors.
In 2012, we see the potential for more merger and acquisition (M&A) activity, specifically in the junior to intermediate sector, given the plethora of small-cap stories in the gold sector. Producers have performed better with respect to their paper in 2011, compared to development stocks, and boast healthier balance sheets. M&A activity will be driven not only by a desire for growth but also motivated by financing risk to capture any synergistic opportunities such as sharing infrastructure and the potential to merge critical skill sets. There is a paucity of people who can bring projects into production and operate them. Merging structures and management is very important right now in the junior and intermediate sector. Without it, a lot of these companies with development assets may continue to struggle.
Large projects that are required to move the needle in the growth strategy of a large gold producer have a scale and scope that naturally expose them to significant execution risk. So, in a nutshell, escalating capital costs for projects of this magnitude are nothing new.
The M&A opportunities I refer to are at a scale that would be accretive to a junior to intermediate company from a growth perspective and offer opportunities to capture synergistic value. From a valuation perspective, many companies with development stage assets are trading well below their underlying asset valuations. M&A activity allows also for some consolidation in the junior sector given the plethora of small-cap gold plays.
TGR: Did you make any adjustments to your investment thesis following the dip in precious metals equities late in 2011?
JM: In our top picks, which we put out on Jan. 9, we focused on producers generating cash flow and developers with permitted or on a clear path-to-permitted projects in low geopolitical risk jurisdictions.
TGR: What do analysts, investors and companies need to look out for in terms of geopolitical risk?
JM: I would highlight countries-emerging or developed-that are in economic dire straits with prospective geology whose mining sector is underdeveloped and has untested mining laws and poor infrastructure. Geopolitical risk carries a few facets including outright expropriation to creeping nationalism, which is linked inextricably to a company’s ability to develop/permit the project. These countries will continue to seek foreign direct investment to explore/develop these assets. Outright expropriation is difficult in countries where there is no mining history and a paucity of critical skill sets locally, unless of course it is looking to sell the asset to another bidder. Alternatively, the country may alter its mining laws to increase its share of resource rents derived from the exploitation of these assets. We have observed higher rent sharing globally via increased royalty payments, higher taxes and/or the introduction of windfall tax structures in countries such as Peru, Argentina and Romania, to name a few.
Assets in higher geopolitical risk jurisdictions must provide the investor a high return and quick payback commensurate with the elevated risk profile. Note that assets within higher geopolitical risk jurisdictions may be more difficult to finance and there may be a limit on potential takeover suitors, depending on their risk appetite. To properly risk adjust and quantify these uncertainties remains a challenge.
TGR: Is that because it is not going away?
JM: Let’s not forget that mining is a great way to get an injection of direct investment into an economy and generate employment. For example, high rates of unemployment in developed countries such as the U.S. and European countries are driving mining activity in places where permits have historically been difficult to attain.
TGR: Joe, thank you for your time and your insights.
Joe Mazumdar is a senior mining analyst with Haywood Securities in Vancouver. Previously, he served as director of strategic planning at Newmont Mining and was the senior market analyst for Phelps Dodge. He has held a variety of geologist positions with other mining companies including RTZ, MIM, North and IAMGold working in South America, Australia and Canada, rounding out ~20 years industry experience. He holds a Bachelor of Science in geology from the University of Alberta, Canada, a Master of Science in exploration and mining from James Cook University, Australia, and a Master of Science in mineral economics from the Colorado School of Mines, U.S.
Article published courtesy of The Gold Report – www.theaureport.com