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Joe Foster: Gold Miners Offer Rally Leverage
By Drew Voros | August 13, 2012
Gold analyst Joe Foster is the investment team leader for Van Eck’s flagship gold fund, the Van Eck International Investors Gold Fund. He also serves on the investment teams for the Van Eck Global Hard Assets Fund and Van Eck VIP Global Hard Assets Fund, and is an advisor to the Market Vectors ETF Trust – Gold Miners ETF (GDX) and Junior Gold Miners ETF (GDXJ). Foster has been in the mining and investment business for more than 25 years and is frequently quoted in the Wall Street Journal and Barron’s. He’s also a frequent guest on CNBC and Bloomberg TV. Hard Assets Investor Managing Editor Drew Voros spoke recently with Foster about the gold market as well as the gold mining sector.
HardAssetsInvestor: In your opinion, what is the biggest influence on gold prices right now?
Joe Foster: The biggest would be expectation towards more monetary easing, either out of Europe or the U.S. That’s the No. 1 driver.
HAI: Because of that, do you expect to see central banks continuing to be long-term buyers of gold in this environment?
Foster: Yes; I think so. Central banks are buying gold for the same reasons a lot of investors are. The level of financial risk is very high. We’re seeing governments debase their currencies, and they’re seeing it as sound money. As long as we’re looking forward to more of that type of activity and these risks, then I think central banks will continue to buy.
HAI: Of course, they have the inside information in some way, too, don’t they? They know where they’re going.
Foster: Exactly. The other thing about central banks’ activity is that China might be a big driver of it as well. China is very secretive, so we don’t know really if they’re buying or not. But our view is that they probably are in the market and maybe substantially.
HAI: Speaking of China, do you consider them the leading gold-producer country now, or is that still difficult to ascertain?
Foster: They’ve become the No. 1 producer the last couple of years. They’re sort of neck-and-neck with South Africa, but I think they produce a little more.
HAI: What does China do with its gold? Do they use to store value? Do you have any idea what it actually goes toward?
Foster: It all goes to three areas. Some of it is probably going into their central bank. Second would be jewelry demand. With growing affluence of the Chinese, we’re seeing more jewelry demand out of China. And then we’re also seeing more investment in bars and coins, physical gold. Gold is one of the few investments that the Chinese can access. They don’t have a mature stock market or functioning bond market—or the investment alternatives that we have in the West.
They can buy gold or they can buy real estate. They can invest in the stock market now, but it’s very volatile and risky. Gold is many times an investment of choice there.
HAI: For central banks to stop buying gold, wouldn’t that require a sea change on their part? They would have to say “We’re not going to debase our currency; therefore, we’re not going to be buying gold as much,” right?
Foster: The dollar makes up something like 60-plus percent of any given central bank’s reserve assets. And the euro probably takes that up to what, 70 or 80 percent. But you have all these countries around the world looking at what the Europeans and the U.S. Fed are doing with printing money and extreme monetary policies. The focus is on what’s going on with the paper in your reserve account, and it’s being debased.
HAI: Moving over to mining, what’s the current thinking about the gold price that is needed to keep gold mining profitable? Is it still around $1,000 an ounce, or has that moved?
Foster: If the price got down to around $1,300 an ounce, we would start to see some of the marginal mines really struggle to stay open.
HAI: Do oil prices have a large influence on that? When oil prices are going up, does that push that minimum gold price needed for profitability?
Foster: The biggest driver of the rising costs is labor. There’s a labor shortage in the mining industry, and so we’re seeing labor costs go up substantially. Energy is probably No. 2. Those would be the big ones. Mining companies are getting hit on all fronts on the cost side.
HAI: Do mining companies typically hedge against oil prices?
Foster: Some of the majors do, but not in a big way. They might hedge 10-20 percent of their oil or fuel needs.
HAI: How would you characterize merger-and-acquisition activity among gold producers within the last year or two? With peak gold prices, would you have expected more activity?
Foster: In 2010, we had probably a record year for M&A activity, but it’s fallen off significantly in 2011 and this year. That’s mainly due to valuations. Gold stocks have underperformed. Gold valuations are at very low levels right now. And when valuations are low, you don’t get a lot of M&A activity, regardless of what’s going on with the gold price.
HAI: Do you feel the level of dividends is high enough to continue to attract investors?
Foster: Companies need to do more. In fact, the market is telling them they need to do more. They’ve implemented aggressive dividend policies and the yield on these stocks has trended toward 2 percent. But to stand out as a dividend-paying stock, you need to be up higher than that. And even though they’ve implemented these policies, it’s not reflected in their share prices. It hasn’t moved their share prices. I think that’s the market saying, “No, we’d like to see more.”
HAI: What do you make of some of the higher-level executive changes at gold companies?
Foster: It’s a sign that companies recognize they need to change the way they manage their business. Boards have gotten the message from the market that these stocks have underperformed because the market sees the managements as inept.
But part of that perception isn’t the fault of management. All of it revolves around escalating costs, and a lot of drivers are beyond their control. But what the managementshave failed to do is forecast properly and guide expectations. Even though their costs are rising, they need to be in front of that. They need to tell investors and let the markets know what to expect. They haven’t done a very good job of that. As a result, every quarter the market gets surprised by costs or operating issues or something that’s not going right within a company. Then they miss expectations, and markets just hate that.
We’ll see a new emphasis on setting and meeting guidance. We’re seeing companies review projects and we’ll see projects delayed or shelved in the industry going forward.
HAI: Is gold always going to move in reverse of the U.S. dollar in general? Is that something that gold investors should really key in on?
Foster: As long as the dollar remains the dominant reserve currency, in the longer term, the dollar and gold will have a negative correlation. That said, we have gone through—and we can easily go through more—periods where there’s a positive correlation between both. There have been periods where both have gone up in tandem, and usually that happens when people are more worried about the U.S. currency.
HAI: Gold is still up 2-3 percent year-to-date. How do you think it will play out for the rest of the year?
Foster: I think gold will end up on the year. In fact, I think it will be up significantly from where it is right now. This gold market has been consolidating since September of last year. This consolidation is almost a year old, and it’s forming a base from which I see it trending higher. We’re still in a deflationary environment and we’re going to see central banks continue to try to stimulate the economy. That’s going to drive gold in the second half.
In addition to that, we have the election coming up and the fiscal cliff and all these sorts of risks going forward. We know about all the problems in Europe. I think at some point following this long consolidation, we’ll see a nice trend higher in the second half.
HAI: Do you think we’ll push close to the high of last year?
Foster: We could. The high this year has been right around $1,800; I think we can make yearly highs between now and year-end, and maybe even test the all-time high [$1921/oz.]. We’ll see.
HAI: If you were to buy gold today, what vehicle would you use to do that?
Foster: I would buy gold stocks. The valuations look really attractive. If we do get the rally that we’re expecting, then these stocks will give us some really nice leverage.
HAI: Are you speaking in general, or majors or juniors or a mix of both?
Foster: The best valuations across the group are in the juniors, but I think we’ll see good performance from the juniors to the majors. They’re all trading at bear market valuations right now.
HAI: When we’re talking about gold, does silver make a logical addition to a portfolio? Or is there really nothing much to be gained from holding both?
Foster: No, silver to me is kind of like a leveraged bet on gold. It’s more volatile, but it’s a monetary metal, so it reacts to some of the same factors as gold. Then again, if we get more stimulus coming out of central banks, silver has a big industrial component. So anything that stimulates the economy is going to drive silver as well.
HAI: Is that industrial component partly why it seems to increase a little faster—and fall a little faster—than gold?
Foster: No; I think silver is just a much thinner market than gold. I think that’s the volatility.
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