Patience does not seem to be a virtue right now...
SENIOR vice president and investment adviser with Macquarie Private Wealth, Jamie Mackie thinks the mining sector could sink further, he also believes now is the time to buy, carefully. In his first interview with The Gold Report, he discusses strategies to mitigate junior mining risk.
The Gold Report: Investing in mining equities is a cyclical play. Are we at a point in the cycle for investors to return to mining equities?
Jamie Mackie: I think the gold mining stocks are at or near the bottom. Research from the Ned Davis Research Group shows that pessimism is extremely high—typically an indication that we are close to a bottom. From our perspective, that is the best time to position yourself. Once the market begins to turn, it will happen rapidly. Investors need to recognize value and get in reasonably early to avoid paying up later.
I compare the situation to being at a huge party; the party being the blue chip, dividend-paying sector. The party has been going on for quite a while, and it is hard to leave the party and sit in a room all alone. But that is what investors should do, spend time in the room alone, waiting for others to join them.
TGR: From a wealth-building perspective, how do mining equities fit in a world that is deleveraging?
Jamie Mackie: Your choice of the word deleveraging is interesting because I would say the world as a whole is not deleveraging.
True, US households have begun to deleverage, which has been positive for the market. Corporations have been deleveraging for some time, but now, due to artificially low interest rates, they are beginning to take on more debt.
Governments—except for those with austerity programs, like Greece, Ireland and Italy—have leveraged up massively. They are trying to make up for shortfalls in spending by corporations and consumers. Once governments ramp up spending, it is difficult for them to reduce expenditures later on. Governments are engaging in currency wars in an attempt to get their currencies down so their economies can compete globally. This is self-defeating. It inflates the money supply and puts downward pressure on the value of the currency.
Money printing is an insidious form of taxation on personal savings. People who want to protect against the ongoing depreciation of their savings need to have hard asset exposure. This process isn't stopping. Witness the March 20 decision by the US Federal Reserve to continue with the Quantitative Easing program. Owning quality mining and energy companies or the commodities themselves offers protection against this.
TGR: As a private wealth manager, how much of a typical portfolio are you allotting to junior mining equities?
Jamie Mackie: Right now, in the 2–3% range, so fairly modest. Our focus is more on energy equities right now.
TGR: How do you counterbalance the risk junior mining equities represent?
Jamie Mackie: Our approach to offsetting the risk in junior mining focuses on senior blue-chip and dividend-paying equities. Although as things get more expensive we are taking money off the table. As price/earnings ratios for specific equities get out of our comfort range, we want safer opportunities.
People often ask whether bonds would be a good risk offset. We view the bond sector as the most expensive, inflated bubble ever. Apart from very short duration bonds, we are on the sidelines.
Perhaps a better way to offset the mining stock risk is with a larger portion of physical gold, perhaps a 70/30 ratio. Of that 30% in equities, 70% would be in larger-cap equities and the rest in smaller, well-capitalized juniors.
TGR: How do you mitigate risk before you take positions in junior mining equities?
Jamie Mackie: Management is number one. Does management have skin in the game? It is important that management be aligned with our interests.
TGR: Do you have a rule of thumb for ownership percentage?
Jamie Mackie: The bigger percentage of management's net worth, the better. Quality of the management team is really more important. Generally, if members of the management team are confident in their abilities and their projects, they will take significant positions.
TGR: What other factors help you mitigate risk?
Jamie Mackie: Time to production is important. The mining sector has something we call the "valley of death." A company has a great discovery, it takes six years to get into production; meanwhile, the stock plummets and the company cannot get financing. It is at 6–12 months before production that interest in the equity picks up again.
Then you look at the size of the ore body: Is the project big enough to attract the attention of an even higher-quality buyer? Is the project in a good jurisdiction? We have had what could be described as investment fatigue over political issues.
TGR: Investment fatigue is an interesting concept. Can you expand on it?
Jamie Mackie: When a government changes, the question becomes what one owns after the change. Egypt and Mali are two examples. Countries that follow British common law tend to be more stable from the point of view of jurisdiction and ownership. Russia is a country with a legal system quite different from British common law. It has been difficult to work in China from a property ownership point of view. Argentina's somewhat erratic government has been tough.
Other countries—Peru, Colombia and Chile, for example—have improved a lot.
TGR: I would like to change the subject to royalties. You are fairly bullish on precious metals royalties. The royalty model is inherently lower risk than actual mining, but royalty companies typically have a lot of exposure to movement in metals prices. What is your outlook for gold and silver prices for the rest of 2013?
Jamie Mackie: The party going on in the blue-chip, dividend-paying equities has resulted in an exodus from the mining sector and from the gold exchange-traded funds (ETFs) into stocks that generate income. The resulting sales of gold drove the gold price down.
On the other hand, physical gold is being bought by longer-term, stronger investors, i.e., the Chinese, Indian and other developing countries' governments, as well as individuals there. Private investors seeking insurance against currency debasement are buying the commodity, too. The ETF liquidations will cease at some point in the near future so in two to six months out we should see stronger gold prices, mid-$1,600/ounce (mid-$1,600/oz) or higher.
Silver is different. It has industrial uses, including some pretty healthy growth areas, such as electronics and water treatment. A lot of its uses are consumptive, and although there is some recycling, a lot of silver disappears. The ETF market has not been nearly as big on the silver side, and therefore not as disruptive as the gold ETFs. By year-end, silver could be, on a percentage basis, somewhat higher than today.
TGR: Could it push $35/oz by year-end?
Jamie Mackie: Silver is a volatile market. There will be spikes and retrenchments, but it could get there.
TGR: How do royalty companies benefit from resource expansion on their mining properties?
Jamie Mackie: That is the big upside on royalty companies. In most of the projects they finance, they are buying into a royalty stream based on resources outlined in an NI 43-101.
Gold mining companies tend not to make capital expenditures to develop new reserves on their existing properties until they need to. Once a project is up and running smoothly, and the company has paid down some debt or proven that the economics are justifiable, it will drill up the surrounding land and get more reserves from that.
The streaming company gets huge upside on the pure future development of the mine.
TGR: Smaller royalty players have entered the market. Do they offer value or are they simply trying to piggyback on the success of the larger names?
Jamie Mackie: I am sure there is some mimicry of larger royalty companies. However, given the disarray in the mining sector and the dearth of capital on the junior side, there is an opportunity for smaller royalty companies to structure really attractive deals. There are just a handful of royalty companies.
TGR: What advice would you give retail investors that they ought to hear, but might not want to hear?
Jamie Mackie: The stock market is massively fickle and the mining sector is in difficult times that could prevail for an extended period. In the long run, this is a self-correcting event. Mines will be delayed if things carry on as they are until demand returns, grows, and outstrips supply.
Further decreases in the commodity price will damage equity values. Strong companies have the upper hand, and at some point, they will use it. They will find and purchase the best projects, although we have not seen much merger and acquisition activity lately.
I think even the big companies are shell-shocked. They have had huge cost escalation in projects and are looking to finish them before taking on others. That has been a real wet blanket on the junior mining sector.
The world keeps growing, along with demand for commodities. Currencies will continue to be debased. Inflation will begin to drive commodity prices higher.
The biggest question right now is when. Nobody has a good answer. The inflation numbers provided by governments are nowhere close to accurate. Good measures might be the cost of building a mine or the associated operating cost. If the costs were the prescribed inflation rate of 1.5%, the mining sector would not be having such huge cost overruns.
If you take a position in the junior mining sector, you have to be patient, although patience does not seem to be a virtue in the current market.
TGR: Jamie, thank you for your time and your insights.
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