The Dust Settles, A Deal Emerges (In Gold!)
After months of being under central bank-administered anesthesia, many investors are pondering outside the repeated mantra of “Money printing equals higher stocks.”
The question they’re asking now? How, exactly, swapping overvalued shares back and forth will create wealth for everybody — including those unfortunate enough to be buying late?
Masking symptoms of troubled economies with oceans of fresh money is not a good prescription for “wealth creation.”
But the Fed and other central banks have gone down that road, and there is no going back, even after the uglier symptoms of inflation emerge.
In the wake of the chaotic break in gold futures market, all gold mining stocks have been smashed. After two dreadful years, it looked like a final, cathartic purge. I haven’t seen sentiment and price moves like this since the depths of the 2008 crash.
The gold panic offers you a rare opportunity to buy one of the best companies in the gold sector.
But first, let’s examine the question of whether or not the gold bull market is over…
After spending much time re-examining gold’s fundamental drivers, my own assumptions and the views of a few dozen top analysts, I’ve come to the following conclusion: Ignore Wall Street’s clueless, half-baked opinions of the gold futures market.
Most of the banks’ opinions, including Goldman Sachs’ famous “short gold” report, are based on an extremely speculative forecast: that the global economy can thrive after central banks stop printing. This cannot happen. The only drivers of the U.S. economy in recent years — rebounded stocks, housing and autos — owe their strength almost entirely to the Fed’s policy. Take away the policy, and all three would collapse. So the Fed simply cannot remove the policy. If it attempts to remove easy money, and the economy crashes, it will reinstate printing in a heartbeat.
The fundamental facts have not changed, so the underpinnings of gold’s bull market are intact.
The number you need to remember is zero.
Zero is where central banks will peg interest rates for several years into the future. Zero is also the number of times in recorded history that the “QE/ZIRP” policies in place worldwide have boosted any economy to “escape velocity” (as economists say).
Such radical policies always result in destruction of the currency being printed. In other words, stagflation — not sustained economic recovery. Japan will discover that history rhymes once its financial market sugar high wears off. It offers a preview for the U.S.
As inflation expectations rise — the great hope of Bank of Japan governor Kuroda — Japanese investors will discover that money printing schemes are addictive, with no practical exit.
Here’s why: Once consumers buy tomorrow’s products today (ahead of expected price rises), what will they buy when tomorrow arrives? When tomorrow arrives, the howls for another round of printing will be louder than ever! We keep bringing up this question because thus far, there is no indication that any policymakers know (or admit) that Japan’s new policy is addictive and irreversible.
The real world isn’t nearly so simple and easily modeled, as the professors running central banks believe. Trying to “boost inflation expectations” will only trap central banks into permanent cycles of easing — both in the U.S. and Japan. And the bigger government debts get, the harder it will be for central banks to tighten policy.
Raising interest rates a few years from now would result in interest expenses consuming an unacceptable amount of government tax revenue; so higher short-term interest rates — which would really put the brakes on gold prices — will not happen.
Finally, zero happens to be the number of fiat currencies in history that held their value. The dollar’s value isn’t going to zero anytime soon, but debasement continues, and stopping the growth federal entitlement spending — the real driver of federal budget deficits — is politically impossible. The guardians of the paper dollar’s sanctity, rather than preserving its value with positive real interest rates and balanced budgets, are aggressively pushing it toward its ultimate destination: zero.
I’m waiting to see a strong rebuttal from the defenders of the paper money system. Thus far, I haven’t seen any cases for a strong dollar — a case that proves central banks have not trapped themselves into permanent cycles of easy money.
The gold bull market lives on…
Franco-Nevada, the Premier Gold Royalty Company, at Clearance Prices
Rising costs have hurt the performance of most gold mining stocks. After sinking billions into exploration and mine development, most big miners have delivered disappointing results.
Until the market starts rewarding gold mine expansion, it’s safer to limit your portfolio to stocks with low financial risk. Royalty companies are among the gold stocks with the lowest financial risk — primarily because they don’t have huge, ongoing capital outlays to sustain production.
We haven’t recommended royalty stocks because until now, they always looked too expensive. But after the recent sharp sell-off, they are now cheap.
Royalty companies spend shareholders’ money upfront to acquire royalties on specific gold mines. Then, they receive a predetermined percentage of the mine revenue over its entire future operating life.
Franco-Nevada Corp. (FNV) is an expertly managed gold royalty company. Chairman Pierre Lassonde and CEO David Harquail lead FNV’s executive team. They’ve delivered exceptional results for shareholders by carefully building a portfolio of gold royalties. Management lists the following key investing principles:
- Exploration upside
- Long-term secure tenure
- Minimize potential for encroachments
- Our first dollar in is our last
- Time is spent on future investments, not operations.
The business model minimizes risk while allowing for huge, positive options in the form of higher commodity prices and volume growth due to exploration.
FNV stock is up 150% since its December 2007 IPO — doubling the 75% rally in gold bullion. For most of the mining stock bear market of the past two years, FNV had outperformed gold bullion:
But in the past three months, as a brutal capitulation in gold mining stocks unfolded, FNV fell much faster than gold bullion. After great financial performance and industry-leading shareholder return in 2012, the stock has been cut nearly in half.
But compared with bullion or an ETF, Franco-Nevada is a vastly superior vehicle to get exposure to gold. In this table, management describes why its stock is a better risk/reward proposition than both ETFs and mine operators:
Franco-Nevada’s business model benefits from rising commodity prices and new discoveries, while limiting exposure to the top risks we’ve seen at mines: huge increases in capital and operating costs.
Thanks to its strategy, FNV has lots of cash, no debt and rising cash flow. Gold equivalent production is projected to grow 37% from 2012-2017; oil and gas revenue is set to double.
Cash flow goes to pay dividends and expand the royalty portfolio. The stock’s decline pushed FNV’s dividend yield up to 1.8%. Assuming gold prices don’t collapse yet again, the dividend is not at risk; in fact, it has grown rapidly from 29 cents per share in 2010 to 54 cents in 2012.
In terms of revenues and number of gold assets, Franco-Nevada is the largest royalty company. Its 348 royalty interests include some of the largest gold development and exploration projects in the world.
Eighty-nine percent of its 2012 revenue came from precious metals. Metals encompass gold and a 14% exposure to platinum group metals — metals with very bullish supply-demand dynamics. FNV’s royalty portfolio is diversified geographically, with most exposure in safe mining districts: the U.S., Canada and Mexico.
FNV also holds high-return interests in oil fields. Last November, it acquired an 11.7% net royalty interest in the Weyburn Oil Unit in Saskatchewan for C$400 million in cash, or just C$16.53 per proved and probable barrel of oil.
Franco-Nevada benefits from rising gold prices and new discoveries while limiting exposure to rising costs. By owning a business with such high profit margins and a high return on invested capital, shareholders are set to enjoy a large, growing stream of future free cash flow. The higher gold, platinum and oil prices rise, the faster FNV’s free cash flow will grow.
At a time when capital is scarce and expensive in the gold mining business, FNV is in a great position, with $1.4 billion in available capital to invest. Management is in a position to create lots of value in this stressed gold mining environment and sow the seeds for the next great harvest of returns to shareholders. At 16 times 2012 cash flow — with a huge upside to cash flow and minimal capital requirements — FNV is a bargain.
Dan Amoss, CFA
Original article posted on Daily Resource Hunter