“ETFs Were Behaving a Bit Like a Wild Central Bank in the Gold Market,” says Dynamic Funds’ Robert Cohen

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Announcer: The SmallCapPower Expert Interview, featuring Robert Cohen.

Mark: Today we welcome back Dynamic Funds portfolio manager, Robert Cohen, who tells us what catalysts he believes will move the gold price sharply higher in 2015. Mr. Cohen also mentions three of his favourite portfolio stocks, as well as a summary of where we’ve been with the gold price in 2013 and 2014.

Robert: Well, 2013 was a really unique year for gold. The advent of ETFs back in 2003 and 2004 was somewhat of a game-changer because they accumulated, between 2004 and 2012, about 2600 tons of gold. That rivals most central banks in the world. So you have basically an ETF behaving like a little bit of a wild central bank. And in 2013 when people saw strength in the U.S. dollar and wanted to liquidate their gold ETF positions, the mechanism that the ETFs use is to sell the underlying physical. So 900 tons of gold was sold last year out of the ETFs. That was equivalent in central banking, for example, saying Russia announcing at the beginning of 2012, we’re going to sell most of our gold in the next 12 months. So you can imagine, that did have an impact in the market.

A good way to measure it, without just looking at the gold price, is actually looking at it in terms of other commodities, so in terms of oil for example. So gold maintains a relatively strong purchasing power over time against oil. The long term average is, one ounce of gold buys you about 16 barrels of oil. By the end of 2013, that number was down to 13:1. So basically the purchasing power of gold against oil lost three barrels of purchasing power. What has been good about 2014 is that so far this year the ETFs have only liquidated 100 tons of gold, so, much easier for the market to absorb, and gold’s relative performance to oil has recovered, it’s been restored. We’re back to that 16:1 ratio once again. So in terms of purchasing power of gold against other hard assets, 2013 was definitely a blip no one could have predicted. But the good news is that for 2014, it’s been restored. But when we look at the absolute price, people are also puzzled. Earlier this year, we had some weak data points out of the U.S. and in the second half of the year some stronger data points out of the U.S. So in terms of the U.S. dollar gold price, gold has been fairly flat over the year, even though it had a rise and then a fall, but at the beginning of the year until today as we speak here in November, we’re just about flat.

Another important thing to look at is gold in Canadian-dollar terms because most of the people probably viewing this are sitting here in Canada, and as you know, the Canadian dollar has taken a bit of a stumble this year. So in terms of the gold price in Canadian dollars, we’ve actually seen more of a steady performance than in U.S. dollar terms. I know with the media we’re bombarded with the U.S. dollar gold price, but what’s really relevant for us is, what is the Canadian gold price, and we have to quite often manually convert that because you can’t just open up the Globe and Mail and find it.

Mark: What catalyst(s) do you think will move the gold price sharply higher?

Robert: Well, some of the strong catalysts for gold is gold’s performance in terms of global liquidity. So if there’s any reason for global liquidity to expand, for example Quantitative Easing, anywhere in the world, and when we’re talking this, we’re talking globally, or particularly, because we are in a U.S.-centric world, any cracking with any of the fundamentals in the U.S. So for example, even though the U.S. has had some good data points, we’re still not seeing a strong recovery in export-driven growth. So people are saying there’s a recovery, but if you look at it from an economist’s point of view, not necessarily. So if you do see some cracking, that would propel the gold price higher, but in the meantime, not too unpleased with the gold price as it stands today.

Mark: What effect will the ceasing of Quantitative Easing have on the gold price?

Robert: Well it just really depends to what magnitude it happens. Over time paper money loses its purchasing power. You can certainly look over one’s lifetime and wealth stored in hard assets, on the other hand, maintains its purchasing power. So you can buy gold, oil, real estate, etc. But in terms of paper money purchasing power, it erodes slowly. It’s kind of like watching grass grow, it doesn’t look like anything’s happening, but something is happening. I think that’s the way to look at it, over time you can expect further deterioration but it will happen in a fashion that is hard to see.

Mark: What do you think is a better investment at this time, gold-related equities or the metal itself?

Robert: It depends on the objectives of the investor. If you buy the gold metal itself, at the end of the day, if you buy one ounce of gold, you always have one ounce of gold. One thing that you might not necessarily have is a currency hedge on that, because if the Canadian dollar is weakening, you’d probably want to be unhedged. If the Canadian dollar is strengthening relative to the U.S. dollar, you’d probably want to be fully hedged. So you might miss out on that. If you own gold equities, it’s a different ballgame. Obviously the risk level goes up, but so does the reward. So your risk to reward ratio is higher but it is certainly more lucrative because if you look at what you’re really buying, you’re buying a projection of the profit margins, or profit margin expansion, presumably, of a gold company. So, for example, if gold price is fairly tied to the cost curve. Let’s say most companies are probably making about a 20% margin right now. And that’s probably expected to stay steady.

But the nice thing is, 20% margin on $2000 gold is twice as much money as 20% margin on $1000 gold. So that’s really the way to think of it.

People sometimes treat the gold equities as, when gold price is going down, oh my God, everyone’s going to go bankrupt and this is all game-over. It’s not really the case, as I mentioned earlier, the gold-to-oil ratio has a parity that it often hugs, so if you look at… if you’re running a business, if your revenue falls because so many other things are tied to pricing, such as oil or things like energy or anything that’s required to produce an ounce of gold, whether it be steel or whatever, it’s also, in the matter of quarters, will fall proportionately. So your profit margin isn’t so much at risk, but obviously people like to own something that has that expanding profit margin, and they like to own it preferentially when things are good. But I think of gold being the most un-correlated asset class with all other asset classes, it’s like insurance for your portfolio. You might not necessarily be happy when it’s not working, but I sometimes equate it to paying for fire insurance premiums, and then crying to me that I hate paying these premiums because I never have any fires. Not necessarily something you’d want to wish for, but you do want that to kick in when the rest of the markets aren’t working out. You have that to counterbalance the overall risk of your portfolio.

Mark: And finally can you tell our viewers what companies you think look promising at this time?

Robert: Well, that’s a good question. We do have a portfolio, we have about 22 companies in our portfolio which we like. We really try to drill it down. Do we have a particular favorite? That’s a bit of a tougher question. The market is certainly beat up for most names. If I were to highlight a few, one more senior company, if you were looking for a big-cap gold stock that is relatively safe, I would pick Rangold (NASDAQ: GOLD). I think it’s the best-managed big-cap company. They’re debt-free, there’s producing cash flow, they have an ability over the next couple of years to actually increase their dividend. So I think that’s a really interesting stock to own. It might not be the most exciting thing, but I think it’s nice and safe.

Down the next tier into the mid-caps, I might highlight something like a B2Gold (TSX: BTO). B2Gold just purchased Papillon Resources out of Australia, which was one of our large holdings, to get the Fekola deposit in Mali, which they will be developing. And in the interim they are just finally finishing the construction of their Otjikoto Mine in Namibia and putting that into production. So you have a few catalysts for the next year that will help propel the evolution of that story, so I think that’s a good long-term stock, and as of late it’s been a little beat up in the market, so I think there’s an opportunity there.

And then in the small-caps, one of the other companies that I like is Roxgold (TSXV: ROG). Roxgold has a high-grade underground deposit in Burkina Faso. This deposit has just over a million ounces of gold at a decent grade of about 1/3 ounce per ton, so you have really robust economics on this project. Internal rate of return on your investment would be over 40% return, less than a one-year payback. So it’s hard to find things that have such robust economics. You’re taking on a little political risk with Burkina Faso, so I have to disclose that too, but overall, I think that represents a good risk-reward in the development company group.

Mark: Thanks for taking the time for today’s interview, Robert.

Robert: You’re very welcome. Thank you.

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