Gold: What? Me, Worry?

December 1, 2020
Founder of Adrian Day Asset Management

First, we have a word on gold. Gold closed under $1,800/ounce on Friday for the first time since mid-July. How did it happen? Gold had declined sharply for the past week, but on Friday, just before the U.S. open, it dropped below its 200-day moving average (dma), setting off a series of stops. Many traders watch this level and place stop losses just below the 200-dma. Happening on a thin, post-holiday trading day, ahead of a weekend, made it worse. This certainly does not necessarily presage further declines.

The last time gold violated its 200-dma were a coin toss as to what happened next. It bounced back within three to five days on as many occasions as it was down for months after. So, as a predictor for more than a couple of days, it's useless.

A confluence of factors provoked gold's recent declines: COVID vaccines; the lack of stimulus; a turn-up in the broad market (and a little more certainly on the election?)—all of which are negative for gold. But we had all of them at a time when gold was already soft, and at a seasonally weak period (end October/November) making the downturn worse.

Will Congress cut back its spending? Will the Fed stop "printing money?"

However, for me the central questions going forward are these: Is Congress going to continue spending, and is the Fed going to continue accommodating unfunded spending?

We may not see a multi-trillion dollar "green new deal," but there will be plenty of spending ahead: cancellation of student debt; bailout of bankrupt states; support for people about to get evicted, etc. A Citibank analyst notes, "The vaccine can kill the virus, but it can't kill the mountain of debt." With Yellen at the Treasury and Powell at the Fed, we have a duo that supports Modern Monetary Theory, in practice if not in theory. This is wildly positive for gold.

As for the stocks, as many were up on Friday as down, notwithstanding the sharp drop in the gold price, suggesting investors are seeing good value in the equities after three weeks of declining prices. Gold stocks typically bottom, after a weak October and November, in early or mid-December. That stocks rose Friday while gold fell is one more indication that the gold market declines may not last long.

Record Results from Franco as It Builds Its War Chest

Franco-Nevada Corp. (FNV:TSX; FNV:NYSE, US$131.09) reported record revenues and cash flow in the third quarter, beating estimates (and this despite a strike at one of its larger streams). Sales just shy of 135,000 ounces of gold equivalent, though short of the last quarter of 2019 record, are back up to first quarter levels. As all mines come back to full operations after the COVID shutdowns, we should see record sales again. Franco expects to be at the top end of its 2020 guidance for the full year, assuming Candelaria (where the strike ended Friday) ramps back up soon. Franco was also aided by some Net Profit Interest royalties, which performed well (mostly) in the higher price environment this year. Oil and gas revenues were up as well.

Franco has continued to add assets, though small ones, mostly buying higher optionality exploration royalties. These include a package of 24 royalties from Freeport-McMoRan Inc. (FCX:NYSE) for $30 million, the most attractive of which is a 1% royalty on Wallbridge's Fenelon property in the Detour Lake trend.

Cash builds on strong cash flow and lack of large transactions

With the lack of major purchases, the cash is building back up. It recently paid off the debt it took on for payments on the large Cobre Panama stream, and now has working capital of $449 million (mostly cash). It raised a modest $21 million in its ATM program (at an average cost of $148); it not intending utilizing this program again for now, given strong cash-flow generation and current stock prices. The company also has a $1.1 billion facility, giving it the firepower to complete a large transaction.

Right now is not the most favorable environment for royalty companies to complete large transactions. Most of the royalties inside the larger mining companies have been sold (Pan American, Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE), Barrick Gold Corp. (ABX:TSX; GOLD:NYSE), Coeur Mining Inc. (CDE:NYSE) spring to mind); better equity markets mean companies can raise funds; and the base metals miners are in strong financial shape, unlike five or six years ago when they undertook large streaming deals to repair balance sheets. But we have been at this stage before, and things do change.

There is still the opportunity to be part of a multifaceted financing package for a large development or merger and acquisition transaction. I suspect some of these have been in the works, with completion delayed due to travel restrictions postponing due diligence.

High valuations, though deserved, a little rich right now

Franco (and other large royalty companies) have traditionally traded at higher multiples than miners, and for sound reasons. The business model mitigates risk and provides visibility on future revenues. Now, however, Franco is trading at the high end of its historical valuations, with price-to-cash flow at 31 times, and a price-to-book of 4.76 times, the highest ever (apart from an anomalous Q2). The stock, however, has come well off its highs of over $160/share in early August, and over $150/share just a few weeks ago.

Franco is a core holding, providing broad exposure to multiple gold and other mines, with strong management and a rock-solid balance sheet. Those who do not own it can take an initial position here, or add if significantly underweight. But we may find that initially, as the gold price moves back up, even if Franco's share price moves up, it may lag and those valuation levels will decline. So we are not adding here to what, for most readers, are presumably already significant positions.

Activity on Multiple Fronts, Including an Alliance with a Major

Midland Exploration Inc. (MD:TSX.V, 0.85–0.91) is on a roll—the company, if not the stock—adding properties, advancing projects and concluding new partnerships. This divergence between what the company has been doing and the stock price will eventually close and presents a great buying opportunity.

Prime among its recent new partnerships is a deal with BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), which last year bought 5% of the shares in an above-market financing. Now the companies have signed a multimillion-dollar strategic alliance to look for nickel, copper and cobalt in the Nunavik territory in northern Quebec. In the first phase, BHP will fund 100% up to CA$2.8 million over two years to generate projects and advance them to the drill-ready stage. BHP can then select projects to be tested over a CA$4 million, four-year program, to earn initially 70% of the designated projects. Given the need for all three minerals for growing electrification of both vehicles and energy sources, this is an exciting partnership with one of the world's largest mining companies.

Earlier in the spring, Midland completed two joint ventures with Probe Metals Inc. (PRB:TSX.V) and Wallbridge Mining Co. Ltd. (WM:TSX), and we suspect there are more in the works as Midland emphasizes its prospect-generation/joint-venture roots.

Drilling completed and more to come

In addition to new transactions, the company has been busy with the drill bit, as well as earlier-stage exploration work, completing several programs in the Abitibi region, on the Detour Lake belt and the Cadillac Break. Agnico Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) resumed drilling on the Cadillac Break, with two deep holes, while Midland conducted a second drill program at its 100%-owned Samson project to follow up on a new gold discovery made in the summer. Assays on all the drill programs are expected in early December.

Extensive exploration work has been conducted by both Probe and Wallbridge on their new earn-in projects, with drilling expected this coming winter. (The Wallbridge property is just south of its Fenelon project, on which Franco just acquired a royalty; see above.) A minimum of 5,000 meters of drilling is expected on various drill programs by both Midland and its partners.

In addition, Midland has continued to pick up new property, including land south of the Wallbridge joint property, where it has already identified some new targets. Midland has been building a significant property portfolio in the Detour Belt, with seven properties east of the prolific Detour Mine.

Midland is well funded, with about CA$12 million in the treasury (as of September); it just raised another CA$2.4 million, most of it in an above-market flow-through deal. Well-funded, with strong management, an active season ahead, and a deep pipeline, Midland offers multiple opportunities for discovery. The company has been extremely active recently, activity not yet reflected in the stock price, which has simply been treading water. Take this opportunity to buy one of the top exploration companies now, before the stock price catches up.

A Mixed Quarter for Royal, Though Improvements on Key Metrics

Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX, US$109.97) had a somewhat mixed quarter, with revenues and operating cash flow increasing, though less than expected. The balance sheet improved significantly; this was the second quarter of net cash, jumping from under $10 million to $138.1 million. The robust cash flow helped to boost Royal Gold's cash position, as did the $61 million in proceeds from the sale of its Peak Gold Ltd. (PIK:TSX.V) joint-venture (JV) interest and its shares in the its JV partner. (Royal retains its 28% net smelter return royalty on silver produced at Peak Gold, though 50% of it can be bought back by Peak.) If not as strong as Franco's, the balance sheet is strong and the company has firepower for additional acquisitions.

Production remains disappointing. Though gold-equivalent sales increased to 76,900 ounces, nearly 10% compared higher than the weak second quarter, they remain down almost 11% from the first quarter of the year, and remain lower than any quarter since 2015. (Royal's fiscal year ends in June; I am referring to calendar quarters.) The production decline is attributable primarily to Mt. Milligan, as well as Andacollo, two of its largest royalties and streams. Mt. Milligan remains a little over one-quarter of the company's revenues, the decline in percentage being attributable both to increases elsewhere and a decline at Mt. Milligan itself. At quarter end, Royal held inventories of nearly 26,000 ounces, up from nearly 19,000 at the end of last quarter.

Future growth and better valuations make Royal attractive again

Two major contributors to future growth are progressing well. The Khoemacau mine in Botswana is 70% constructed, with first shipments expected in the third quarter of next year. Royal paid another $44 million in advance payments under the silver stream arrangement. Barrick continues on its mine expansion at Pueblo Viejo. Royal's revenues are currently 79% from gold; it is well diversified, with 88 properties in 12 countries, though its concentration of producing assets is far higher than that of Franco.

As the stock price has declined since August (from a peak of $145/share) and revenues have increased, valuation has improved. At a little over 3 times book, it is lower than its peers, though still at a 10-year high. But on a cash flow metric, at 20 times, it is near the low end of its historical range and well below its peers. With an improved balance sheet, and growth over the next couple of years, Royal is now a buy again. There is no need to chase the stock price, and if the gold price declines further, there is risk in Royal's price down to the $90 level. Nonetheless, if you are underinvested, it can be bought again.

Originally posted on November 29, 2020.

Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."

Disclosure
1) Adrian Day: I, or members of my immediate household or family, own securities of the following companies mentioned in this article: Franco-Nevada, Midland Exploration, Royal Gold, Barrick. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management hold shares of the following companies mentioned in this article: Franco-Nevada, Midland Exploration, Royal Gold, Barrick. I determined which companies would be included in this article based on my research and understanding of the sector.
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5) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their immediate families are prohibited from making purchases and/or sales of those securities in the open market or otherwise from the time of the decision to publish an article until three business days after the publication of the article. The foregoing prohibition does not apply to articles that in substance only restate previously published company releases. As of the date of this article, officers and/or employees of Streetwise Reports LLC (including members of their household) own securities of Franco-Nevada, Midland Exploration, Royal Gold, companies mentioned in this article.

Adrian Day's Global Analyst disclosures: Staff may have positions in securities discussed herein. Adrian Day is also President of Global Strategic Management (GSM), a registered investment advisor, and a separate company from this service. In his capacity as GSM president, Adrian Day may be buying or selling for clients securities recommended herein concurrently, before or after recommendations herein, and may be acting for clients in a manner contrary to recommendations herein. This is not a solicitation for GSM. Views herein are the editor's opinion and not fact. All information is believed to be correct, but its accuracy cannot be guaranteed. The owner and editor are not responsible for errors and omissions. © 2020.

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Adrian Day

Adrian Day is London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."

In 1933 President Franklin Roosevelt signed Executive Order 6102 which outlawed U.S. citizens from hoarding gold.

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