Why gold miners should bank and be banked in gold
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GEOFF CANDY: Hello
and welcome to this Mineweb.com Gold Weekly podcast and joining me on
the line is Robert Cohen, he is the VP and portfolio manager at GCIC.
Robert you recently wrote a note titled “Why miners should use gold as a functional currency”
and in it you write, among other things, “Gold is a better form of
money”. Perhaps that’s a good place to start – could you explain that
statement?
ROBERT COHEN: Yes I think gold – it is a purer form of currency and when we mine it we’re effectively adding to the currency base at probably about 1.5% a year give or take and versus paper money currencies that expand a lot faster. So a lot of the capex in operating cost increases we see have gone up for the exact same reason the gold price has gone up. So when you normalise everything to banking in gold, everything looks like there is no inflation effectively.
GEOFF CANDY: Now I want to unpack that a little bit, especially if you look at graphs like the ratio of gold to oil and if you look at gold as a monetary asset, which is effectively the manner in which you're talking about it, and it makes gold companies unique in the fact that they're the only ones that can indeed mine a monetary asset.
ROBERT COHEN: That’s the thrust of my paper and that is why the companies should also be banked in gold. There's plenty of gold out there in the world to fund new gold projects and as you know with normal banking, paper money currency banking, the risk free asset for the bank is dollars. So when they're lending dollars to construct a gold mine they are trying to mitigate risk so they put all kinds of onerous hedging requirements and other requirements on the gold companies in order to ensure that they are paid back. But if you are lending gold, your primary concern is ‘am I going to get my gold back with call it my interest in gold?’ so now you just boil it down to tactical risk. There would be no requirement to hedge, so this would alleviate the burden on the miners first of all, that are paying now only high interest rates on loans, but the opportunity loss on the hedging requirements and back to my gold-to-oil ratio point, since 1971 since gold has been floating, the average gold to oil ratio has hugged about 16.5:1, yes it does fluctuate around that, but as we speak its actually pretty close to 16.5:1. So what does that tell you – here we have gold as a monetary asset, oil is “a commodity” that is consumed and burned, yet the ratio of these two has hugged in and then we can extend it further. We can say look at the gold to copper ratio, we can look at gold to real estate, all kinds of things and when you use a currency like gold, the world doesn’t look too unusual that gold relative to other hard assets has not done anything too unusual and you can even extend it further and then go other hard assets with reference to each other, haven’t done anything unusual. Yet gold winds up becoming the Rodney Dangerfield of all hard assets – it gets no respect.
And so the industry is a very unique industry where we can totally finance and back this in gold and so my paper extends further and says, “Ok, once you’ve paid back your capital on a project, why are you accumulating cash on your balance sheet, let's accumulate gold instead of cash”. This is important because when gold companies want to grow and build new projects you will find that... we’ve looked at a number of large global projects over the years and looked at how stable the capital costs were in ounces of gold versus what we always see on the headline numbers of forever-increasing, dollar capex and if you hold your retained earnings in gold, it provides you the purchasing power to build an equivalent mine for the same number of ounces in the future – in other words all the benefits of your hard work if it’s not redeployed for some time, there's no loss of purchasing power and you get full benefit of that. And this is the only industry that can do that.
GEOFF CANDY: You talk about the need for – at least initially from the mining companies’ perspective, to stop thinking about gold as a risky asset. Now the question is, and a large portion of this premise is people are going to have to buy into this. What has the reception been to this kind of thinking and how likely is it that it would extend to, at the moment, the bankers and the rest of the financial system as well.
ROBERT COHEN: Yeah I think we’ve had really good support across the sector, but not widely. When I say across the sector I’ve had excellent support from some senior companies, from some mid-cap companies and from some junior companies. It’s a very basic concept that a lot of people in a dollar centric world that we live in, they have a hard time getting their head around banking it entirely in gold. What I would like to see effectively is as many companies as possible becoming somewhat like at ETF. So when people are trading shares of a company, they're buying into an existing hoard of gold in a bank vault, i.e. the retained earnings, and also the gold that would be added to that hoard and as you know the companies are well enjoying 50% margins right now, give or take, and therefore they can add to their hoard of gold for half the price as ETFs who, when they want to add to their gold reserves, they have to step into the market and buy at full price.
So that’s the premise there but I’m also looking at it from the... getting companies thinking about that can build a hoard of gold to think about lending that out at the lease rate plus a premium, they get paid back and it can actually do it on better terms than if you were a paper money bank. You can do it on better terms and be a very powerful gold banker.
GEOFF CANDY: This of course would require some education of investors as well, but particularly in terms of talking about the notion of becoming almost part stock, part ETF that talks very much to the kind of narrative that’s built up in the market place around the premium that used to be offered to gold companies that has been decreased or minimised, at least in large part by the rise of the ETF. Would this perhaps go and change the way in which investors see gold companies?
ROBERT COHEN: I’ll start out by saying everyone seems to blame what's gone on in the world on ETFs. I will say there's no evidence of that whatsoever. The ETF and banking in gold is basically in one manner or another it’s recreating the pre-World War One US dollar. But what has gone on is, effectively, the broader stock market has fallen off the tracks basically between 2007 and 2008 and the market hasn’t recovered. And as a result of that interest rates and Contango have fallen basically to a minimum. So the option value that people saw in gold deposits for now has dried up. I think when we see more functionality in the broader stock market, and that would probably be spurred on by less debt in the US and Europe and so on and so forth, we’ll see a return to that option value premium in the gold companies. I’d be careful about blaming the ETFs, I think the gold industry and the ETFs can co-exist and they're actually allies.
GEOFF CANDY: Indeed, talking about it from another perspective, from the cost side of things, you talk about the notion of cost creep and the fact that a lot of this is monetary reflation, and this as you mentioned earlier, is proved to some extent by the type of graphs that you were looking at in terms of cost per ounce, or cost in ounces I should say. From a cost point of view there's been a lot of talk about trying to get to an all in cost number and those kinds of things. Is there a way to combine these two things and talk about costs in gold ounces as well that would perhaps make it easier to compare various gold companies?
ROBERT COHEN: Yeah I think so. I like the all-in cost idea because gold mining isn’t just the operating cost level. There's a layer of sustaining capital that is required, but we want to unveil the true profit margins of the companies for two reasons, for investor understanding as we talked about already. For example the gold to oil ratio is hanging in and as a matter of fact in recent weeks when everyone’s panicking over the sell-off in gold, in fact the oil price on a percent basis has fallen a little bit more. So that actually would tell you if oil is a proxy for costs for the mining business, while the revenue line has fallen, some of your cost line has also fallen and I think what investors out there are panicking about is that the oil price isn’t moving, its flat and gold prices are going to dovetail into oblivion and all these margins are going to dry up.
So if we express things like you know the company’s profit margin is dropping from 45% to 43% there might not be a big panic. Maybe the stocks fall off 2% but they don’t fall off 25% like we’ve seen recently especially with a lot of the smaller companies. So I think that’s important. Then, lastly, if we just express things in terms of profit margin, it makes it very clear that nothing is changing. We have another problem out there in industry is that a number of governments out there, they look at the headline number on the gold price and they figure these companies must be rolling in money because the last time they looked, when the gold price was $800 the cash costs of the companies was $400 an ounce... they failed to miss the fact that now the gold price has doubled the cash costs have doubled. No surprise but the governments that see that, they're now talking about increasing royalties, so now the industry has another new fight on the side that no, we’re not rolling in 80% margins here, we are still on the same track to keep doing what we’re doing and try to kind of fight back. I even get surprised in a monetary inflating environment see some governments put on a sliding scale royalties that well if gold is between $1000 and $1200 an ounce there’ll be this royalty level, and so on and so forth. And anything above say $1600 an ounce will be at the maximum level. Well, we may look back one day at $1000 gold and think about it something the way we think of $200 gold today. It’s not going back there and so you're always going to be maxed out and what's the point of this whole sliding scale – it’s not tied into anything economically that lasts through time.
GEOFF CANDY: Two questions to close off with. Firstly, while this is a compelling argument, what would stand in the way of it actually happening, who wouldn’t want to see this happen?
ROBERT COHEN: Well you probably could see accounting and tax authorities, maybe getting a bit of pushback. Effectively what I want them to do is buy back their production from themselves. Thereby it is a feature that would fall under investing activities on your cash flow statement, and many companies are welcome to buy shares in public companies or invest it however. I think investing in gold, it can work, but I think the pushback you see is people getting their head around the concept but it is the unique case of mining a monetary asset so I think it should all be closed off in such a way that the whole thing is worked out in the same monetary asset that you're mining, I think you would bring a lot of simplicity to the sector and in fact less complication.
GEOFF CANDY: And in terms of particularly the junior companies that you mentioned earlier, if we look at the state of the sector as it is now, leaving aside the notion of using gold as a functional accounting asset, how do you see the market placed at this stage and particularly in terms of the junior market that is at least part of its struggling to raise capital?
ROBERT COHEN: Yeah, let's focus on development companies for the purpose of this conversation. Development companies can have excellent assets, for example there are some new discoveries out there, three, four, five million ounce ore bodies, rates of return north of 25%, yet these companies are unfinanced and those are the ones getting hurt the hardest because the perception out there is there's no access to capital. The debt lenders aren’t there, the equity isn’t there, if you want to go raise equity there's a lot of downward pressure on your share price, so if you include that in your cost of equity, it can actually exceed your rate of return. So, again, bringing back things to banking and gold, I think it’s pretty clear, these companies can have two to three year payback periods and banking in gold can actually resolve a lot of those problems. So I think the under performance of the development companies, notwithstanding the gold price fell, but the perception out there these companies are going to have a hell of a time trying to finance. I think if we had a big ability or a big lender of gold out there that was willing to look at projects on their absolute economics, there would be more open lending markets available for the industry.
GEOFF CANDY: And very quickly to close off with, we have seen a significant change at the major level, at CEO level at a lot of the majors, we are seemingly seeing a significant rise of caution if you will in terms of projects, down the line, how do you see that affecting the supply side of the market?
ROBERT COHEN: Well with the change in CEOs I don’t know if that changes much. You obviously are seeing people looking at capital cost increase and rather than blaming it on monetary reflation, they’ll blame it on the CEO. No one gives the CEO credit for higher gold price, but they will blame the CEO for higher costs. So you could literally see further turnover in CEOs I think one way to look at it is if CEOs understand better that they're mining a monetary asset. What I find out there are numerous CEOs, are a little bit with their blinders on, they say look, I’m mining ore and I’m going to sell it for this price and I’m going to cover all my costs for this price, and what's left over in between is profit margin. I think we need thinking similar to what Rob McEwan was doing when he was the CEO of GoldCorp and thinking harder that we are mining quintessential monetary assets and let's treat it as such.
Let's stop getting the notion of the idea that we need to sell every ounce of gold that we produce. I think whatever ounces of gold that you can actually hold on as retained earnings, they should be held in gold. So I think once we start seeing a bit of change and some fresh thinking, shareholders will be more lenient with CEOs but right now you're seeing a lot of CEOs being thrown out right across the board.
Mineweb
Robert Cohen
explains the unique position miners of a monetary asset like gold find
themselves in and why they should use the metal as a functional
currency.
Interviewer: Geoff Candy
Posted: Wednesday , 27 Feb 2013
Posted: Wednesday , 27 Feb 2013
GEOFF CANDY: Hello
and welcome to this Mineweb.com Gold Weekly podcast and joining me on
the line is Robert Cohen, he is the VP and portfolio manager at GCIC.
Robert you recently wrote a note titled “Why miners should use gold as a functional currency”
and in it you write, among other things, “Gold is a better form of
money”. Perhaps that’s a good place to start – could you explain that
statement?ROBERT COHEN: Yes I think gold – it is a purer form of currency and when we mine it we’re effectively adding to the currency base at probably about 1.5% a year give or take and versus paper money currencies that expand a lot faster. So a lot of the capex in operating cost increases we see have gone up for the exact same reason the gold price has gone up. So when you normalise everything to banking in gold, everything looks like there is no inflation effectively.
GEOFF CANDY: Now I want to unpack that a little bit, especially if you look at graphs like the ratio of gold to oil and if you look at gold as a monetary asset, which is effectively the manner in which you're talking about it, and it makes gold companies unique in the fact that they're the only ones that can indeed mine a monetary asset.
ROBERT COHEN: That’s the thrust of my paper and that is why the companies should also be banked in gold. There's plenty of gold out there in the world to fund new gold projects and as you know with normal banking, paper money currency banking, the risk free asset for the bank is dollars. So when they're lending dollars to construct a gold mine they are trying to mitigate risk so they put all kinds of onerous hedging requirements and other requirements on the gold companies in order to ensure that they are paid back. But if you are lending gold, your primary concern is ‘am I going to get my gold back with call it my interest in gold?’ so now you just boil it down to tactical risk. There would be no requirement to hedge, so this would alleviate the burden on the miners first of all, that are paying now only high interest rates on loans, but the opportunity loss on the hedging requirements and back to my gold-to-oil ratio point, since 1971 since gold has been floating, the average gold to oil ratio has hugged about 16.5:1, yes it does fluctuate around that, but as we speak its actually pretty close to 16.5:1. So what does that tell you – here we have gold as a monetary asset, oil is “a commodity” that is consumed and burned, yet the ratio of these two has hugged in and then we can extend it further. We can say look at the gold to copper ratio, we can look at gold to real estate, all kinds of things and when you use a currency like gold, the world doesn’t look too unusual that gold relative to other hard assets has not done anything too unusual and you can even extend it further and then go other hard assets with reference to each other, haven’t done anything unusual. Yet gold winds up becoming the Rodney Dangerfield of all hard assets – it gets no respect.
And so the industry is a very unique industry where we can totally finance and back this in gold and so my paper extends further and says, “Ok, once you’ve paid back your capital on a project, why are you accumulating cash on your balance sheet, let's accumulate gold instead of cash”. This is important because when gold companies want to grow and build new projects you will find that... we’ve looked at a number of large global projects over the years and looked at how stable the capital costs were in ounces of gold versus what we always see on the headline numbers of forever-increasing, dollar capex and if you hold your retained earnings in gold, it provides you the purchasing power to build an equivalent mine for the same number of ounces in the future – in other words all the benefits of your hard work if it’s not redeployed for some time, there's no loss of purchasing power and you get full benefit of that. And this is the only industry that can do that.
GEOFF CANDY: You talk about the need for – at least initially from the mining companies’ perspective, to stop thinking about gold as a risky asset. Now the question is, and a large portion of this premise is people are going to have to buy into this. What has the reception been to this kind of thinking and how likely is it that it would extend to, at the moment, the bankers and the rest of the financial system as well.
ROBERT COHEN: Yeah I think we’ve had really good support across the sector, but not widely. When I say across the sector I’ve had excellent support from some senior companies, from some mid-cap companies and from some junior companies. It’s a very basic concept that a lot of people in a dollar centric world that we live in, they have a hard time getting their head around banking it entirely in gold. What I would like to see effectively is as many companies as possible becoming somewhat like at ETF. So when people are trading shares of a company, they're buying into an existing hoard of gold in a bank vault, i.e. the retained earnings, and also the gold that would be added to that hoard and as you know the companies are well enjoying 50% margins right now, give or take, and therefore they can add to their hoard of gold for half the price as ETFs who, when they want to add to their gold reserves, they have to step into the market and buy at full price.
So that’s the premise there but I’m also looking at it from the... getting companies thinking about that can build a hoard of gold to think about lending that out at the lease rate plus a premium, they get paid back and it can actually do it on better terms than if you were a paper money bank. You can do it on better terms and be a very powerful gold banker.
GEOFF CANDY: This of course would require some education of investors as well, but particularly in terms of talking about the notion of becoming almost part stock, part ETF that talks very much to the kind of narrative that’s built up in the market place around the premium that used to be offered to gold companies that has been decreased or minimised, at least in large part by the rise of the ETF. Would this perhaps go and change the way in which investors see gold companies?
ROBERT COHEN: I’ll start out by saying everyone seems to blame what's gone on in the world on ETFs. I will say there's no evidence of that whatsoever. The ETF and banking in gold is basically in one manner or another it’s recreating the pre-World War One US dollar. But what has gone on is, effectively, the broader stock market has fallen off the tracks basically between 2007 and 2008 and the market hasn’t recovered. And as a result of that interest rates and Contango have fallen basically to a minimum. So the option value that people saw in gold deposits for now has dried up. I think when we see more functionality in the broader stock market, and that would probably be spurred on by less debt in the US and Europe and so on and so forth, we’ll see a return to that option value premium in the gold companies. I’d be careful about blaming the ETFs, I think the gold industry and the ETFs can co-exist and they're actually allies.
GEOFF CANDY: Indeed, talking about it from another perspective, from the cost side of things, you talk about the notion of cost creep and the fact that a lot of this is monetary reflation, and this as you mentioned earlier, is proved to some extent by the type of graphs that you were looking at in terms of cost per ounce, or cost in ounces I should say. From a cost point of view there's been a lot of talk about trying to get to an all in cost number and those kinds of things. Is there a way to combine these two things and talk about costs in gold ounces as well that would perhaps make it easier to compare various gold companies?
ROBERT COHEN: Yeah I think so. I like the all-in cost idea because gold mining isn’t just the operating cost level. There's a layer of sustaining capital that is required, but we want to unveil the true profit margins of the companies for two reasons, for investor understanding as we talked about already. For example the gold to oil ratio is hanging in and as a matter of fact in recent weeks when everyone’s panicking over the sell-off in gold, in fact the oil price on a percent basis has fallen a little bit more. So that actually would tell you if oil is a proxy for costs for the mining business, while the revenue line has fallen, some of your cost line has also fallen and I think what investors out there are panicking about is that the oil price isn’t moving, its flat and gold prices are going to dovetail into oblivion and all these margins are going to dry up.
So if we express things like you know the company’s profit margin is dropping from 45% to 43% there might not be a big panic. Maybe the stocks fall off 2% but they don’t fall off 25% like we’ve seen recently especially with a lot of the smaller companies. So I think that’s important. Then, lastly, if we just express things in terms of profit margin, it makes it very clear that nothing is changing. We have another problem out there in industry is that a number of governments out there, they look at the headline number on the gold price and they figure these companies must be rolling in money because the last time they looked, when the gold price was $800 the cash costs of the companies was $400 an ounce... they failed to miss the fact that now the gold price has doubled the cash costs have doubled. No surprise but the governments that see that, they're now talking about increasing royalties, so now the industry has another new fight on the side that no, we’re not rolling in 80% margins here, we are still on the same track to keep doing what we’re doing and try to kind of fight back. I even get surprised in a monetary inflating environment see some governments put on a sliding scale royalties that well if gold is between $1000 and $1200 an ounce there’ll be this royalty level, and so on and so forth. And anything above say $1600 an ounce will be at the maximum level. Well, we may look back one day at $1000 gold and think about it something the way we think of $200 gold today. It’s not going back there and so you're always going to be maxed out and what's the point of this whole sliding scale – it’s not tied into anything economically that lasts through time.
GEOFF CANDY: Two questions to close off with. Firstly, while this is a compelling argument, what would stand in the way of it actually happening, who wouldn’t want to see this happen?
ROBERT COHEN: Well you probably could see accounting and tax authorities, maybe getting a bit of pushback. Effectively what I want them to do is buy back their production from themselves. Thereby it is a feature that would fall under investing activities on your cash flow statement, and many companies are welcome to buy shares in public companies or invest it however. I think investing in gold, it can work, but I think the pushback you see is people getting their head around the concept but it is the unique case of mining a monetary asset so I think it should all be closed off in such a way that the whole thing is worked out in the same monetary asset that you're mining, I think you would bring a lot of simplicity to the sector and in fact less complication.
GEOFF CANDY: And in terms of particularly the junior companies that you mentioned earlier, if we look at the state of the sector as it is now, leaving aside the notion of using gold as a functional accounting asset, how do you see the market placed at this stage and particularly in terms of the junior market that is at least part of its struggling to raise capital?
ROBERT COHEN: Yeah, let's focus on development companies for the purpose of this conversation. Development companies can have excellent assets, for example there are some new discoveries out there, three, four, five million ounce ore bodies, rates of return north of 25%, yet these companies are unfinanced and those are the ones getting hurt the hardest because the perception out there is there's no access to capital. The debt lenders aren’t there, the equity isn’t there, if you want to go raise equity there's a lot of downward pressure on your share price, so if you include that in your cost of equity, it can actually exceed your rate of return. So, again, bringing back things to banking and gold, I think it’s pretty clear, these companies can have two to three year payback periods and banking in gold can actually resolve a lot of those problems. So I think the under performance of the development companies, notwithstanding the gold price fell, but the perception out there these companies are going to have a hell of a time trying to finance. I think if we had a big ability or a big lender of gold out there that was willing to look at projects on their absolute economics, there would be more open lending markets available for the industry.
GEOFF CANDY: And very quickly to close off with, we have seen a significant change at the major level, at CEO level at a lot of the majors, we are seemingly seeing a significant rise of caution if you will in terms of projects, down the line, how do you see that affecting the supply side of the market?
ROBERT COHEN: Well with the change in CEOs I don’t know if that changes much. You obviously are seeing people looking at capital cost increase and rather than blaming it on monetary reflation, they’ll blame it on the CEO. No one gives the CEO credit for higher gold price, but they will blame the CEO for higher costs. So you could literally see further turnover in CEOs I think one way to look at it is if CEOs understand better that they're mining a monetary asset. What I find out there are numerous CEOs, are a little bit with their blinders on, they say look, I’m mining ore and I’m going to sell it for this price and I’m going to cover all my costs for this price, and what's left over in between is profit margin. I think we need thinking similar to what Rob McEwan was doing when he was the CEO of GoldCorp and thinking harder that we are mining quintessential monetary assets and let's treat it as such.
Let's stop getting the notion of the idea that we need to sell every ounce of gold that we produce. I think whatever ounces of gold that you can actually hold on as retained earnings, they should be held in gold. So I think once we start seeing a bit of change and some fresh thinking, shareholders will be more lenient with CEOs but right now you're seeing a lot of CEOs being thrown out right across the board.
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