Contributing editor Gavin Graham is with us this week, writing from his home base in England. Gavin is the president of Graham Investment Strategy and has many years of experience in international investing. This week he takes a look at what's been happening in the gold market and revisits his precious metals investment picks. Here is his report.
Gavin Graham writes:
With six months of 2014 behind us, it seems timely to review how that most perplexing of investments, gold, has performed.
I call it an investment, rather than a precious metal or a speculation, because gold fulfills many of the characteristics that people look for from an investment. First, it is readily accepted anywhere in the world. Second, it has a price that is set in a transparent fashion. Finally, it has retained its real value after adjusting for inflation over a long period of time.
The one area where it fails the test of an investment is that it produces no income, but then the same criticism could be made of many growth stocks, particularly in the technology and biotechnology sectors.
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In fact, as I have tried to demonstrate in my gold stock recommendations in the IWB over the last few years, even this last issue is addressed if investors are prepared to buy well-run gold mining companies that pay dividends linked to the price of gold. All of the three companies I have recommended have paid dividends for many years and had been increasing them in line with improved production and a higher gold price. They are precious metals royalty company Franco-Nevada (NYSE:FNV) and well established gold miners Goldcorp (NYSE:GG) and Agnico-Eagle (NYSE:AEM).
Gold fell from its all-time high of $1,850 an oz. (all figures U.S. dollars) in August 2011, when the Eurozone crisis first impressed itself on investors' attention, to $1,145 at the end of last year. That was the first time gold actually fell over a calendar year since 1999 when it lost 26%. So far this year, it's up 10%. That compares favourably with the S&P 500, which is up 6.5%, and is line with the S&P/TSX Composite, which was up 11.6% at the time of writing. Over the last 12 months, gold is up 6.3%, although this is a long way behind both the S&P and the TSX, which are up 20.5% and 25.6% respectively.
Bullion drop hit stocks
As far as gold stocks are concerned, the fall in the gold price in 2013 had some major negative effects. Share prices of all the stocks fell dramatically. Goldcorp's price on the NYSE dropped from $31.62 in mid-August to as low as $20.84 in December, a decline of 34% in just four months. Agnico-Eagle's decline happened even faster although it wasn't as severe, with the shares dropping from $32.88 in late August to $24.05 in mid-October. Franco-Nevada, which tends to be more stable because of its royalty structure, went from $47.20 in late August to $37.39 in early December.
Dividends were also affected by the decline in the gold price. Goldcorp has not raised its dividend since an 11% increase in January 2013 when it went to $0.05 a month ($0.60 per year), equivalent to a 2.2% yield at the current price. Agnico-Eagle slashed its dividend by 64% from $0.22 a quarter to $0.08 at the beginning of 2014, equivalent to a 0.9% yield.
The sole exception was Franco-Nevada. Bucking the trend, the company increased its dividend in May by 11.1% to $0.20 per quarter, from $0.06 per month previously. That's equivalent to a 1.4% yield.
The bottom line as far as dividends are concerned is that two of these companies (Goldcorp and Franco-Nevada) provide a higher yield than money held in a cash account in either the U.S. or Canada while Agnico-Eagle's yield is higher than you'd get in a U.S. cash account and close to what's available in Canada.
Obviously, this requires the management teams at mining companies to exercise discipline over the use of the cash that they generate and miners have notoriously been bad allocators of capital. One only has think of the write-downs taken by such majors as Barrick (NYSE:ABX) and Kinross Gold (NYSE:K) in the last couple of years on major acquisitions made at the height of the mining boom at the end of the last decade to be reminded of how rare a feature this is.
The Osisko takeover
That was why it was encouraging to some investors to see the willingness of Goldcorp to walk away from its increased hostile $3.5 billion bid for Osisko Mining in May. That happened after its bid was trumped by an agreed joint bid worth $3.9 billion from Agnico-Eagle and Yamana Gold (YRI) at C$8.15 a share. That was 11% more than Goldcorp's bid.
Osisko's Canadian Malartic mine in Quebec produces 600,000 ounces per year, which will be split equally between Agnico-Eagle and Yamana through a joint venture along with Osisko's highly prospective Kirkland Lake and Hammond Reef projects in Ontario. Osisko shareholders also received shares in a new company which, following the Franco Nevada royalty model, will receive a 5% Net Smelter Royalty (NSR) on Malartic and a 2% NSR on Kirkland Lake and Hammond Reef, as well a large Mexican land package with exploration potential.
This new company is estimated to be worth C$1.20 a share, which made the joint bid more attractive than Goldcorp's cash and shares offer. Agnico and Yamana have each paid $501 million in cash and the remaining $1.16 billion each in shares. That's equivalent to C$2.43 each to Osisko shareholders and represents 14.4% of Yamana's equity and 16.7% of Agnico's after the issuance of the shares. With estimated proven and probable gold reserves of 23.2 million ounces and 21.6 million ounces respectively after the deal, Yamana and Agnico-Eagle will become the second and third largest mid-tier gold producers after Eldorado Gold.
Having initially attempted to structure a joint venture deal with major Canadian pension plans, Yamana gains its first Canadian producing mine in co-operation with an established Canadian producer in Agnico-Eagle which already has existing Quebec operations in Goldex and La Ronde. Meanwhile Agnico-Eagle reduces its cost per ounce while enhancing its net asset value, cash flow, production reserves, and resources on a per share basis.
As a result, it's not surprising that Agnico-Eagle's price has increased by 45% over the last year, while Goldcorp's has only risen by 17%. Yamana, interestingly, has fallen 10% over that period.
Meanwhile, Franco-Nevada is up 63%, showing the attractions of the royalty model, where the royalty is a set percentage of revenue and is paid regardless of rising costs.
Gold itself was trading at around $1,320 per ounce last week, having touched $1,340 during the Ukraine crisis. While it is too early to proclaim the gold bear market is over, the write-downs of major projects, and the willingness of experienced and successful miners such as Goldcorp, Agnico-Eagle, and Yamana to pay $3.5 to $4 billion for Osisko, indicate that they feel valuations are now attractive.
Should the new Indian government of Narandra Modi relax some the restrictions on legal gold imports into the country ahead of the festival of Diwali in the fall, demand could be added to a market in which supply has essentially stopped growing, leading to higher gold prices. Even without this boost, Agnico-Eagle, Franco-Nevada, and Goldcorp all have ridden out the bear market successfully.
GAVIN GRAHAM’S GOLD UPDATES
Agnico-Eagle Mines (NYSE:AEM)
Originally recommended on Dec. 3/12 (#21242) at C$55.39, US$55.80. Closed Friday at C$40.99, US$38.29.
Agnico-Eagle's share price has been moving higher, in part thanks to strong first-quarter results. The Toronto-based international mining company reported record quarterly production of 366,421 ounces at a cash cost of $537 per ounce.
Excluding extraordinary items, adjusted net income was $106.8 million ($0.61 per share), a big improvement over last year's $23.9 million ($0.14 per share). Note that Agnico-Eagle reports its results in U.S. currency.
Cash provided by operating activities was $247.7 million compared to $146.1 million in the first quarter of 2013.
The higher net income and cash provided by operating activities was achieved in spite of lower gold prices. The company said that realized gold prices in the first quarter of 2013 were 23% higher than those realized in the first quarter of 2014. Significantly higher gold production (55%), combined with lower production expense in 2014, was largely responsible for this year's strong financial results.
"Given the strong first quarter performance, we currently expect to exceed the top end of our production guidance and do better than the lower end of our cash cost forecast for 2014," said CEO Sean Boyd.
Production guidance had originally been in the range of 1.175 million to 1.205 million ounces. If the first-quarter rate were to be maintained, final 2014 production could exceed 1.4 million ounces.
Despite the strong quarter it is unlikely we will see a dividend increase this year because of the cost of the Osisko acquisition. But the stock has more upside potential.
Action now: Buy.
Originally recommended on Jan. 16/12 (#21202) at C$46.45, US$45.42. Closed Friday at C$29.33, US$27.67.
Goldcorp also reported a significant production increase in the first quarter but unlike Agnico-Eagle this was not reflected on the bottom line.
Gold production came in at 679,900 ounces, compared to 614,600 ounces a year ago. Silver production was up dramatically, from 5.6 million ounces in the first quarter of 2013 to 9.6 million ounces this year. Copper, lead, and zinc production was also higher although these base metals are only a small part of Goldcorp's business.
In spite of the higher production, revenue fell from $964 million in last year's first quarter to $898 million this year. Net earnings attributable to Goldcorp shareholders were down even more dramatically, coming in at $98 million ($0.12 per share fully diluted, figures in U.S. currency) compared to $309 million ($0.33 per share) last year. Adjusted net earnings, which exclude one-time items, totaled $209 million ($0.26 per share) compared to $253 million ($0.31 per share) in the first quarter of 2013.
The company reconfirmed production guidance for 2014 of between 2.95 and 3.1 million ounces at all-in sustaining costs of between $950 and $1,000 per gold ounce. Capital spending guidance of between $2.3 billion and $2.5 billion for 2014 was also reconfirmed.
Action now: Goldcorp remains a Buy.
Originally recommended on July 26/10 (#20127) at C$31.69, US$30.45. Closed Friday at C$60, US$56.63.
Franco-Nevada reported slightly lower revenue than in the same period of 2013 ($104.1 million compared to $108.8 million last year). Earnings were flat at $35.4 million ($0.24 a share, figures in U.S. dollars). However, as mentioned previously, the company raised its dividend to $0.20 per quarter ($0.80 annually) from $0.06 per month ($0.72 annually).
The company reported earning revenue from 65,836 Gold Equivalent Ounces (GEOs), an 11.8% increase over the same period of 2013. Despite a 20.6% lower average gold price and a 12.6% lower average platinum price for the quarter compared to last year, Franco-Nevada experienced growth in its GEOs from recent acquisitions and higher production levels from international and Canadian gold assets and other minerals. In addition, the company's oil and gas assets generated $18.7 million in revenue. The breakdown in revenue was 79% from precious metals (67% gold and 12% Platinum Group Metals, or PGMs).
"Our revenue, cash flow, and net income have held up well despite significantly lower gold prices," said CEO David Harquail. "This has allowed us to continue the tradition of increasing dividends each year."
Action now: Buy.