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Gold price pressure obscures long-term opportunities – Kosowan

Gold price pressure obscures long-term opportunities – Kosowan

Photo by Bloomberg

29th September 2014

By: Simon Rees

Creamer Media Correspondent

  

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TORONTO (miningweekly.com) – Gold’s long-term prospects were positive and current market conditions presented an opportunity to buy into discounted junior mining companies with the potential for impressive returns, Sprott Private Wealth senior investment adviser Michael Kosowan told attendees at the Global Chinese Financial Forum on Saturday.

But, given current market conditions, the careful assessment of a company’s strengths and weaknesses was critical for success, he cautioned. This included an in-depth evaluation of management teams and project dynamics.

Kosowan considered the yellow metal’s fall over the past three years, charting its decline from highs of around $1 900/oz in 2011, to its current price of about $1 220/oz.

“There’s been a lot of downward pressure on gold lately, stemming from competing assets like real estate and the broader equity markets, as well the US dollar’s extreme uptrend. In addition, there are regulatory curbs on the extra purchase of gold and there have been weak income gains.

“But the radical monetary policy and the irresponsibility we’ve all witnessed will not end well. [Currently,] the general equity markets are over-exuberant, with little differentiation in the bond market between junk and quality,” he explained.

Kosowan believed these were indications that we were in an endgame for financial assets, adding that gold had not yet been to the reflation party; 'it's conspicuous through its absence".

The situation was ripe for contrarians seeking value at discount within the junior resource space, he pointed out, and highlighted that the conditions experienced during and just after 1998 to 2000 as indicative of the current potential.

“Gold stocks [from] 1998 to 2000 were low as well, with senior mining companies at that time also experiencing write-downs and bad news. In addition, there was a widespread belief that gold prices would continue to fall, which they did – all the way to $330/oz by April 2001,” Kosowan said.

“But if the past informs us about the future, then that period also highlights some of the best value plays in exploration, ones that would go on to define the market,” he added.

Kosowan referred to Southwestern Resources as an example, noting that the company’s share price climbed from $2 a share to eventually peak at $25 a share. “Now that’s impressive. But the most impressive aspect was Southwestern having $2.50 a share in cash [at the start],” which meant investors achieved value with a discount, he noted.

“Fast forward to the present and I find myself again talking about immense latent opportunities in the junior gold space,” Kosowan commented, noting the ratio of the HUI Gold Index against the gold price.

“From 1998 to 2000, the ratio was all the way down and gold stocks were hated,” he said. “There’s been disdain for gold over the past three years and guess where we are today? The ratio is again sitting at an all-time low.”

“For me, this represents a buy signal,” he explained. “As any contrarian investor will tell you, bargains are usually found among things that are controversial, people are pessimistic about and have performed poorly of late.”

MIKE’S MATRIX

But recognising an opportunity is only one part of the equation as successful investment also depends on careful research, Kosowan stressed. “I constantly research junior resource companies and other opportunities by getting on the phone with CEOs and geologists, and digging deeper.”

“So recognise the opportunity and be prepared to act on it, but do this in a well-informed and strategic manner. A disciplined, patient and prudent investment approach is required for the investment climate we’re in and may experience into 2015,” he said.

Kosowan outlined his four guiding principles, or “four Ms”, when researching – money, management, margin and misery. “From the money perspective, a company should have two years’ worth of working capital. This is necessary in this kind of environment because those without the funds might have to make a dilutive financing, making it difficult to proceed.”

“The second ‘M’ is management and I can’t stress enough how important this is. The management team must have the necessary experience for the task in front of them,” he stressed. For example, if a company was looking for gold in a volcanic massive sulphide system, it would be necessary to ensure that its staff and technical teams had prior experience.

“The incentive of a management team is also important. As a shareholder you need to know that your interests are aligned with theirs, which is why it’s a good thing if management is a large equity holder,” he said.

The advantage in margin was obtained by keeping capital expenditure low and by developing a project that returned high grades.

“Grade is king, as they say in the mining business. Indeed, there’s been such an absence of high-quality discoveries that the whole sector is starving for them,” Kosowan said. “The average grade now being mined is roughly 1 g/t gold, while it was as high as 4 g/t only 14 years ago.”

Misery represented the contrarian conditions to enable an investor to buy undervalued stock that had upside potential embedded for the longer term.

Overall, the “four Ms” heralded quality. "And quality does two things; it allows the company to survive for a longer period and provides you with stocks that have the most upside potential.”

Kosowan recognised that contrarian investing can be difficult for those investors who continue to experience the downside until conditions improve. “I recognise it’s not easy to do things that can sometimes result in discomfort. But the high upside potential of the juniors has always been there and, right now, the cost to entry has never been lower,” he said.

Many excellent companies were available at a fraction of their net asset value, Kosowan added, emphasising that junior resource stocks represented a phenomenal risk-to-reward proposition.”

Edited by Tracy Hancock
Creamer Media Contributing Editor

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