Finding Fundamentals Key to Gold Investing: Byron King

The Gold Report: Byron, anyone who reads your reports knows two things: you like to tell stories and you like precious metals. The gold price has spent the last 11 years trending higher. Do you see it continuing upward?

Byron King: I anticipate that gold, silver and platinum will all continue to rise in price. There are currency-driven reasons why metal prices are going to keep rising, as well as other issues with overall supply and falling production.

In terms of production, the gold and the platinum production spaces are very precarious. A few very bad things could happen at random and knock global production for a loop and seriously impact supply. Think in terms of a major mine accident in, say, South Africa. Supply could fall off a cliff overnight.

In terms of politics and monetary issues, precious metals create an outside limit on people's political power. Thus I expect massive amounts of manipulation as we roll along, too. The dollar value of gold, silver or platinum will tend to rise over time, but we could see price spikes up and down due to that manipulation.

TGR: The junior precious metals sector fell hard in 2011. You tend to stick toward the midtier and major precious metals producers with strong cash flow. Those names often have lower risk, but risk can rear its head in that space, too. Major gold producer Kinross Gold Corp. (K:TSX; KGC:NYSE) watched about $3.1 billion (B) of its market cap get buzz sawed off in mid-January after it announced that it would take a $4.6B write-down on its Tasiast gold mine in Mauritania. Kinross spent $7.1B acquiring Tasiast and other assets in the September 2010 takeover of Red Back Mining. Does this serve as a warning to the other majors?

BK: It might be 15 years past the Bre-X scandal, but when it comes to buying and selling gold mines, no amount of due diligence is too much. It gets back to Mark Twain's comment about how to define the term gold mine. It's a hole in the ground with a liar standing at the opening of the shaft.

The Kinross writeoff is scary. They're supposed to be better than that. So when you own physical gold, you can go to bed and close both your eyes. With gold mining shares, you still need to keep one eye open.

TGR: Were you recommending Kinross?

BK: Kinross has been in the Outstanding Investments portfolio for over four years. I'm hanging on to it in the hopes that it will go higher, but it's been disappointing. It's not been able to get the share price up and keep it up despite a gold price that has quadrupled.

TGR: Its strategy was to grow through acquiring assets. Apart from buying Red Back Mining, Kinross bought Underworld Resources in the Yukon and Aurelian Resources in Ecuador. Do you believe that was the wrong strategy?

BK: Much of the gold mining investing business is about takeovers. The large companies with, say, 10 million ounces (Moz) a year of output couldn't discover that much just by sending out their own geologists with rock picks. Gold mining requires an entire process of prospect developers, generators and joint ventures. The better assets get picked up by the larger companies. In fact, Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) just announced a takeover of Minefinders Corp. (MFL:TSX; MFN:NYSE). Minefinders is a one-trick pony, but it's one heck of a pony. It's the Dolores play in Mexico.

TGR: Sure, acquisitions are key, but many analysts believe that Kinross paid too much for Red Back and it's now writing down three-quarters of what it paid. Will companies be more loath to spend big dollars in takeovers now?

BK: The acquiring companies have to be smarter and cheaper about takeovers. They have to pay less. Then again, you're lucky if you get what you pay for, and you never get what you don't pay for.

The news from Kinross could serve as a wet blanket for the rest of the intermediate and junior mining space. Future takeout plays might see more lowball offers.

It gets back to the idea that an allegedly savvy company like Kinross could make as bad a mistake as it did—at least in retrospect. It's a wakeup call to the industry. I suppose in the boardrooms of the big mining companies they're sitting around saying, "We're much smarter than those guys at Kinross." All I can say is to be careful of admiring yourself too much in the mirror because I'm sure Kinross thought it was doing the right thing, too.

TGR: In an ironic twist, some analysts are now speculating that Kinross could become a takeover target. Keith Wirtz, chief investment officer at Fifth Third Asset Management, said, "Every dollar lower pushes the stock higher up the list of potential takeovers. That will attract the sharks in the water." Do you think Kinross will be taken out in 2012?

BK: Kinross has made a big mistake. Now the company has a big bull's eye pinned on its back. Kinross has some very strong assets. I'm sure other companies are looking at these assets and thinking they could do a much better job at managing them than the guys running the show right now.

TGR: Something else of note in the large-cap gold space is the increase in dividends as gold companies jockey for investor attention with other instruments like real estate investment trusts, exchange-traded funds and even master limited partnerships. One company in particular, Goldcorp Inc. (G:TSX; GG:NYSE), recently raised its dividend again. Do you prefer gold companies with a significant dividend or are other factors more important?

BK: All things considered, I like companies that pay dividends. I like the idea that they bring the shareholders into the equation by sharing some of the wealth. There's a certain capital discipline in running a company that comes with the knowledge that it has to write a check to the shareholders as well.

TGR: What are some of the major gold producers that are running a dividend that you like?

BK: Newmont Mining Corp. (NEM:NYSE), Barrick Gold Corp. (ABX:TSX; ABX:NYSE), IAMGOLD Corp. (IMG:TSX; IAG:NYSE) and Goldcorp are nice dividend players.

TGR: Which one has the strongest growth profile?

BK: Goldcorp. Five years from now, it could be the best overall return.

TGR: Are you following any midtiers?

BK: I've been following Minefinders, but it just got bought. I'm waiting for the development at Donlin Creek, Alaska, to come through for NovaGold Resources Inc. (NG:TSX; NG:NYSE.A). Investors are going to have to be patient with this one. It's over 30 Moz of gold. It's partnered up with Barrick, but the development has been slower, longer and more painful than I expected. However, over enough time, NovaGold could be quite rewarding to a patient resource investor.

TGR: What undervalued junior or midtier producers could rebound in 2012?

BK: Carlisle Goldfields Ltd. (CGJ:CNSX) at Lynn Lake, Manitoba. It's an old copper-nickel producing area, but it has had a very aggressive drilling program. I am waiting for an updated NI 43-101 to come out, which could show an expanded resource base.

Reservoir Minerals Inc. (RMC:TSX.V), a spinout of Reservoir Capital Corp. (REO:TSX.V), is a play on mineralization in Serbia. Reservoir Capital was a hydropower and geothermal company with some mining assets as well. Last fall, it spun out the mining assets into Reservoir Minerals.

It's now a copper project that is joint ventured with Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE). It has had extremely good drilling results in a historic gold producing area in Serbia that was one of the richest gold mines in Europe in its day. It was sealed up just before World War II and not unsealed until about two years ago.

Reservoir also controls numerous other mineralized areas in Serbia, which is a very well-run, mining-friendly jurisdiction. That is, we're not dealing with the Serbia of the 1990s. This isn't the Serbia that NATO bombed in 1999. This is a modern, European country that is looking desperately for investment. Reservoir Minerals is a key part of the future of Serbia.

TGR: Carlisle has the historic MacLellan mine. What stood out when you visited that project?

BK: It's in Precambrian greenstone in a shear zone, in a known mineralized district. The greenstone and the shearing outcrop at the surface. Carlisle has great land position in terms of following the strike. It has a very aggressive drilling program, and while results aren't out officially, from what I can gather from my own examination of the cores, there is a very nice consistency of mineralization all along the strike. I think that when Carlisle gets done with its analysis we're going to see a very nice resource number at very respectable, mineable grades.

TGR: What investment themes do you expect will be prevalent in the gold space this year?

BK: The gold price should continue the 11-year trend of increasing nearly every year with the possibility of a big jump if a one-off type of event, such as a mine accident, chokes off a large amount of the world's gold supply. I know accidents aren't ever supposed to happen—nuclear plants in Japan and cruise ships in Italy are failsafe, right? We have to watch that.

TGR: What about increasing tension in the Middle East?

BK: Tension in the Middle East always seems to drive up the price of oil and the price of gold. People move their resources from one jurisdiction to another, from one form of investment to another. I went to one of the gold souks at the grand bazaar in Istanbul about two years ago. I was astonished that people were mobbing the gold souks, throwing money down and grabbing all the gold coins that they could get their hands on. I saw Russians and people from across Europe just peeling out these €500 notes and buying as much gold as they could take. It was fascinating.

TGR: Surreal.

BK: It was surreal to literally watch people scoop up gold, put it in their pockets and walk out of the stores. People were trying to get rid of cash and buy gold. There's an entire gold-buying culture that a lot of people in the West are not used to seeing.

TGR: What about the protests, violence and economic sanctions being brought to bear on certain Middle Eastern countries? It seems like the tensions there are certainly hotter than they have been since the early '80s.

BK: War is bad for business, but the rumors of war are sometimes good for business. I think if the Strait of Hormuz closed or if there was a shooting war in the Middle East, it would drive the price of gold upward. As the price of gold goes up, it's going to lift the share price for the miners that have good fundamentals.

Right now the stock market is barely paying for fundamentals. It really doesn't respect stories, let alone blue sky. But if the price of gold keeps going up, the companies with decent fundamentals will also rise.

TGR: Thanks for your insight, Byron.

Byron King is the resident energy and natural resource expert at Agora Financial, LLC. A geologist by training, he worked for the former Gulf Oil Co. and has followed oil industry developments for over 30 years. King's career path also took him into the U.S. Navy, both in active duty and reserve. In the 1990s and 2000s, King engaged in a vigorous private law practice. For the past five years, King has been writing about energy and natural resource issues for an international audience. Currently, King writes and edits Daily Resource Hunter, Outstanding Investments and Energy & Scarcity Investor. He holds degrees from Harvard, the U.S. Naval War College and the University of Pittsburgh.

Click here for a free copy of Bryon King's award-winning Outstanding Investments.

Want to read more exclusive Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.

DISCLOSURE:
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Goldcorp Inc., Minefinders Corp. Ltd., NovaGold Resources Inc. Streetwise Reports does not accept stock in exchange for services.
3) Byron King: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise for participating in this story.

( Companies Mentioned: ABX:TSX; ABX:NYSE, CGJ:CNSX, G:TSX; GG:NYSE, IMG:TSX; IAG:NYSE, MFL:TSX; MFN:NYSE, NEM:NYSE, NG:TSX; NG:NYSE.A, RMC:TSX.V, )