The Gold Report: In your Morgan Report, you have written extensively about the impact of global financial issues on gold and silver prices. At least temporary solutions have been found for the euro-Greek tragedy and the U.S. debt limit debacle. Will this give the U.S. dollar a boost at the expense of precious metals?
David Morgan: It is getting more difficult to predict what the market reaction will be to specific events. As people figure out that there really is no solution to the global financial system without a great deal of pain and some defaults along the road, more will seek the safety of precious metals. So, even when things calm down for the moment, it does not mean the precious metals will not get pushed down. You could see gold and silver react to the downside, perhaps dramatically—a $5/ounce (oz.) drop in silver is not entirely out of the realm of possibility. My best guess is we will see some pullback going into mid-August.
TGR: Today, gold hit $1,700/oz. during what is normally a summer slow season. Can this climb continue? What are the drivers?
DM: Yes, it can continue and the driver is uncertainty. Look at all the problems in the currency markets. It seems interbank lending is starting to freeze up in Europe. This was one of the main factors contributing to the financial crisis of 2008. So there is much to consider and it boils down to the fact we are in the final stages of a currency depreciation on a global basis.
TGR: A lot of the economic indicators—GDP and consumer confidence, in particular—are coming in weaker than expected, not to mention the Standard and Poor's downgrade of U.S. debt. Could we see another 2008-style sell-off, and how would that impact precious metals?
DM: Fundamentally, nothing of substance has changed since 2007 except that the banks have lots of money on hand. You have to understand that the silver market has a mind of its own. What happened in 2008 was a silver sell-off that caused a shortage, pushing the physical price of silver at the retail level to around $13/oz. while paper silver traded under $9/oz. on the futures exchanges. Excessive short selling then ran the price from about the $20/oz. level to the brink of $50/oz. The next leg up could take out the $50/oz. level after a few tries and then not look back until establishing a new nominal level of $65/oz.–$75/oz.
TGR: Where is the demand for silver coming from? Is it industrial or investment-driven? Is the developed or developing world pushing the market?
DM: Look East. In July, the Hong Kong Mercantile Exchange launched a U.S. dollar-denominated silver futures contract. It cited "surging international demand for silver" as the cause for the launch, pointing out that silver demand rose 67% domestically between 2008 and 2010. China accounted for almost 23% of the world's silver usage last year. It is now using four times as much silver per-person as it did 12 years ago, but this is still one-fifth the amount used on a per-person basis in the U.S. and Canada. Silver demand is growing for both industry and as an investment.
The game has changed, however. The physical market is gaining control day-to-day and the bankers are finding it more difficult to persuade the market in their favor. This will only add to the volatility.
TGR: How will the new Silver Institute standard help investors assess production cost accounting and make smarter investment decisions?
DM: The silver version of the Gold Institute Revised Production Cost Standard is an attempt to create an apples-to-apples yardstick for silver production across the sector. In the past, companies used different metrics to arrive at cost/oz. estimates. Some excluded royalties, while others ignored shipping refining costs. A significant benefit of the new cost standard is that it helps clarify the use of silver equivalent/gold equivalent ounces jargon. About 70% of silver extraction comes as a result of base metals production. But what happens when a company with very little silver on its property decides to report its silver equivalent ounces? Theoretically, the property could be devoid of silver and still use this term by assigning a "silver value" to its base metals. The silver standard should eliminate that practice.
The standard is a general accounting system. So, by definition, it will not fully address all circumstances that producers in the sector might face. For example, a "pure" silver producer with relatively low base metals production in relation to silver ounces will not be able to post a significant base metals figure under the "byproduct credits" entry. And given that the refinement cost of base metals can be substantially higher (up to 40%) than for silver ore, this disparity could work against a given producer when "Total Production Costs" are tallied. Other disparities that might arise can happen when looking at "payable versus produced" ounces, taxation/shipping costs on the export of doré versus silver concentrate, etc.
The standards are also voluntary. Time will only tell how consistently this reporting process will be followed. It was widely embraced on the gold side. Early indications should be evident this fall, when silver producers begin filing their third-quarter financial statements. However, if investors feel it helps them clarify how much profit a silver producer actually makes from its operations, then it is likely to become a de facto yardstick in such matters.
One word of caution. This, or any measurement tool, should never be thought of as a yardstick that will lead to an investment go/no-go decision. Even assuming that this metric gave a totally accurate picture of a company's silver production costs, it would be unwise to "pull the trigger" just because Company A showed a lower production cost than Company B. What if your lowest cost-of-production company gets nationalized? How about the effects of a major mineshaft collapse on production? I'm just saying that the path to high-probability investment decisions depends on a multiplicity of factors, assigning subjective weighting to each, and then accepting a certain level of risk to compensate for unknowns, no matter how the numbers stack up. Therefore, the more factors that jibe, the more likely one is to have arrived at a "profitable" trading consideration.
TGR: Can you give us an example of how to look at a company's reporting?
DM: In 2010, First Majestic Silver Corp. (TSX:FR; NYSE:AG; Fkft:FMV) was the top-performing silver company partially as a result of reporting total production at 93% pure silver. This also made the company the purest silver producer in the world (so far in 2011 the percentage is 97%). Due to the high silver purity, mining costs are less likely to be artificially skewed and reflect the costs associated with a true low-cost producer.
Some silver producers record net revenue in the sales figure, which is net of smelter and transportation fees. The net figure includes sales of both silver and byproducts, and is stated in revenue per ton and costs per ton—a methodology that makes sense because most silver production is a byproduct of base metals retrieval. In this case, if the smelting charges are, say, 40% of the credit value, and are recorded separately, then it would give the appearance that the credits were providing a higher net value than was actually the case. Continuing with this scenario, it would be best to disclose the non-silver production as a credit, rather than as silver equivalent.
TGR: What is another way investors can have exposure to a variety of precious metals?
DM: Royal Gold, Inc. (TSX:RGL; NASDAQ:RGLD) is a leading precious metals royalty company that owns and manages royalties primarily on precious metals mines with a focus on gold. The company's royalty portfolio provides investors with a unique opportunity to capture value in the precious metals sector without incurring many of the costs and risks associated with mine operations. Royal Gold is an ideal investment vehicle for exposure to gold and other minerals, absent most of the inherent mining risk in your average gold miner.
Royal Gold offers leverage to the gold price, unlike many of the gold ETFs out there, while also providing a much higher dividend, relative to the industry average. It encompasses all the characteristics of a truly dynamic company, owning interests in 59 producing and development assets, geographic diversification, long-lived assets, fixed-cost structure and attractive valuation.
Like Franco-Nevada Corp. (TSX:FNV), Royal Gold has also embraced an aggressive acquisition strategy in the midst of unprecedented worldwide currency debasement. Royal Gold has near, intermediate and long-term production growth as well as longer-lived assets on its cornerstone projects based on current reserves.
Royal Gold has meaningful interests in some of the premier mineral deposits around the world with regard to gold, silver, copper and other base metals. Additionally, management believes in its products, which is more than can be said of the majority of operators, and it has proven so by way of spending more than a billion dollars in 2010 alone and is likely to continue as deals present themselves.
Royal Gold has also been on a buying streak. It purchased Teck Cominco, a diversified mining company and proven operator, that found itself in financial distress after the 2008 crash. Teck's Chilean Andacollo Mine is primarily a copper mine, but it possesses significant gold byproduct—approximately 55 thousand ounces (Koz.) annually for 20 years based on current reserves. This amounts to just over 41 Koz. annually payable to Royal Gold, more if the company can optimize milling operations and increase throughput. The present value of this royalty alone, using $1,550/oz. gold discounted at 8%, equates to nearly $60M, or $10.97 per share. Royal Gold also purchased International Royalty's (IRC) portfolio of 85 royalties on 79 properties. The present value of IRC's Pascua-Lama alone is nearly $600M, or $10.78 per share, using $1,550/oz. gold discounted at 8%. Completing the transformation, Royal Gold acquired its first streaming royalty in Mt. Milligan. This 25% streaming interest will become its largest single asset, contributing approximately 65 Koz. annually at an ongoing cost of $400/oz. Royal Gold has structured its cornerstone assets in mining-friendly countries, allowing investors to sleep easier at night. Using $1,550/oz. gold discounted at 8%, the present value is $799M, or $14.40 per share.
TGR: Those are great examples, David. Any final thoughts you would like to leave our readers?
DM: Yes, as economic times continue on a path of increasing stress it is a great time for people to reflect upon true wealth. The old adage that the best things in life are free is a bit naïve in my book. Nonetheless, people can reflect upon family, character, health, contribution and all the things that make us human. Perhaps you could do a thought experiment and ask, “What are the 10 things I value the most that do NOT involve money?”
TGR: Thank you for taking the time to share your ideas with our readers.
DM: Thank you.
David Morgan (Silver-Investor.com) is a widely recognized analyst in the precious metals industry and consults for hedge funds, high net worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, author of "Get the Skinny on Silver Investing" (Morgan James Publishing, 2009), and featured speaker at investment conferences in North America, Europe and Asia.
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) Sally Lowder of The Gold Report conducted this interview. She personally and/or her 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: Franco-Nevada Corp. and Royal Gold Inc.
3) David Morgan: I personally and/or my family own shares of the following companies mentioned in this interview: Franco-Nevada, First Majestic, Royal Gold. I personally and/or my family am paid by the following companies mentioned in this interview: None.
David Morgan: It is getting more difficult to predict what the market reaction will be to specific events. As people figure out that there really is no solution to the global financial system without a great deal of pain and some defaults along the road, more will seek the safety of precious metals. So, even when things calm down for the moment, it does not mean the precious metals will not get pushed down. You could see gold and silver react to the downside, perhaps dramatically—a $5/ounce (oz.) drop in silver is not entirely out of the realm of possibility. My best guess is we will see some pullback going into mid-August.
TGR: Today, gold hit $1,700/oz. during what is normally a summer slow season. Can this climb continue? What are the drivers?
DM: Yes, it can continue and the driver is uncertainty. Look at all the problems in the currency markets. It seems interbank lending is starting to freeze up in Europe. This was one of the main factors contributing to the financial crisis of 2008. So there is much to consider and it boils down to the fact we are in the final stages of a currency depreciation on a global basis.
TGR: A lot of the economic indicators—GDP and consumer confidence, in particular—are coming in weaker than expected, not to mention the Standard and Poor's downgrade of U.S. debt. Could we see another 2008-style sell-off, and how would that impact precious metals?
DM: Fundamentally, nothing of substance has changed since 2007 except that the banks have lots of money on hand. You have to understand that the silver market has a mind of its own. What happened in 2008 was a silver sell-off that caused a shortage, pushing the physical price of silver at the retail level to around $13/oz. while paper silver traded under $9/oz. on the futures exchanges. Excessive short selling then ran the price from about the $20/oz. level to the brink of $50/oz. The next leg up could take out the $50/oz. level after a few tries and then not look back until establishing a new nominal level of $65/oz.–$75/oz.
TGR: Where is the demand for silver coming from? Is it industrial or investment-driven? Is the developed or developing world pushing the market?
DM: Look East. In July, the Hong Kong Mercantile Exchange launched a U.S. dollar-denominated silver futures contract. It cited "surging international demand for silver" as the cause for the launch, pointing out that silver demand rose 67% domestically between 2008 and 2010. China accounted for almost 23% of the world's silver usage last year. It is now using four times as much silver per-person as it did 12 years ago, but this is still one-fifth the amount used on a per-person basis in the U.S. and Canada. Silver demand is growing for both industry and as an investment.
The game has changed, however. The physical market is gaining control day-to-day and the bankers are finding it more difficult to persuade the market in their favor. This will only add to the volatility.
TGR: How will the new Silver Institute standard help investors assess production cost accounting and make smarter investment decisions?
DM: The silver version of the Gold Institute Revised Production Cost Standard is an attempt to create an apples-to-apples yardstick for silver production across the sector. In the past, companies used different metrics to arrive at cost/oz. estimates. Some excluded royalties, while others ignored shipping refining costs. A significant benefit of the new cost standard is that it helps clarify the use of silver equivalent/gold equivalent ounces jargon. About 70% of silver extraction comes as a result of base metals production. But what happens when a company with very little silver on its property decides to report its silver equivalent ounces? Theoretically, the property could be devoid of silver and still use this term by assigning a "silver value" to its base metals. The silver standard should eliminate that practice.
The standard is a general accounting system. So, by definition, it will not fully address all circumstances that producers in the sector might face. For example, a "pure" silver producer with relatively low base metals production in relation to silver ounces will not be able to post a significant base metals figure under the "byproduct credits" entry. And given that the refinement cost of base metals can be substantially higher (up to 40%) than for silver ore, this disparity could work against a given producer when "Total Production Costs" are tallied. Other disparities that might arise can happen when looking at "payable versus produced" ounces, taxation/shipping costs on the export of doré versus silver concentrate, etc.
The standards are also voluntary. Time will only tell how consistently this reporting process will be followed. It was widely embraced on the gold side. Early indications should be evident this fall, when silver producers begin filing their third-quarter financial statements. However, if investors feel it helps them clarify how much profit a silver producer actually makes from its operations, then it is likely to become a de facto yardstick in such matters.
One word of caution. This, or any measurement tool, should never be thought of as a yardstick that will lead to an investment go/no-go decision. Even assuming that this metric gave a totally accurate picture of a company's silver production costs, it would be unwise to "pull the trigger" just because Company A showed a lower production cost than Company B. What if your lowest cost-of-production company gets nationalized? How about the effects of a major mineshaft collapse on production? I'm just saying that the path to high-probability investment decisions depends on a multiplicity of factors, assigning subjective weighting to each, and then accepting a certain level of risk to compensate for unknowns, no matter how the numbers stack up. Therefore, the more factors that jibe, the more likely one is to have arrived at a "profitable" trading consideration.
TGR: Can you give us an example of how to look at a company's reporting?
DM: In 2010, First Majestic Silver Corp. (TSX:FR; NYSE:AG; Fkft:FMV) was the top-performing silver company partially as a result of reporting total production at 93% pure silver. This also made the company the purest silver producer in the world (so far in 2011 the percentage is 97%). Due to the high silver purity, mining costs are less likely to be artificially skewed and reflect the costs associated with a true low-cost producer.
Some silver producers record net revenue in the sales figure, which is net of smelter and transportation fees. The net figure includes sales of both silver and byproducts, and is stated in revenue per ton and costs per ton—a methodology that makes sense because most silver production is a byproduct of base metals retrieval. In this case, if the smelting charges are, say, 40% of the credit value, and are recorded separately, then it would give the appearance that the credits were providing a higher net value than was actually the case. Continuing with this scenario, it would be best to disclose the non-silver production as a credit, rather than as silver equivalent.
TGR: What is another way investors can have exposure to a variety of precious metals?
DM: Royal Gold, Inc. (TSX:RGL; NASDAQ:RGLD) is a leading precious metals royalty company that owns and manages royalties primarily on precious metals mines with a focus on gold. The company's royalty portfolio provides investors with a unique opportunity to capture value in the precious metals sector without incurring many of the costs and risks associated with mine operations. Royal Gold is an ideal investment vehicle for exposure to gold and other minerals, absent most of the inherent mining risk in your average gold miner.
Royal Gold offers leverage to the gold price, unlike many of the gold ETFs out there, while also providing a much higher dividend, relative to the industry average. It encompasses all the characteristics of a truly dynamic company, owning interests in 59 producing and development assets, geographic diversification, long-lived assets, fixed-cost structure and attractive valuation.
Like Franco-Nevada Corp. (TSX:FNV), Royal Gold has also embraced an aggressive acquisition strategy in the midst of unprecedented worldwide currency debasement. Royal Gold has near, intermediate and long-term production growth as well as longer-lived assets on its cornerstone projects based on current reserves.
Royal Gold has meaningful interests in some of the premier mineral deposits around the world with regard to gold, silver, copper and other base metals. Additionally, management believes in its products, which is more than can be said of the majority of operators, and it has proven so by way of spending more than a billion dollars in 2010 alone and is likely to continue as deals present themselves.
Royal Gold has also been on a buying streak. It purchased Teck Cominco, a diversified mining company and proven operator, that found itself in financial distress after the 2008 crash. Teck's Chilean Andacollo Mine is primarily a copper mine, but it possesses significant gold byproduct—approximately 55 thousand ounces (Koz.) annually for 20 years based on current reserves. This amounts to just over 41 Koz. annually payable to Royal Gold, more if the company can optimize milling operations and increase throughput. The present value of this royalty alone, using $1,550/oz. gold discounted at 8%, equates to nearly $60M, or $10.97 per share. Royal Gold also purchased International Royalty's (IRC) portfolio of 85 royalties on 79 properties. The present value of IRC's Pascua-Lama alone is nearly $600M, or $10.78 per share, using $1,550/oz. gold discounted at 8%. Completing the transformation, Royal Gold acquired its first streaming royalty in Mt. Milligan. This 25% streaming interest will become its largest single asset, contributing approximately 65 Koz. annually at an ongoing cost of $400/oz. Royal Gold has structured its cornerstone assets in mining-friendly countries, allowing investors to sleep easier at night. Using $1,550/oz. gold discounted at 8%, the present value is $799M, or $14.40 per share.
TGR: Those are great examples, David. Any final thoughts you would like to leave our readers?
DM: Yes, as economic times continue on a path of increasing stress it is a great time for people to reflect upon true wealth. The old adage that the best things in life are free is a bit naïve in my book. Nonetheless, people can reflect upon family, character, health, contribution and all the things that make us human. Perhaps you could do a thought experiment and ask, “What are the 10 things I value the most that do NOT involve money?”
TGR: Thank you for taking the time to share your ideas with our readers.
DM: Thank you.
David Morgan (Silver-Investor.com) is a widely recognized analyst in the precious metals industry and consults for hedge funds, high net worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report on precious metals, author of "Get the Skinny on Silver Investing" (Morgan James Publishing, 2009), and featured speaker at investment conferences in North America, Europe and Asia.
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) Sally Lowder of The Gold Report conducted this interview. She personally and/or her 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: Franco-Nevada Corp. and Royal Gold Inc.
3) David Morgan: I personally and/or my family own shares of the following companies mentioned in this interview: Franco-Nevada, First Majestic, Royal Gold. I personally and/or my family am paid by the following companies mentioned in this interview: None.
