Six mining companies that pass this filter
From his perch in Johannesburg, Swiss-born Craton Capital Fund Advisor Markus Bachmann has been watching the metals price and cost cycles, and he has some good news. The days of mining company managements using shareholders to support their lifestyle may be nearing an end. He is seeing more companies run like a business, throwing off free cash flow even in a depressed price environment and providing opportunities to get in on the ground floor of turnaround stories. In this interview with The Gold Report, Bachmann shares six names from the portfolio that pass his rigorous resource and operational criteria tests.
Markus Bachmann has advised the Craton Capital Precious Metal Fund since its inception in 2003 and has more than 18 years of experience managing/advising natural resources and related portfolios. Prior to cofounding Craton Capital in 2003, he held positions at Credit Suisse in corporate finance, UBS as an analyst and fund manager for SBC Brinson in Zurich, and Coronation Asset Management as senior PM and global resource specialist in Cape Town, South Africa. Bachmann holds numerous awards for fund management.
Gold Price 1970 to Present Courtesy Craton Capital
The Gold Report: What are the indicators you watch when evaluating the fundamentals behind gold, silver and copper? Are you looking at financial policies in the U.S.? Gross domestic product (GDP) in China? Economic headlines from Europe? Something else entirely?
Markus Bachmann: Those are all short-term catalysts. A potential interest rate increase in the U.S. might be a midterm overhang, but it could also be a catalyst. We shouldn't overanalyze the gold market. The gold market will do what the gold market will do. It often comes down to a longer-term sentiment. We learned over the last few decades that gold moves in rather lengthy cycles.
One fallacy is that gold is a safe haven. During a financial crisis like the one in 2008, gold is often used as a source of liquidity of last resort. That's why when the world goes to pot, gold declines because it is being sold into a falling environment to fulfill margin calls or it is sold because other assets are falling even harder.
Distressed financial markets, as we saw when the Shanghai Composite declined and corrected significantly over a very short period of time, can put pressure on the gold price, too. We suspect a lot of gold was released into the market during what many thought would be a positive for the shiny metal. The reality is that gold was used as a collateral to buy equities by some of the Chinese investors.
All of these headline issues might have a short-term news impact or a midterm overhang, but overall, they don't move the needle. We don't know when the sentiment in favor of gold is going to turn, but it will. It may depend on where you sit. An investor in Sydney, Australia, probably sees gold's value in Aussie dollars completely differently because it had a great return over the past two years. Someone sitting in New York, Los Angeles or San Francisco will use a U.S. dollar measurement and had a negative return over the same time period.
Calling the market can be a fool's game. It's difficult to say that June/August was the bottom for gold after a four-year correction. We're a little cautious. We are convinced it is the last curtain call approach for a correction. Gold always has a few tricks up its sleeves, but I think we are probably close to 97% through. While we are waiting for the last act in the metals correction, investors should watch it very carefully and keep their powder dry. Companies are sweating costs out, capital expenditures are falling and a free cash flow cycle is emerging. If gold turns the corner it will trigger a strong recovery in equities. But to call the bottom in bullion I would like to see an increase to about $1,280/ounce ($1,280/oz) for the multiyear low to be confirmed.
Plus, the investing world became much more complex over the last few years with the introduction of algorithmic trading. That makes everything more challenging to try to understand the direction.
TGR: How does your understanding of the cyclical nature of commodities, including the cyclical nature of all-in costs for mining companies, impact your investing strategy?
MB: The high cost inflation we saw from 2003 to 2012 was a function of the biggest investment cycle of the past 200 years. That investment boom led to a lot of capital chasing a very limited pool of skills, labor, equipment and contractors in a neglected sector. The result was massive cost inflation and company excesses. Since the investment cycle peaked in 2012, costs have moved into a deflationary direction. Shareholders have forced companies into austerity mindsets. Capital investments are coming down dramatically. For the first time, shareholders could benefit. For years to come, we could enjoy good free cash flow generation. Even companies like Barrick Gold Corp., Newmont Mining Corp. and Goldcorp Inc. have started to turn around. That cycle of declining costs has a lot of legs across the sector.
TGR: You are a Swiss-born fund adviser living in Africa. How does that impact your analysis?
MB: The Swiss aspect is that we might be a bit pedantic when it comes to numbers. We want to find the reasons behind a specific event. The African component is that we learn to improvise because often things do not work the way they should. That is great preparation for operating in commodity markets. Particularly in the gold space, you always have to expect the unexpected because there is no fixed rule book.
In Johannesburg, we are very close to the commodity complex. The city is actually built on gold and mining tailings. My children go to school with the children of owners of iron ore mining companies, suppliers, refiners and financiers. We live very tangibly with the ups and downs of the commodity cycle every time we go to a barbecue.
TGR: What do you consider to be countries with manageable risk?
MB: It's a tricky question because, again, there are fallacies. You would think that a First World country is a safe jurisdiction to operate in, but you have a lot of regulator risk in places like the United States. While you may not have people protesting at your factory gates, you might have lawyers harassing you, and legal bills and fines can be excessive. Mexico has its own different challenges. It's a very prospective mining domicile, but companies need to give the security aspect a high importance. That goes for places in Latin America, like Colombia, as well.
It might actually be easier to operate in a country perceived as a "challenging environment" because the political system is less stable and the infrastructure is underdeveloped. There are domiciles to avoid, places with hostile mining policies or a lack of rule of law. I would probably include South Africa in that category. But by and large, I think every domicile is workable with a few exceptions. If you show respect, work on relationships and stand your ground, you can be successful almost anywhere.
In particular, we like Canada. It has a clear regulatory environment, great infrastructure and a skilled workforce. To a large extent, that applies to Australia as well. China has suddenly started to make acquisitions in domiciles like Canada and Australia; that tells you a lot.