Picking gold and silver equities in a stagnant price environment is a stock picker's game that requires a particular thesis—and a fair portion of patience, says Joe Reagor, an analyst with ROTH Capital Partners. In this interview with The Gold Report, Reagor outlines types of companies he prefers and pairs those with names that patient investors could parlay into promising profits.
The Gold Report: In a report from RBC Capital Markets in late January, the firm said gold could reach as high as $1,200/ounce ($1,200/oz) in the short term but remains in an overall downward trend. Does ROTH Capital Partners share that view?
Joe Reagor: A lot of people are reacting to a bounce in the gold price here in early February and need to set a number, but they still believe the factors that have held gold down over the last few years remain intact. Our view is a bit different. Gold at $1,100/oz is not a sustainable long-term scenario. The costs of production are still relatively high, and they're only going to get higher as companies mine higher grades to lower costs. Miners did this in the late 1990s, and that's why gold moved higher for 12 straight years in the 2000s before we had a healthy pullback. We think we're heading toward the end of the 1990s time frame again, where the fundamentals will drive the gold price higher.
TGR: Please explain those fundamentals.
JR: Gold can't go much lower without costs having to adjust lower. The strength of the U.S. dollar helps non-U.S. producers somewhat, but in general, the fundamentals suggest that if you want an industry to survive, it needs a 20% profit margin. If all-in sustaining cash costs are $1,100/oz for gold, then you already need over $1,300/oz to sustain the business. That is where gold needs to be in the long run or we won't have as much gold production for the world to consume.
TGR: The Bank of Japan recently cut its interest rate on bonds to minus 0.1%. In fact, much of the global economy now is in a negative interest rate environment. Is deflation now the global economy's greatest threat?
JR: Deflation and inflation are difficult to peg. The governments of the world are good at spinning numbers to make them look like what they want them to look like. But loose monetary policy usually drives inflation—it just doesn't always drive the type of inflation that the government is seeking. Governments might insist we're in a deflationary environment, but that doesn't mean that the consumer or the investor is seeing deflation. Loose monetary policy is usually good for gold, and gold generally goes up with inflation. It's hard to say exactly what side of that fence we're on. The inability of lower interest rates to drive more economic growth is a real concern in the near term.
TGR: The global economy clearly has more faith in the U.S. dollar than in gold. Is that a case of misplaced faith?
JR: Yes. We're the best of the worst, and the U.S. dollar is valuing up as most other currencies are devaluing. That can only go on for so long before the global recession finds its way back to the United States. Eventually the U.S. dollar momentum trade could come to an abrupt end and that would be good for gold. People know that but they're making money in the U.S. dollar trade. Similar to mortgage-backed securities and credit default swaps, people are taking advantage of it and hoping that they aren't the last person into the trade.
TGR: How does ROTH Capital Partners expect gold to fare amid all this uncertainty and fear in the global economy?
JR: In the near term, we expect to see a slow, steady recovery in gold prices—$1,200/oz seems reasonable. A healthy, slow, steady recovery in gold is possible based on more and more people moving away from the U.S. dollar and into gold as a store of value. If there is a global recession and it becomes obvious that it is going to be a multiyear issue, gold could see a big increase in value.
The big key is China. If China's growth rate continues to decline, that would significantly impact the world economy. Perhaps China can find new ways to spur its economy to continue to grow at closer to Third World than First World rates. If it does, there's some question as to how it funds that. It could sell our debt, which would likely result in a devaluing of the U.S. dollar and give it the funds it needs to start public works projects. The rest of the world could, in a sense, come out of recession but at the same time still cause gold to go up by devaluing the dollar. There are lots of avenues where gold goes up, and very few where we see further decline toward that infamous $1,000/oz level.
TGR: So you don't dismiss what's happening in gold as a strictly seasonal event.
JR: There's usually a bounce in January following a down year, and in December we were talking to our clients about this possibility. But at the same time, we expected that without the world economy slowing and the U.S. stock market pulling back. Now there are potential concerns about how the U.S. Federal Reserve reacts or overreacts to the pullback in the market. The first move from $1,050/oz to $1,100/oz was seasonality. Now it's a little bit of a fear trade, in our view. Therefore, there's more room for it to run.
