TO GOLD LONGS...LEWIS ON RGLD & gold
Lance Lewis...his wrap up has a detailed piece on rgld
War Drums Beat Softer, But They’re Still Beating
Asia was mostly higher last night, with Japan rallying over a percent. Europe was up a touch this morning, and the US futures were higher. Over the weekend, we had several geopolitical events. Iraq destroyed a few missiles like it said it would, Turkey said “No” to allowing US troops to base an attack from the country, and the US caught a major Al Qaeda terrorist figure. Those events seemed to have people in a good mood during the overnight session as well as the pre-open. Now, the capture of the terrorist is certainly something to be pleased about, and I suppose you could make the stretch that perhaps Al Qaeda will be irreparably weakened by the capture. So, that could be a positive for stocks and the economy, albeit a small one in relation to our real problem: dealing with the aftermath of a bubble. People, however, seemed to be more excited about the fact that, in their opinion, Iraq’s destruction of the missiles and Turkey’s refusal to allow troops meant any potential war was put off.
Now, this has to be the dumbest thing I have ever heard. How many times has Bush said that he felt he did not need a new UN resolution in order to attack? How many times has he said Iraq has weeks and not months? Lastly, how many men and tons of hardware does the US have in the region? It doesn’t take a rocket scientist to figure out that the US will attack Iraq. It’s only a matter of what day. Thus far, any rally based on the misguided belief that maybe there won’t be a war has been a sale, and today’s rally was no different. We opened up and pushed up to a marginal new high for the move amidst heavy call buying once again. We struggled for a bit near that high but never really could push forward. Finally, when the February ISM came in at 50.05 (slightly below the consensus and well below January’s reading of 53.9), we reversed and sold off to a new low for the day. After a small bounce, we began a steady march lower that took us to new lows for the day and closed us pretty much on the very worst levels of the session. Volume was light once again (1.2 bil on the NYSE and 1.3 bil on the NASDAQ). Breadth was near even on the NYSE and slightly negative on NASDAQ.
The semis opened higher and quickly reversed, completely reversing Friday’s gains and more in most cases. The equips were pounded a little harder. CYMI fell 5 percent to a new low for the year on rumors that its biggest customer (ASML) would be guiding down in the very future. The SOX fell 4 percent and just shy of a new low for the move.
There has been so much hyping of semis as “beta plays” for a war rally as well as last week’s hyping of the INTC’s mid-quarter update this Thursday, that the semi complex could really come unglued at some point this week I think. I don’t’ remember the last time so much speculation was built up around an industry that was truly on the edge of a cliff (more so in the equipment area than the chips themselves, where valuations remain more the issue). People are so convinced that a war and the resulting rally will make everything magically OK that they have piled into the sector with probably the weakest fundamentals out there in order to try and score the biggest “hit.” The concept works both ways though. Sure, if a rally appears, the semi complex will fly. But if it doesn’t, these same stocks will implode that much faster.
The rest of tech was also weaker, although not near as weak as the semis.
Financials were a little softer. The BKX fell a percent, and the XBD fell 2 percent. The derivative king rose a percent. GE fell a percent. Credit insurers were off a percent or so here and there. FRE and FNM both rose a touch.
Retailers were mostly a little weaker, as the RTH fell a percent, giving up Friday’s gains and more. The big dog fell a percent. The homebuilders were mixed and continue to outperform for the most part.
The petroleum complex was weaker on the same “excuse” that stocks were higher earlier this morning. Namely, that this weekend’s events had somehow postponed a war. In fact, oil was simply due a correction. Oil fell 72 cents to $35.88. Natural gas fell 93 cents to $7.16. The XOI rose a percent, the OSX fell a percent, and the XNG rose a touch. The CRB fell a percent to a new low for the move. The commodity complex is in a tricky spot here. Either it needs to rally soon, or it’s going to be due a fairly steep correction.
Gold gapped down a couple dollars and proceeded to stumble its way to down $5 at its lows to just a few dollars shy of its February lows. The dollar began to weaken sharply at that point, and that action appeared to spark a rebound in the metal that saw it climb all the way back to a new high for the day, finishing on its very best levels of the day but still down a dollar to $349.20. The HUI fell 3 percent to a new low for the move and below its February lows, once again underperforming the metal, which is not a very positive development. The gold shares need to hold here in this area, or I fear they could revisit the summer lows in a similar selloff to what we saw last July when the equity market and gold and its shares were dumped together in a deflationary panic. A big break in the dollar, which appears to be possibly building, could, however, give us a surprise and actually boost the shares and commodities in general (including gold) even as stocks decline. We’ll just have to see how things play out in the coming weeks.
RGLD was trashed for almost 33 percent on the back of a Barron’s article that painted the stock as wildly overvalued and only worth between $5 and $9 a share at best. This has to be one of the more moronic pieces I have ever read. Now, when I mentioned the stock back on January 7th, I said it was getting “pricey” at level it was at back then, but this article’s claims are bordering on ridiculous.
RGLD is the only pure-play gold royalty company in the US. It’s chief asset is a sliding scale royalty (Pipeline) that increases as the price of gold rises, giving it tremendous leverage to the price of gold. The company has $1.50 in cash, no debt, and pays a dividend. As a royalty company that takes its royalties based on a net smelter royalty (NSR), which is a percent of sales, the company does not have the risk of increases in expenses due to cave-ins, cost overruns, miner strikes, etc . Thus the company's cashflow should carry a premium to that of other miners. While the stock has certainly not been cheap over the last few months, the recent Barron's article is a bit of a stretch. The article attempts to value the company at $9 a share based on the "generous assumption" of $400 gold.
What most never seem to understand about gold mining companies (or royalty companies, as in this case) is that it all depends on the price of gold. PE ratios, multiples of sales, etc are meaningless for gold miners because they typically lead the price of gold, and even more so for a royalty company like RGLD that has virtually no expenses. If $400 gold is indeed "generous" as Barron’s called it (a price we were virtually at earlier last month), then none of the gold miners are worth owning. If indeed this $400 price is not generous and we are still in the early stages of a long bull market as I believe, then it is a minimum assumption. The 1970s bull market saw gold rise nearly 2300%, as the Dow Jones Industrial Average/Gold ratio moved to 1. Now, whether we'll see that sort of a rise again is certainly up for some debate, but my only point here is to say that if one is bullish on gold then $400 is a minimum price objective.
With that general background out of the way, we can look closer at RGLD's valuation. The Barron's article takes RGLD's pre-acquisition royalties and values them based on reserves x $400 oz gold x royalty and then values the High Desert acquisition merely at the purchase price of $31 mil. $1.50 per share cash is then added to come up with the $9 value. This analysis is somewhat sophomoric and fails to account for not only High Desert's value but exploratory potential as well. More importantly, this analysis fails to take into account the primary driver of gold stocks, the price of gold.
Let's value the company at $500 gold for example. Using Barron's same maximum theoretical value model, the company's potential royalties based on reserves look like the following:
Pipeline (which is operated by PDG)
GSR1= 5% (the sliding scale NSR jumps to 5% over $470) of 6.36 mil proven and probable (P&P) reserves x $500 oz gold= $159 mil
GSR3= .7125% x 6.36 mil P&P x $500 oz gold = $3.18 mil (*Note: in the Barron's article, this GSR3 was even mislabeled as GSR2. GSR2 is in fact a HIGHLY leveraged royalty (9% above $470) based on any finds on the property outside of the current Pipeline mine)
NVR1= .37% x 4 mil P&P x $500 oz gold = $7.4 mil
Like Barron's, I won't even include the 1.75% NSR on the 1 mil P&P reserves at Bald Mountain, the 2% NSR on CDE's Yamana, or the Greek property, Milos, although these reserves certainly have value. But again for comparison purposes, we'll leave those out in order to give the article’s author the benefit of the doubt.
That gives us a total of $169.58 mil.
Next we’ll look at the High Desert Acquisition. Unlike Barron's, I am going to give management a little credit and value these royalties on the same theoretical basis as above (reserve ounces x price of gold x royalty) rather than merely the valuing it at the purchase price as Barron’s author did.
High Desert Acquisition:
SJ Claims (operated by ABX) = 1% x 16.43 mil P&P x $500 = $82.15 mil
Leeville (operated by NEM) = 2% x 3 mil P&P x $500 = $30 mil
Like Barron’s, we'll also value the remainder of High Desert's royalty portfolio at zero, just to give the author the benefit of the doubt.
That gives us a second total of $112.15 mil. When we add in the company’s cash of $28 mil, we get the following calculation: $169.58 mil + $112.15 mil + $28 mil = $309.73 mil/ 19.06 mil shares = $16.25 a share
Obviously, a higher price of gold, raises all of these calculations. Here again, this theoretical value calculation is valuing not only the company's smaller royalties at zero, but also any exploratory success on any of the properties that the company has claims on. Additionally, this is assuming that company does not acquire any additional royalties with its war chest of cash, despite the fact that the company has repeatedly said that it continues to actively pursue additional royalties with the aim to broaden its portfolio.
Lastly, the article cites recent insider selling of 267,000 shares by "the people who know RGLD best." Insiders owned 5 million shares, or 26% of the outstanding before these sales. If we're going to assume that management is fairly sharp (and thus far all of their moves have been very smart), the fact that they are still holding over 4.7 mil shares or almost 25% of the outstanding says something. As Barron's says these are "the people who know RGLD best." If they're still holding 25% of the outstanding, they certainly appear to be fairly confident in the stock even at its recent valuation.
Sure, the stock is not cheap, but it trades at a premium for a reason. Royalty streams are highly desirable and favored over mining profits, which are subject to more risk and uncertainty. Like all gold shares, RGLD's ultimate destiny lies in the direction of the price of gold, and that should be the primary focus of any analysis. If gold is going higher, then RGLD will benefit immensely, period. And in my opinion, gold will once again move back to a one to one ratio with the Dow, just as it did during the last bear market. So that means if the Fed can manage to inflate and keep the Dow at 5000 or 4000 or wherever, then gold will be at the same price per ounce. Try calculating RGLD’s theoretical value by plugging in $2000 or $4000 gold above just for fun.
Why go through all of that? I have received several emails about the stock over the past few weeks as it has sold off, and after this hatchet job appeared in Barron’s, I thought it was worth going through the facts. I haven’t bought any yet myself, because I’m not quite sure that the gold shares are ready to rally just yet, but RGLD is definitely on my list as one of the top companies in the sector. One might wonder why the stock was pummeled on this “news” (if we can even call it that, since this article was not new information to those who understood the company). RGLD had outperformed the entire sector, and with the sector continuing to be weak, I think it was just ripe for a big correction (and no doubt was the focus of a lot of short selling ahead of the article as well over the last few weeks by those that knew it was coming). This article merely served as the catalyst for a panic. One cannot expect a stock that has moved up as much as RGLD has to not eventually have an ugly shakeout at some point. You no doubt had a bunch of people in the stock that had no idea what the company really did other than the fact that it sure “acted good” over the last year and probably deserved the losses that they suffered. As of today’s haircut, the stock has fallen back to its trading range of this summer, which is roughly inline with the rest of the gold mining sector. In any event, I’d keep it on the radar screen in the coming weeks as a name to add to one’s portfolio of gold shares.
Back to the day’s action, the US dollar index fell almost a full percent back to just shy of its recent multiyear low. The yen rallied a touch, and the euro rallied almost a full penny to 1.087 and just shy of a new high. Treasuries rallied again, as the March 10yr rose to another new contract high, and the yield fell to 3.67%.
On the war calendar, we have the Blix report scheduled for Friday and a UN Security Council vote next Wednesday.
Obviously, there was no US attack over the weekend to give the market some “certainty” and the expected rally in stocks. Bulls seemed to want it both ways and claim that both “war” and “no war” are bullish. With the month-end nonsense out of the way, now we may see if indeed stocks are poised to move lower ahead of any conflict in Iraq, as I believe they are. Despite today’s selloff, hope is kept alive for a 1991 meltup if we just look at the charts, which is what a lot of hopers are doing right now. So, I wouldn’t expect any aggressive selling (if at all) until we take out the February lows and make such a repeat performance theoretically impossible. I am focusing on the dollar and February lows in stocks as the keys over the next couple weeks. War noise will wax and wain over the coming days, but there is definitely going to be a war I think. The odds are probably better than 90 percent. And the cost of this war (and more importantly the cost of the reconstruction, which could take years and tremendously tax the US military and government coffers) is far from bullish. Throw in an already weak consumer in a faltering economy that is being pounded on both sides by structural inflation in basic commodities and a weak job market, and it spells a pretty bearish situation all around for both the dollar and stocks.
