Canada Connection: Going for the gold
The Royal Canadian Mint recently unveiled what will likely become the largest symbol for Canada’s vast resource wealth.
In April, the Ottawa-based mint took the drapes off the world's first 100-kilogram (220 pounds or 3,215 troy ounces) gold coin with a face value of C$1 million. And the pizza-sized coins are now on sale for between C$2 million and C$3 million.
The timing was a bit ironic, however.
Gold prices have been slumping this year after a huge 23% increase in 2006 on top of an 18% increase in 2005. After peaking at about US$730 in mid-May 2006, gold is currently trading at about US$665. Part of the reason is the amount of gold suddenly hitting the markets as central banks such as the European Central Bank, the Bank of Spain and the Bank of France unloaded large volumes. “There have been unusually large central bank sales over the past couple of weeks and that’s weighed on the market,” said Bill O’Neill, co-founder of the commodity consultancy, LOGIC Advisors.
The Royal Canadian Mint’s monster gold coin debuts at a time when Canada, once one of the world’s largest gold producers, has seen its production drop in the last decade by almost a third to about 140,000 kilograms a year, mostly from about 330 so-called hard-rock underground mines. And few analysts believe that there is the likelihood of any major discoveries in Canada.
But that does not stop the gold bugs.
For publicly traded companies in Canada, gold exploration and production are still a big deal. Dominated by major producers like Placer Dome Inc., Barrick Gold Corp. (NYSE: ABX) and TVX Newmont Americas (previously known as TVX Normandy Americas), gold companies on the Toronto Stock Exchange (TSX) raised about US$1.5 billion in 2005. Combined, their 3 billion shares are worth about C$58 billion.
On Canada’s small cap exchange, TSX Venture, nearly one-fifth of 988 mining companies are gold explorers.
And that makes it a mine field for small cap investors looking for Canadian gold stocks.
That is why small cap specialist Martin Ferguson, director of Mawer Investment Management Ltd. in Calgary, says he never invests in small-cap “golds.” “I avoid them altogether,” he says.
Ferguson says gold stock prices are now down despite bullion prices still being strong, even with the recent drop. “So stocks look cheap,” he says.
But beware, he adds.
“Small cap gold stocks don’t always trade on fundamentals,” says Ferguson. “It’s often just prices and psychology. And the gold market is a tough one – it’s illiquid and it’s small and there are so many other factors.”
Those include everything from the value of the U.S. dollar against other major currencies to oil prices. Gold production in Canada is very energy intensive because of the country’s prevalence of hard-rock formations.
And because there are so many gold explorers in Canada, it is tough for a small-cap investor to find the right one.
“It’s a little scary out there,” says Lysle Stein, head of Red Barn Capital Inc. in Toronto.
Stein says the recent tailing off in gold prices after a sharp increase may have frightened gold mining investors, especially those who have become comfortable with high gold prices sending share prices soaring. However, if an investor believes gold prices will soon go up again, now might be a good time to look at small-cap Canadian gold stocks, Stein says.
Stein says he has several rules that include checking the reserve allocation, preferably using a new resource accounting tool called a 43101 report – think of it as the accounting equivalent of the Sarbanes-Oxley law -- introduced after the famous Bre-X salting scandal. (Bre-X was a Canadian company that sprinkled its core samples from a mine in Borneo with gold. It led to the largest scandal in Canadian mining history when the company collapsed in 1997, spawning a number of fraud charges that have not yet even gone to court.)
Stein likes companies that have large, multi-million “referred” ounces, meaning there is large upside potential. He also likes companies that operate in the relatively politically stable regimes in North America. Once such company Stein recommends is Seabridge Gold Inc. (AMEX: SA), which has a large potential find in British Columbia and the Northwest Territories.
There are also several gold-influenced heavy funds such as Nesbitt Burns small-cap weighted index, AGF Canadian Resources Fund, and Investors’ Canadian Small Cap Growth-B. As well, there is Barclays Global Investors’ iShares Canadian S&P/TSX Global Gold Index that has had a five-year return of 9.5%, a three-year return of 16.1% but a one-year loss of 12.2%. The fund, which trades like a stock, tries to replicate the S&P/TSX Global Gold Index.
One small cap specialist, Blue Sky Canadian Small Cap Research, said some time ago it liked Vancouver-based Energold Drilling Corp. (TSX Venture: EGD) which is looking for gold and silver in Mexico and Dominican Republic.
“Energold is an unusual junior gold company in that it is profitable,” Blue Sky said in its original recommendation in 2004. Since then, Energold has produced a steady stream of profits. In April, it reported 2006 earnings of C$3.7 million, compared with C$1.1 million in 2005. It’s seen its share price go from C$0.60 to C$2.25 currently, and analysts see a price target of C$3.75 by the end of this year.
Despite the soft gold prices, there are those who believe the market will return.
“The fundamentals for gold are strengthening on an almost daily basis and are inexorably underwriting a sharp upward move in the price in the very near future,” John Embry, chief investment strategist at Sprott Asset Management in Toronto, said recently in Investors’ Digest of Canada.
In the meantime, if you can’t find a Canadian small cap gold stock to your liking, the Royal Canadian mint will sell you one of its gold supercoins for between C$2.5 million and C$3 million.
So far, the mint has received confirmed orders for five coins.
