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Picking Undervalued Gold Equities Akin to Picking Strawberries: Randall Abramson

Source: Brian Sylvester of The Gold Report  (4/27/15)

Randall AbramsonRandall Abramson, CEO/portfolio manager with Toronto-based Trapeze Asset Management, says that picking stocks can be like picking strawberries. If a strawberry looks terrific, other than a tiny blemish, you simply remove it and enjoy the rest. But if the fruit turns out to be rotten, the entire strawberry is for the birds. Is the stock price below fair market value because there's a little blemish and the market is overreacting? Or is it a sign that the stock is rotten to the core? In this interview with The Gold Report, Abramson offers advice for investors so they can look past the blemishes to see quality fruit.

The Gold Report: A 10-year U.S. bond yields 2% currently. How is that changing the market?

Randall Abramson: We typically view the markets and our investment process through top-down and bottom-up lenses. Our top-down tools are telling us that all systems are "go," and that there are no immediate hurdles ahead. This low-growth environment has allowed the broader markets to remain in a bull phase for longer than is typical. In fact, we've not had even a market correction of 10% or so for way longer than normal.

TGR: The World Gold Council (WGC) reports that central banks bought 477.2 tons of gold in 2014, which was nearly a 50-year high. What do you make of central banks buying gold at peak Cold War-era levels?

RA: Gold does not have a built-in return. When interest rates are higher, everybody is less apt to hold gold because there's too much of an opportunity cost. When interest rates are negative, as they are in some countries today, you'd probably rather own gold than lose money on bonds.

Central banks are perhaps trying to spur inflation by buying gold, or they could be less interested at these elevated U.S. dollar prices to hold dollars in their reserves, or they could be concerned about the U.S.'s balance sheet. All of those are factors. But the key driver is that there are places like China, which is flush with cash and willing to hold more gold. China always takes a long-term approach to the way it manages things. It may even be making a run at the U.S. dollar for reserve currency status and holding more gold in its coffers will help.

TGR: The WGC report also said gold demand jumped 6% in Q4/14 to 987.5 tons but was down 4% year-over-year. Does that bolster your spirits as a gold investor?

RA: The 2014 growth rates were a bit deceiving because the 2013 numbers were out of sight, driven by huge investment demand in both India and China. And at the same time, India put curbs in place to limit gold buying, which probably slowed down demand growth for gold last year. In the overall picture gold demand has been growing nicely over time, while the supply has more or less flatlined. Now that the price of gold is around $1,200/ounce ($1,200/oz) and close to the all-in sustaining cost of production, our take is that about half of the global gold producers would not make a profit below $1,150/oz. That should support the price at that level. And given that the marginal cost of production for gold is around $1,400/oz, we believe that we will see $1,300–1,400/oz gold in the not-so-distant future.

TGR: Pick one: long gold or short gold?

RA: Long. The world's central banks are, in aggregate, accommodative, some of them highly accommodative, in terms of quantitative easing. We think that they will ultimately win the day, and this disinflationary period that we've lived through for years will transition into a reflationary period. The key indicator of that so far is that the gold price, while it's near a recent low in U.S. dollars, looks terrific on the charts in just about every other currency.

TGR: Trapeze positions itself as value investors, stock pickers. Are we in a stock picker's market for gold equities?

RA: That's a great question. You can go through periods where the overall sector is a better bet than finding a specific stock, especially from a risk-reward perspective. For instance, when the market bottomed in 2009, using a net to capture a bunch of stocks might have been better than a mere handful of particular stocks because the whole market was trading near $0.50 on the dollar. You didn't want to miss out on the market reverting to fair value.

The gold equities market is in a similar phase. You would have been better off as a stock picker over the last couple of years to avoid highly levered or high-cost producers. Those companies witnessed unprecedented declines in their stock prices. But now that we're sitting with gold stocks versus bullion at the lowest level in 75 years and the price:book value (P:BV) of the overall senior golds in the sector trading at about one times P:BV, it seems to be a period where casting a wide net may make more sense. And that's an interesting comment coming from a bottom-up value investor like me.

TGR: Everyone obviously has their own methods of picking everything from fresh fruit to baked goods. Tell us about your process for picking equities, especially precious metals equities, in this market.

RA: You pick baked goods based on what you like to eat. Some people like éclairs. Some people like cookies. But we pick our fruit differently. Most of us like strawberries but not all strawberries are the same. If a strawberry looks terrific other than a tiny blemish, that's no problem. You can cut out the blemish and enjoy the rest. But if that piece of fruit turns out to be rotten, the entire strawberry is for the birds. That's similar to how one should look at stocks on a bottom-up basis. Is the stock price below fair market value because there's a little blemish and the market is over-reacting? Or is it a sign that the stock is rotten to the core? That's what we do as value investors.

TGR: Most of our readers follow small-cap precious metals equities. Please give us an overview of that sector.

RA: It's been beaten up as badly as the large-cap sector. The large caps are trading at about book value, and the small caps are valued similarly. About 2,000 companies are listed on the TSX Venture Exchange and about two-thirds of those are resource equities, mostly gold and oil and gas stocks. The Venture started in 2001 and the index is now below the level at which it started. It's essentially at the same level it was at the market bottom at the end of 2008. There is a treasure trove of potential investments there.

The problem is that a lot of companies need capital and the gold business is complex—there are geological issues, engineering issues, commodity price fluctuations and other moving parts. When the sector is out of favor, it's very difficult for some companies to attract capital. It's the ultimate value trap. Having said that, there are companies out there without debt, with cash on their balance sheets and that ultimately can control their own destiny.

TGR: What's your best guess as to when the bear market for gold bullion will end?

RA: Gold in every other major currency except the U.S. dollar is clearly out of a bear market because it's up significantly. Gold in U.S. dollar terms, while it's barely off of its bottom, has already triggered a buy signal in our proprietary Ratio of Adjusted Capital work. Since 1990 we've seen that buy signal happen 14 times with an average gain of about 25% from its trough. Only once did it decline.

TGR: Could that just be a bear market rally?

RA: It's possible, but it's unlikely because you have to liken gold to any other commodity, like pork bellies, and look at the commodity fundamentals. While the gold supply is flatlining and demand is growing, at current levels gold is far below the marginal cost of production. Gold is sitting at the average cost of production, but commodities typically sit, on average, at 40% above the average all-in cost of production. The gold price has to normalize to the upside. What's inhibiting gold isn't necessarily disinflation, it's the U.S. dollar and that could continue given that interest rate differentials still favor the U.S. over other regions. If you're a pension investor, you've been earning 2% on your U.S. Treasuries versus next to nothing, or even negative yields, on your European bonds, and worse, the euro has plummeted versus the dollar. But that could all turn on a dime.

TGR: Any parting thoughts?

RA: It's interesting that I just conducted interviews with The Gold Report and The Energy Report because as you look around the world, it's very difficult, more than any other time that I've seen, to find value. When you're in a bear market, value abounds, and when you're in a bull market, you can still typically find pockets of value. Yet it's difficult to find undervalued stocks today. But the two groups that keep coming up on our screens, from all over the world, on a bottom-up basis, are energy and gold stocks. Now, if we could just get commodity prices to cooperate.

TGR: Thank you for your insights, Randall.

Randall Abramson, CFA, is CEO and portfolio manager of Trapeze Asset Management Inc., a firm he cofounded in 1999 shortly after founding its affiliate broker dealer, Trapeze Capital Corp. Abramson was named one of Canada's "Stock Market Superstars" in Bob Thompson's Stock Market Superstars: Secrets of Canada's Top Stock Pickers (Insomniac Press, 2008). Trapeze's separately managed accounts are long/short or long only, and have either an all-cap orientation or large cap-only mandate via the company's Global Insight model. Abramson graduated with a bachelor's degree in commerce from the University of Toronto in 1989, and his career has spanned investment banking, investment analysis and portfolio management.

Email: jluther@streetwisereports.com



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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