Editor's note: In today's second instalment of Morningstar's manager roundtable on resources investing, we turn to the outlook for mining stocks. Our panellists are Benoit Gervais, vice-president, investments, at Toronto-based Mackenzie Financial Corp., who co-manages a number of resource funds with Fred Sturm including Mackenzie Universal World Resource Class 
; Robert Lyon, senior vice-president and portfolio manager at Toronto-based AGF Investments Inc., who oversees all of AGF's resources funds including AGF Global Resources Class; and Norman MacDonald, vice-president at Invesco Trimark Ltd., who manages Trimark Resources. Leading the discussion was Morningstar columnist Sonita Horvitch, whose series began on Monday and concludes on Friday.
Q: Time to discuss the materials sector, including gold.
Gervais: Gold has a modest weighting in the global materials index. The giant global players such as BHP Billiton, Xstrata, Rio Tinto, Vale, Dow Chemicals and Alcoa dwarf gold companies, when it comes to weightings and earnings.
Lyon: Canada's major gold producer, Barrick Gold Corp. ABX, is a pipsqueak relative to BHP. But globally, if you had been overweight the gold stocks, you would have handily beaten the global materials index.
Gervais: Barrick represents 20% of the S&P/TSX Materials Index. In the overall Canadian equity market, gold stocks represent about 15% of the S&P/TSX Composite Index.
Lyon: This gold weighting is high relative to its weighting in the leading indexes of other major countries and relative to gold's historic weighting in the S&P/TSX Composite Index.
MacDonald: Canada is a listing point for these companies, but gold companies are not the greatest businesses. Take Barrick as an example. It has been in business for 25 years and has difficulty translating production into earnings and cash flow.
Lyon: The whole gold mining industry is not dissimilar. I own a small weighting in Barrick.
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| Norman MacDonald: Barrick has been in business for 25 years and has difficulty translating production into earnings and cash flow. | |
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Gervais: I have a big weighting in Barrick.
MacDonald: I also have a big weighting in Barrick.
Gervais: This stock is at the same price as it was 10 years ago.
Lyon: Pretty much.
Gervais: Over the past 10 years, you did not want to be in big-caps, but in those companies that found the gold and probably developed the deposit to a certain level and then sold it. Senior producer Goldcorp Inc. G has reached an agreement to acquire Andean Resources Ltd. AND, which owns the Cerro Negro gold project in Argentina. This could be dilutive to Goldcorp's earnings because of the $3.5-billion acquisition price.
Lyon: It is dilutive in the short term.
Gervais: These acquisitions are very dilutive. What surprises us is how little these major companies invest in themselves by way of exploration and how little they invest in their own employees. It is indicative of a sub-par industry.
Lyon: The large caps have been buying it, rather than finding it. Historically, the large-cap gold companies have commanded premium multiples on their stocks, relative to the smaller caps, and that has enabled this game to perpetuate itself. If you can acquire quality assets at a great price, then it is a good strategy. But if you pay a top price, it is not so.
Gervais: It is like American Idol, you have to figure out which of the exploration companies the judges -- the big caps -- are going to like.
Lyon: The Andean shareholders must be pleased. Shareholders in Red Back Mining Inc. RBI must also be pleased with the $7-billion acquisition bid by Kinross Gold Corp. K.
Gervais: The question is which gold companies are of a reasonable size and are doing what they should be doing? Agnico-Eagle Mines Ltd. AEM, Eldorado Gold Corp. ELD and Randgold Resources Ltd. GOLD are examples.
| Agnico-Eagle Mines Ltd. | Barrick Gold Corp. | Goldcorp Inc. | ||
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| Sept.14 close | $69.02 | $46.41 | $44.14 | |
| 52-week high/low | $53.16-$77.32 | $36.01-$50.65 | $35.12-$48.37 | |
| Market cap | $10.9 billion | $46.1 billion | $65 billion | |
| Total % return 1Y* | -8.0 | 15.9 | 0.2 | |
| Total % return 3Y* | 12.0 | 7.6 | 16.6 | |
| Total % return 5Y* | 32.9 | 8.1 | 13.7 | |
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| *As of Sept. 14,2010 Source: Morningstar |
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Lyon: These are the easy three standouts. Eldorado has been a smart acquirer over the years. Eldorado and Goldcorp both went after Andean Resources. Eldorado pulled out, which shows that it is disciplined.
Q: What is the outlook for the bullion price?
Gervais: The governments around the world are likely to continue to print more money, if the increase is 15% for 2011, then this will be reflected in the gold price.
Lyon. Gold will continue to go up in the next year or two. Look at the debts that governments have accumulated. Historically, they have exited this by inflating it away.
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| Benoit Gervais: The governments around the world are likely to continue to print more money, and this will be reflected in the gold price. | |
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Q: Time to talk about agricultural producers, including Potash Corp. of Saskatchewan. POT
Gervais: Potash is in the top 10 holdings in Mackenzie Universal Canadian Resource . Our long-term view of the commodity remains positive and we got lucky with Potash.
Lyon: We do not own it. While, the long-term outlook for the commodity is good and the company's asset is an excellent one, Potash's fundamentals over the last 12 to 18 months did not look that great.
MacDonald: I did not own it. I saw better value in other agricultural stocks. Hats off to BHP Billiton for capitalizing on the short-term weakness in the commodity price, which translated into short-term weakness in Potash's stock.
Lyon: I am not sure that BHP will own it at the end of the day.
Gervais: If BHP retreats, you have about a 10% to 15% downside on the stock. Then someone else will buy it. We are going to wait and see. The Russian government is encouraging the merger of two potash companies, Silvinit and Uralkali, to create a major Russian global player.
Lyon: It is looking to create a global selling consortium.
Gervais: It is interesting that the BHP bid comes in at the time when the major potash players are about to form a cartel.
MacDonald: The BHP bid also says something about the cost of developing new potash mines.
Gervais: It was thought that BHP was going to build new potash mines in Saskatchewan. Its most advanced project is Jansen. Now it is bidding for Potash, so I assume that the Jansen mine was going to cost more than BHP thought.
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| Robert Lyon: Potash's fundamentals over the last 12 to 18 months did not look that great. | |
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Q: Can we talk about copper?
MacDonald: I am positive on copper because new mines with good ore grades are not being found in politically safe jurisdictions. The emerging economies require base metals. Copper companies with good management and good assets that can reinvest their cash flow, which is being enhanced by strong copper prices, should continue to do well. The stocks are trading at low multiples because the market does not believe that the strong commodity price will persist. Their enterprise value (equity plus debt) to EBITDA (earnings before interest, tax, depreciation and amortization) is under four times, based on next year's estimates, which assume US$3 per pound for copper. I see a lot of opportunity in Quadra FNX Mining Ltd. FNX, one of my top 10 holdings in Trimark Resources.
Gervais: Copper looks great, and we are looking for companies that have that volume lever as well. First Quantum Minerals Ltd. FM is one of our largest holdings in Mackenzie Universal Canadian Resource. The company has shown it can build mines. It is having issues in the Democratic Republic of Congo. We are hoping that there will be one more mine in Zambia and the company is building two others. We also like Antofagasta PLC, a copper-mining company in Chile. We also own a lot of Rio Tinto, a diversified materials play.
Lyon: Copper recently traded at US$3.40 to US$3.50 a pound. At US$3.50 a pound, the companies can make a lot of money. The price is not going a lot higher from here, without a significant pick up in global industrial production.
One of our names is Freeport-McMoRan Copper & Gold Inc. FCX, a large liquid and cheap stock. The company is bringing on its massive Tenke Fungurume mine in the Democratic Republic of Congo. There is political risk with that mine. But Freeport has assets all over the world. Tenke can make them, but it cannot break them.
Photos by: www.paullawrencephotography.com
