Investing in the Australian Gold Sector

This post is a copy of my presentation  at the Excellence in Mining and Exploration conference at the Hilton Hotel in Sydney on the 8th of October 2006.

“Thank you Mr Chairman for the introduction, OK, why the gold sector as an investment category? 

Over the last 2,500 years, gold has always been a great investment when times are tough. With the huge debt issue in the US, terrorism uncertainty, energy, water and environmental issues, rising interest rates and inflation……gold as an investment category in its own right has been increasing in popularity since 2001, but especially in the last year.

 So, lets have look at the global gold sector: 

1. On the supply and demand front the global supply/demand tonnage for 2006 has been about 820 tonnes per quarter; therefore supply and demand are reasonably even.
2. Gold Derivative turnover is very hard to estimate but figures indicate the physical market (i.e. supply/demand) is only about 5% of the derivatives market, making derivatives by far the biggest factor affecting the bullion market in general, with real potential for price manipulation.
3. The Central banks are said to be holding about 30,000 tonnes of bullion, but some say due to gold loans it’s more like 10,000 tonnes. In fact I rang the Reserve Bank of Australia in 2002 to ask if I could take a photos of bullion for our website and they told me that the gold was out on loan and that the vault was empty, even though for accounting reasons the bank officially holds about 80 tonnes of gold.
4. China has been deregulating its gold market over the past couple of years and we have all seen the potential of China to affect commodity prices when they decide that they want to increase demand.
5. On the spot price we’ve seen a price high of $716 US on the 12^th of May this year, which was $922 per oz in Australian dollars…a new Australian record. We still haven’t reached the all time high of $800 US per oz that was reached on the 21^st of January 1980 and at that time the price of gold in Australian dollar terms was $744 per ounce. So, we still have some way to go to reach a new international gold price.
6. Market sentiment, which has always been a driver of the gold price, has changed to the positive now and the general investment population is just starting to pick up on gold as an investment, or at the very least as a hedge against financial uncertainty.

  So, that’s the global scene, now let’s have a look at the Australian gold sector 

The Australian gold sector is the 4^th largest export earner for the country at about $6 billion per annum. The top three are oil/gas, (grouped as one) coal and Iron Ore. The Australian gold sector is about 65% foreign owned. 

Australia is the third largest producer of gold behind the US and South Africa, but that will probably change over the next few years. As a country we missed out on the opportunity to introduce a flow through share scheme, which would have been a great to kick-start the exploration industry from say 2001 to 2003, but we basically got managed investment schemes for the forestry industry instead. The introduction of the flow through share scheme could have possibly seen Australia hold its global production ranking for years to come and keep those important export dollars. 

Having said that, the gains in commodity prices has seen a substantial flow of capital into the exploration sector generally, especially over the last two years. 

There are a few hundred companies searching for gold in Australia, most of them listed on the ASX, with some duel listed in the UK and Canada because the international markets are structured differently than here and for some companies these markets are easier to raise capital in. I expect that we’ll see changes in the way that the Australian market is structured over the next few years purely for reasons of competition for business. 

It has been widely (and possibly wrongly) stated that the top 200 metres of Australia, from the surface down, has been pretty heavily explored, with some areas having had dozens of companies scratch the same piece of ground over the decades. 

Generally speaking technology and systematic exploration strategies are being used in Australia like never before and we believe that through this some great discoveries will be made over the next few years. 

The investment risk factors can be seen largely as technical and from a purely sovereign risk perspective, Australia is a safe place to explore and develop mineral resources. Relative to the rest of the world, we have very few problems with title and continuing ownership. 

So from an overall viewpoint, the gold sector generally has merit for further price rises and capital gains and we believe that the Australian gold sector mitigates some of the potential risks that faces other countries. Also, Australian gold companies are cheap on an International market.  

So, that’s the reason we’re investing in the Australian gold sector.    So, this brings us to……how do we decide where to invest our funds? 

Apart from the obvious, like unhedged or low-hedged producers and companies close to production, our main area of interest is in the junior exploration sector……as that’s where the best capital gains are to be made, we’ve all seen the massive share prices rises based on a new discovery.

So on that front, we look at the basic business model of a potential investee company and to start off……I’ll tell you what we don’t invest in. 

We don’t invest in companies that conduct most of their business through joint ventures (JV’s), i.e. picking up ground, making a story interesting and getting someone else to take the capital risk on exploration…….as that model is giving away 95% of the risk, but also gives away 95% of any potential reward, so where’s the growth profile. Don’t get me wrong; JV’s are great in the right circumstances 

Exploration is inherently a risky business, so if we invest in a gold exploration company, we expect the company to take on that risk, but put practices in place that will mitigate the risk as much as possible.

We also don’t invest in companies that could be described as milking the market for board, founder and management interests. We expect our investment dollars to be spent on exploration that will best enhance the growth potential of a company, especially through drilling. Drilling holes is the only way to really discover an orebody.  

I don’t apologise for not treading lightly here, as there are some very high quality people and companies in this industry and these companies usually find it hard to get real investor interest and get their message across because investors are swamped so much rubbish from the other end of the market that sounds similar……it’s almost a cry wolf scenario. 

We have a few other factors that will convince us not to invest, but what I have just said are the main ones. 

So what do we look for? 

We look for undervalued companies that understand the basics of successful exploration….which is…..the application of perseverance to a well-funded strategic, systematic exploration program, obviously to a good geological model in the right area.

We look for project focus, a management team that has good board support, a reasonable corporate structure (i.e. how many shares on issue, options, who are the shareholders and how much do they control, etc) and we look at the cash burn rate of a company (i.e. the project versus board and management which gets back to what I just said)  

So, now we come to how we evaluate the data from the hundreds of companies listed on the ASX and make an investment decision. This is where the Gold Report Australia information system comes in to play. 

Some background here is probably relevant  

Myself, having worked in the mining and exploration industry throughout Australia for several years…..and after the gold price bottomed in 2001…….I developed a keen interest in ASX listed gold companies but found it hard to research all of these companies concurrently and I was continually scouring several forms of media for cutting edge information that would allow me to conduct my research before investing, but not to miss out on any potential price rise. So, through necessity, I developed the concept and had some computer programs built that would do this work for me and it made sense to have it as a web application. 

After establishing Gold Report Australia and the information system, the value of our portfolio increased by almost 61%, for 2002, when most fund managers, at the time, were achieving single digit returns at best.  

In late 2002 an opportunity arose that changed my focus and allowed me to put together, a large high quality gold project, which effectively gave us the best risk/reward strategy for taking a substantial position in the Australian gold sector as a private company.  Since then we have grown that project valuation from less than $1m to $12m, achieved in May this year based on the corporate structure of the last capital raising, and we are in the process of exceeding a $25m valuation over the next year or so, before implementing a $45m development strategy. 

As I am now in a position to take a step out of that project, our investment focus has now returned to ASX listed companies and I have put togther a very experienced team that will take the best advantage of the Gold Report Australia information system. 

The Gold Report Australia information system is a research tool designed specifically for the Australian gold sector. It is totally independent as we receive no fees or commisions of any kind what-so-ever from any investee companies, broking or financial houses anywhere. 

We have applied the KISS theory to this web based tool, to just keep it simple, which makes it really easy to use……with no advertising. It is a simple tool that works very effectively. We also show you what we invest in and explain why as I wish to share our knowledge to help investors become educated about the pro’s and cons of the exploration industry. 

So, if you would like to know more, feel free to visit our website at the URL on the screen, which is in it’s final testing mode as we speak. Regardless of last weeks gold price, it’s still trading in the 5 year upward trend and we expect another 5 years before any major correction. Good luck in the market.”