«Part of the recent strength of gold is what I call a risk premium on the world.»
Few people have achieved more success in the mining business than Pierre Lassonde. The savvy Canadian is the co-founder and chairman of Toronto based Franco-Nevada (FNV 105.69 0.84%) and pioneered the royalty business model in the gold mining sector based on the model used in the oil-and-gas industry. For investors this strategy has paid off golden returns. Today however, Mr. Lassonde points out that the gold industry hasn’t made any large discoveries for years which will put heavy upward pressure on prices in the years to come. He also thinks that US President Donald Trump is good for the yellow metal and that investors will fare better with gold than with stocks.
Mr. Lassonde, after a few difficult years gold seems to get its shine back. What’s next for the gold price?
Right now, there is more demand for paper gold than for physical gold. For instance, when you look at the refineries in Switzerland they will tell you that they’ve got the bouillon but they’re not busy. It’s not like a year and half ago when they had no stock and the gold bars basically were flying off their shelf the minute they were produced. So the pressure is in the paper gold market, the futures market.
What’s the reason for that?
Part of the recent strength of gold is what I call a risk premium on the world. There is a lot of speculation that has to do with the tensions around North Korea and President Trump. I don’t have a personal relationship with Mr. Trump but I know the man a little bit. When he was elected, my prediction was that he was going to tie up the US administration in a knot because he’s totally unpredictable. Nobody knows where he’s going and you cannot run a country that way.
And what does this have to do with gold?
Anyone else in the Oval Office would not make such outlandish statements as Mr. Trump makes. Gold (Gold 1346.41 0.5%) is benefiting from that. After the US election, my prediction was that the dollar was going to suffer from Mr. Trump being in office. The price of gold is intimately related to the dollar. Gold is essentially the »anti-dollar»: If the dollar is strong, gold is weak and if the dollar is weak, gold is strong. So what we are seeing now is exactly what I have expected: a lower dollar and therefore a stronger gold price.
So where do you think the gold will go from here?
My view has been between $1250 to $1350 per ounce for this year and then slightly ramping up next year to around $1300 to $1400. But for gold to get into the next real bull market we need signs of inflation. So far we haven’t seen them. The Federal Reserve and other central banks have piled up huge reserves. But there is no inflation because the money is sitting within the banks and they are not lending it. Therefore, you don’t get a multiplier effect. But what happened recently in the US – the one-two punch with respect to the hurricanes »Irma» and »Harvey» – is going to require an enormous amount of reconstruction. This could finally move the needle on inflation. Also (ALSN 129.6 -0.77%), Europe is doing much better. So at some point I suspect we are going to see inflation start to pick up a little bit.
What does this mean for the mining industry?
First of all, at a gold price of $1300 the industry by and large is doing well. I tell my peers: »If you are not making money at $1300 you should not be in this business.» So it’s a good price and you should be making good money. But the industry has had to shrink a lot. When the gold price dropped to $1000 at the end of 2015 everybody in the business was too fat. So the industry laid people off, consolidated, shrunk and many junior companies have been wiped out.
What are the consequences of that?
Production is declining and this is going to put an enormous amount of pressure on prices down the road. If you look back to the 70s, 80s and 90s, in every of those decades the industry found at least one 50+ million ounce gold deposit, at least ten 30+ million ounce deposits and countless 5 to 10 million ounce deposits. But if you look at the last 15 years, we found no 50 million ounce deposit, no 30 million ounce deposit and only very few 15 million ounce deposits. So where are those great big deposits we found in the past? How are they going to be replaced? We don’t know. We do not have those ore bodies in sight.
Why aren’t there any large discoveries anymore?
What the industry has not done anywhere near enough is to put money back into exploration. They have not put anywhere near enough money into research and development, particularly for new technologies with respect to exploration and processing. The way our industry works is it takes around seven years for a new mine to ramp up and then come to production. So it doesn’t really matter what the gold price will do in the next few years: Production is coming off and that means the upward pressure on the gold price could be very intense.
Why didn’t the industry put more money into exploration?
The industry has had to shrink a lot. Also, the boom in Exchange Traded Funds has changed the capital markets in a huge way: Companies that are part of an ETF get treated like chosen sons. But when you’re not in an ETF you’re getting marginalized. You become an orphan and the junior companies in particular have been completely orphaned.
How does that impact the funding of mining?
The thing with this industry is that you have to have an incredible amount of patience and you have to have money. And right now, it’s hard to get money. The risk appetite of investors has been gone for many, many years. If you are not one of the chosen few you can’t get money. You sit on the sideline and wait. In the past, more than half of the new discoveries have been made by junior companies. But they haven’t had any money now for like 10 years. So how are you going to find anything if you don’t fund the junior companies?
How is Franco-Nevada doing in this environment?
I’m so fascinated by the mining industry and I love it so much because it’s the only industry with the oil and gas industry where one single drill hole can create a billion dollars of wealth – and we’ve done it three times. That’s why they call me »lucky Pierre».
How did you do it?
There is an old, old saying in the mining business: the best place to find gold is beside a gold mine. Because if mother nature created a gold deposit in one place the odds are very good that if you just go along this structure you are going to find more. And that’s exactly how we do it. When we bought back Franco-Nevada from Newmont Mining in 2007, we paid $1.2 billion for the company and we had around 17 million ounces gold of reserves and 20 million ounce of resources. The next ten years down the road we produced around 17 million ounces of gold. And today we have 29 million ounces of reserves out of the same land and approximately another 30 million ounces of resources. That’s the tremendous power of optionality and that’s how you make money for shareholders.
Then again, the most attractive spots are sometimes in countries with difficult political and legal conditions. How does Franco-Nevada deal with that?
The mining industry is too easy for governments to pick on because you can’t move a mine. Once you’ve spent your capital you’re stuck. But resource nationalism has always been around. For instance, back in the 60s and 70s Chile nationalized all of its copper mines. Peru did somewhat the same thing. In Africa, they nationalized everything and of course everything went downhill and they had to start all over again.
What are the difficult countries to operate in today?
There are countries that are more difficult like Brazil. It’s a fabulous country but very difficult to operate in because the tax laws are just terrible. In South America the same thing: Chile has been an incredible place for a long time to invest in. It’s still a good place but it’s not as good as it used to be. Peru has always been a bit problematic. But that being said it also works. During my time at Newmont, we had our biggest gold mine in Peru and we were able to get all of our dividends out. So it worked out well. Argentina is coming back. It was a great place to work in the 90s but then they made it not so.
What does that mean for the strategy of Franco-Nevada?
You have to be agile with your money. You have to be careful and you have to be diversified. At the end of the day, it’s diversification: you can’t put all your eggs in one basket. At Franco- Nevada we don’t want to get stuck. The way we respond to that is that we limit our exposure to any mine and any country to 10 to 15% of our portfolio. So if something catastrophic was to happen then only a small percentage of the company would be affected.
Like many other gold companies, Franco-Nevada has its headquarters in Toronto. What’s special about Canada when it comes to mining?
Canada will be in the mining business forever because we have a natural born advantage: It’s the fact that Canada has the second largest landmass in the world. And to be in the mining business you need land. So with this gigantic landmass accessible, a democracy that works, a government that supports mining and universities that produce some of the best graduates in the industry we are going to be in the mining business forever. Canada also has very rigorous environmental laws and we have to deal with aboriginal people. So any company that can work in Canada can develop resources in any country anywhere in the world.
What’s your advice for investors who are interested in gold?
It’s very interesting. When you look over a hundred years back there are periods of 10 to 30 years where you would rather be in the stock market. But then, there are other periods from 10 to 15 years where you would rather be in gold.
In which period are we today?
Let’s take the Dow Jones (Dow Jones 26112.53 0.09%) Industrial. To my mind, the Dow is essentially an expression of financial assets. Gold on the other hand is what represents hard assets: real estate, paintings and other hard assets. So when you look at the gold cycle from 1966 to 1980, you can see that the ratio between the Dow and the gold price at the beginning topped out at almost 28:1: It took 28 units of gold to buy one unit of the Dow. Then the long term trend reversed and the ratio went all the way down to 1:1. A similar cycle took place in the 30s. The Dow crashed from around 360 in 1929 to 36 in the next years. So it lost like 90% of its value. On the other hand, the gold price went from 20 to 34 and the ratio essentially bottomed out at almost 1:1, like at the end of 1966 to 1980 cycle.
And what does that mean for investors today?
Today, the Dow is over 22,000 and the price of gold is around $1300. This equals a ratio of almost 18:1 and you can clearly see that the trend is starting to roll over. So what does it mean if we go down to a ratio of 1:1 once again? The gold price would hit a big number and nobody is prepared for that. I don’t know any more than anybody else because it’s about the future. But it happened already twice in the past 100 years. So I think the odds that it’s going to happen a third time are pretty good. History does repeat itself, never exactly in the same fashion, but in the same form. Therefore, I would rather own a little bit more gold than not. So I think for an average investor, it should be the absolute rule to hold around 5 to 10% gold in your portfolio, like rule number one.