Beyond bullion

AGF's Robert Lyon says gold-mining stocks haven't kept pace

Sonita Horvitch 20 July, 2011 | 6:00PM

 Robert Lyon, senior vice-president and portfolio manager at AGF Investments Inc., says that there is value to be found in selective gold producers, given that gold stocks overall have not kept pace with the ascent in the bullion price to record levels.

A specialist in resources, Lyon reports that he has been adding to his gold exposure in the portfolios he manages. His emphasis, he says, is on those companies with "the right assets, a good reserve profile, strong production growth and low production costs."

Lyon is bullish on gold. "We do believe that the bullion price is going to US$2,000 per ounce; the timing is the question."

The fundamentals for gold are powerful, he says. "Global demand is expanding, reflecting a broadening base of central banks buying bullion and an increasing retail demand in China, Europe and the United States." In China, he says, the quest is for an inflation hedge. In Europe and the United States, it reflects a search for a safe haven.

Against this demand, global supply is essentially flat, Lyon says. "While there was a slight uptick in the supply of gold in 2009 and 2010, this has since levelled out." Lyon notes that gold stocks essentially kept pace with the rising bullion price from 2000 to July 2008, which was when the global financial crisis struck. Since then, he says, the stocks have lagged.

Lyon says investors were disappointed that gold stocks, which historically have had a low correlation with the rest of the market, failed to hold up during the financial crisis. "During the heart of the crisis from July 2008 to November 2008, the S&P/TSX Gold Index fell 50%."

This, he says, in turn, caused investors to question why gold stocks should command a safe-haven premium to other mining stocks and to the stock market as a whole. Since the crisis, "this premium has been shrinking."

Robert Lyon

Finally, he says, the recent $7.3-billion purchase by Barrick Gold Corp. ABX of copper producer Equinox Minerals Ltd. raised eyebrows. "Investors queried why the world's biggest gold producer was buying a pure copper producer?" Part of the answer, he says, is that there are "limited production-growth prospects in the gold-mining business."

At AGF, Lyon is responsible for the team managing almost $2 billion in assets in a number of natural-resources funds and their clones including AGF Canadian Resources Class ($590 million) and AGF Global Resources Class ($460 million). As well, Lyon co-manages AGF Precious Metals ($900 million) with Ani Markova.

AGF Canadian Resources Class has 120 names. At the end of June, the three biggest industry weightings were gold and other precious metals (22%), energy including energy-services companies (55%), and diversified metals and mining (17%).

Lyon's discipline is to combine a top-down approach with stock selection. He determines the economic factors driving commodity prices overall, and then analyzes fundamentals for each commodity. This focus on individual commodities helps to determine the weightings of the different resource industries in the portfolios.

In stock selection, Lyon looks for the best value and growth opportunities within each resource industry. When it comes to gold, Lyon's strategy is to "overweight small- and mid-cap producers relative to their large-cap counterparts."

Three stocks that represent holdings in both AGF Canadian Resources Class and AGF Precious Metals, and which meet Lyon's production-growth criteria, are: Eldorado Gold Corp. ELD; Belo Sun Mining Corp. BSX; and Goldcorp Inc. G.

Belo Sun Mining
Eldorado Gold
Goldcorp Inc.
July 19 close $1.08 $17.25 $51.37
52-week high/low $1.54-$0.35 $21.35-$13.09 $53.34- $38.99
Market cap $0.22 billion $9.5 billion $41.1 billion
Total % return 1Y* 208.61 6.27 23.26
Total % return 3Y* 72.61 30.09 4.25
Total % return 5Y* 44.74 27.50 9.78
*As of July 19,2011
Source: Morningstar

A mid-cap producer, Eldorado is expected to expand its production by 40% between 2010 and 2012, he says. The company. a low-cost producer, has a cash cost of US$400 per ounce, says Lyon.

Eldorado's producing properties are in Turkey and China, Lyon notes. "These are young assets as opposed to mature ones and they have solid growth prospects with incremental exploration upside." In addition, Eldorado has development-stage projects in Brazil and Greece, he says.

"The company, under the stewardship of president and CEO Paul Wright, has a track record of building mines on time and on budget." The stock trades at 1.1 times to company's net asset value per share. "At the current time, we believe you are getting a top-quality company at an average price."

Lyon's approach to the juniors is to hold a basket of stocks. Belo Sun Mining is early stage, he says, with exploration and development projects in Brazil. The company's focus is on its wholly owned Volta Grande Project in Para State. "We expect to see a resource estimate by year-end." Production is a few years away, he adds.

Among the seniors, Lyon likes Goldcorp for "its good growth profile and low-cost production." The company, under the helm of Chuck Jeannes, is "well managed." Lyon says he "expects to see an increase in Goldcorp's dividend reflecting its strong free cash-flow generation."

Turning to energy, Lyon's long-standing favourite among the producers and the biggest holding in AGF Canadian Resources at 6% is Tourmaline Oil Corp. TOU.

Although Tourmaline is "predominantly a natural-gas producer and the gas price have been persistently weak, the company is profitable, growing strongly, and will benefit significantly from any improvement in the commodity price." This stock is not cheap, says Lyon. "Tourmaline is a high growth, quality producer and you have to pay up for this."

Lyon is enthusiastic about energy-services companies. "The story just keeps getting better." The producers, currently focused almost exclusively on oil prospects, are using all of the existing service capacity, he says. "The service companies have strong pricing power and are generating robust earnings per share and cash flow." If the gas price recovers, the fundamentals will get even stronger, he says.

Two companies that are "poster children" for the industry are Calfrac Well Services Ltd. CFW and Trican Well Services Ltd. TCW. These companies, says Lyon, have both a Canadian and an international presence. Trican recently made "a small acquisition in Australia, providing it with a strategic entry-point into a growing market."

In the base-metals industry, Lyon sold his holding in Thomson Creek Metals Co. Inc. TC. Its main assets are two large operating molybdenum mines. "The commodity price has been steady, but unspectacular." Furthermore, the company recently diversified into the copper mining business and "is diluting its franchise as a pure play on molybdenum."

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Sonita Horvitch

Sonita Horvitch