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Metal trading giant, China Minmetals Corp. bid for Canada's biggest mining
company, Noranda Inc., reflects less China's voracious appetite for commodities
and more China Inc.'s arrival on the world's stage as the world's financier.
Nationalist and xenophobic fears are being raised because China Minmetals is
a state-owned enterprise. What can people be thinking? All of China, until
recently was owned by the state, but that is changing as reforms, privatization
and liberalization policies take hold. Those wrapping themselves in the flag,
don't complain when state-supported Bombardier takes over an Irish plane company
or when once nationalized PetroCanada acquires resources in Egypt. China is
simply flexing its financial muscles.
China has become one of the world's locomotives, becoming the world's third
biggest exporter. China's boom has sparked an unprecedented expansion in world
commodity markets. China produces two-thirds of all DVD players, microwaves,
and over half of all digital cameras. It has become the world's largest consumer
of aluminum, copper and cement and the world's second largest import of oil.
China is the Saudi Arabia of the Capital Markets
Unlike the Japanese, who bought Van Goghs and golf courses with their surpluses,
the Chinese appear to be more sophisticated in spending their almost $500
billion of foreign exchange reserves. In the past, China seemed content to
replace Arab investors as purchasers of U.S. treasury bills. Asian central
banks were active in the foreign exchange markets by buying up U.S. dollars
to deter their currencies from appreciating further. China is to the US financial
markets what Saudi Arabia is to the world oil markets - the primary provider
of capital. Chinese companies to date have invested about $33 billion throughout
more than a 160 countries, but the Noranda purchase is the biggest, so far.
Prompted by this prudent desire to diversify and the recognition that the
U.S. dollar is vulnerable, China has also bought euros, Canadian dollars, and
even gold last year. But now, instead of settling for more low-yielding dollars,
China has bought dollar assets or proxies with their surplus dollars lessening
their dependence on the dollar. The Chinese central bank likely lost $10 billion
due to the drop in the US dollar, and no central bank can do that for very
long. Increased protectionist measures by Americans and the nationalist outcry
against Chinese companies exposes America's vulnerability. Americans must realize
that the rules of the game have changed. He who owns the gold, makes the rules.
Investors should adjust accordingly. The Chinese subsidization of the American
economy is over.
China has one of the highest savings rate in the world, and in recognition
has liberalized the ownership of gold. China's central bank governor estimated
that Chinese citizens currently have 1.2 trillion yuan or $145 billion of savings,
which contrasts sharply with the spent savings of the Americans. Historically,
the Chinese have an affinity to gold and the government's recent move to allow
individual ownership has prompted the World Gold Council to predict "the rise
in demand for gold in China from the current 200 tonnes to an annual 600 tonnes
over the next few years." We believe Chinese demand will surprise even the
World Gold Council. Already five banks jumped the gun and queues were formed,
similar to the long lineups outside the Bank of Nova Scotia in the late 1970s.
The Chinese have one of the lowest grams per capita usage, at 0.1 grams per
capita in contrast to 0.73 in India and 1.41 in the United States. China's
official gold reserves are less than 2 percent at only 600 tonnes. The central
bank is expected to boost its holdings in line with the more industrialized
nations. To achieve a level of the Europeans at 15 percent of reserves, China
would need to consume all of the gold produced in the next two years.
The Big Risk
For sometime now, we have warned about America's financial imbalance and vast
accumulation of domestic debt, which are the dollar's Achilles heel. To date
the dollar has lost over twenty percent of its value and appears poised to
slide another 10 percent. Without the largesse of foreign investors, the
Americans must somehow attract more than $50 billion of net investment each
month. Foreigners bought $39 billion in net purchases of US securities in
August, less than the $64 billion bought in July.
The big risk lies on the United States whose debt load threatens to endanger
the world's economy. The US has become the world's biggest debtor. Every day,
the superpower is looking more like another big Latin American debtor. For
the past decade, America has been living beyond its means. The US government
has increased spending while cutting taxes, causing a swing of $700 billion
of red ink. America's households have also spent more than they earn, subsidizing
their lifestyle against the illusory value of their home. We believe a potent
cocktail of twin deficits will lead to a collapse of the dollar, exacerbated
by $55 oil prices and continued geo-political uncertainties.
America's bubble was spawned by a huge reliance on debt and its way of life
is unsustainable. Unlike the Chinese whose boom is built on traditional wealth
creation, America's boom is built on debt and the false illusion of "asset
wealth". Since 2001, a potent mixture of leveraged assets, deficits at 10 percent
of GDP, $7.3 trillion of government debt, negligible savings and the opiate
of artificially low interest rates have contributed to a huge U.S. credit binge,
which will be passed on to the next generation. The United States today has
over $53 trillion in government debts and liabilities that start to mature
in four years when the first of the baby boomers begin to retire. The average
household's personal debt today is about $85,000, and if you include Medicare
and social security, this increases five times to $475,000. A mixture of spent
savings and huge fiscal deficits, financed largely by foreigners, has ruined
many Latin American economies. The US is poised to follow, but just how big
a crash, we don't yet know (almost half of the US government debt is currently
held by foreigners). And in this quarter, this appetite for American assets
appears to be waning along with interest in the greenback. Gold will be a good
thing to have.
Fannie Enron Mae
Falling rates are also a problem for "too big to fall" Fannie Mae. Fannie Mae
with $1 trillion of assets is the second largest financial company after Citicorp
and among its biggest derivative players. Fannie's accounting practices and
misuse of "generally accepted accounting rules" are the focus of an interim
scathing 211-page report by The Office of Federal Housing Enterprise Oversight
(OFHEO). The regulator of America's giant mortgage company recounts how Fannie
Mae improperly expensed half of $400 million so that the company could meet
its earnings guidance allowing top management to receive the maximum bonus
payouts. Fannie Mae deferred the other $200 million of prepayment losses or
expenses following the collapse of interest rates in the third quarter of 1998.
Last year, its top executive, Franklin D. Raines was paid $20 million. The
report was searing, it stated "the misapplication of GAAP are not limited occurrences,
but are pervasive and are reinforced by management" and, "the Enterprise was
making preemptive adjustments for the sole purpose of managing prospective
earnings". Indeed the OFHEO report also revealed billion of dollars of derivative
losses. Fannie improperly recorded $12.2 billion in deferred losses relating
to cash flow hedges that if adjusted, Fannie would be undercapitalized. Just
how undercapitalized was Fannie Mae? We don't know. The company subsequently
agreed to boost its reserves by 30 percent, as an interim measure but must
raise billions of new funds or liquidate assets.
As private companies with a government charter that guarantees its debt, Fannie
and its smaller cousin Freddie were able to borrow huge sums of money. Today,
Fannie Mae and Freddie Mac owns or guarantees nearly half of the United States
$7.9 trillion of residential mortgages outstanding. Like Enron, the roles and
responsibilities of the key executives are being questioned as well as executives
from the Controller's department. Key management may be replaced, and congressional
hearings have begun. The Justice Department has also launched a criminal probe.
Even Alan Greenspan issued warnings that there was a danger in this concentration
of mortgage risk and suggested the privatization and removal of the contentious
government guarantee. The International Monetary Fund also waged in, warning
that both Fannie and Freddie's "bias" concentrated interest-rate risks and
the hedging of which would amplify interest-rate movements."
Last year, Fannie Mae's retained earnings only stood at $24.5 billion, against
a derivatives book of $1.04 trillion. And the other mortgage company? Freddie
Mac recently restated $4.5 billion of earnings, removed key executives and
settled with federal regulators. Foreigners today hold more than 12 percent
of outstanding US agency securities and nearly half of its debt. The question
then to ask, who bails out the bag holder? Gold is a good thing to have.
Recommendations
We continue to expect gold to post a new high this year, driven by dollar weakness,
high oil prices, strong investment demand and continued geo-political tensions.
Gold will average $450 next year with an interim target of $510 per ounce.
Gold stocks have outperformed bullion and volume has also increased. Joe
Ismail, our technical analyst, notes that many of the intermediates and junior
producer charts display long bases and the stocks have recently broken above
their short and intermediate term moving averages. There have been few "hot
plays" other than Guyana Gold and the Cortez Hill discovery, and thus the
junior exploration stocks are lagging. Gold stocks need a discovery.
Among senior producers, we like Kinross, Placer Dome, and Newmont.
The Harmony/Gold Fields/Iamgold ménage á trois signals a resumption
of the industry's consolidation and if harmony is successful expect the next
round will include the big cap players this time. Among the intermediate producers
we continue to recommend Bema, Meridian, Agnico-Eagle,
and Goldcorp. The junior and emerging producers are still lagging but Eldorado, Northgate, Crystallex,
and Miramar look interesting here. Until a discovery, we would stay
with the junior producers.
Cambior Inc.
Cambior acquired 55.3% in Minera Poderosa SA, a private Peruvian gold producer
from two of the Arias sisters for $25 million in cash, 2.2 million common
shares and a contingent payment of $6 million. The Poderosa mine has been
in production since 1982 with an average of 75,000 ounces produced annually
over the last five years from a series of high-grade veins but reserves are
limited. Cambior paid more than double our valuation and it is noteworthy
that the other two sisters did not sell but instead swapped their interest
for shares of another non-producing Canadian gold producer, raising questions
about the valuation. Cambior has refinanced this acquisition with a $110
million stock issue putting a lid on that stock. The acquisition and dilutive
stock issue distracted investors from the operating problems at the Doyon
mine in Quebec, masking the good news of the successful start-up at Gros
Rosebel in Suriname, which boosted Cambior's production to over 700,000 ounces
in 2004. We believe the stock dilution together with the expensive acquisitions
makes Cambior a sell at current levels.
Crystallex International Corporation
Crystallex is expecting the final permit (Permit to Impact Renewable Resources)
shortly, which will allow physical construction to begin. Crystallex has
completed engineering and drilled 18 infill holes, which is expected to add
about 2 million ounces to its reserves by yearend. We expect the company
to pursue its 40,000 tonnes per day model but will first begin production
at 20,000 tonnes per day, producing 300,000 ounces by first quarter 2006.
Upon receipt of permitting, financing arrangements could then be arranged;
although this project could also be financed outside the usual or traditional
bank financing. Crystallex shares remain undervalued and the company remains
a tasty takeover candidate particularly when compared to other 10 million
ounce deposits. Unlike other projects, there is no technical risk, strong
government support and with Chavez winning the referendum, no political risk.
We continue to recommend the shares here and expect the stock to outperform
its peers.
Eldorado Gold Corporation
Eldorado received all permits and approvals to build the heap leach Kisladag
mine in Turkey. The long awaited construction permit was granted and Eldorado
completed the roads and utilities work. Kisladag should be in production
late next year, producing 240,000 ounces over the next fourteen years. Eldorado
should produce 90,000 ounces at Sao Bento in Brazil as the shaft sinking
continues and about 10,000 ounces are expected from Kisladag late in the
year as the mine starts up. Permitting is continuing at the other Turkish
site, the Efencukuou project, a mine capable of producing 90,000 ounces per
year. Eldorado shares have lagged and thus we recommend purchase here.
Gabriel Resources Ltd.
Gabriel Resources received a lifeline $25 million investment from Newmont,
which gave Gabriel much needed cash and credibility to pursue the Rosia Montana
project, a large 10 million ounce undeveloped gold/silver deposit in Romania.
While Newmont's arrival is welcome, we believe the Rosia Montana development
is still difficult from a social and permitting standpoint - Gabriel is still
considered a junior in the eyes of the government. Newmont's purchase gives
it a stake in a potential major producer, but we believe the difficulties
that plague the project remain and we would avoid Gabriel here.
Goldcorp Inc.
Goldcorp shocked the Street when Rob McEwen offered to relinquish the CEO spot.
Rob McEwen has been the main driver behind making Goldcorp a much admired
intermediate sized gold producer and was a major part in the identification,
exploitation, and expansion of the Red Lake mine. Rob's desire to bring in
a new manager to finish the Red Lake expansion is unselfish and will likely
put Goldcorp into play. The big problem was that Rob was too successful and
Goldcorp is so richly valued that many producers cannot pull of an accretive
transaction. However, under a $500 gold scenario, the Red Lake mine is an
attractive asset for many of these senior producers, who are lacking a premium
deposit and sitting with bloated hedge books. As such, we continue to recommend
the shares of Goldcorp, particularly on any weakness.
Newmont Mining Company
When it rains, it pours. Newmont has had a run of bad karma. In Indonesia,
Newmont has been unfairly accused of environmental damages and its workers
have been "detained". At Yanacocha, Newmont has been hit with a workers'
strike where water is a big issue and production has been adversely affected.
Ironically little has been written about Newmont's royalty business and oil & gas
interests, which were inherited from Franco-Nevada. Little attention is being
paid to those assets, but those assets are an effective hedge. Newmont's
dilemma in the near term is the replacement of depleting reserves. For too
long, the Street has been abuzz that Newmont would acquire Placer Dome. Even
though such an acquisition might excite the Street but such a merger would
bring little benefit to either company and frankly would not solve both companies'
problem, the need to replace of reserves. We continue to like Newmont as
a core holding, particularly for its' strong balanced sheet, lack of hedges
and strong core asset, at Yanacocha and Nevada. A $10 change in the gold
price causes a $50 million bottom line improvement to Newmont's earnings.
Buy.
Placer Dome Inc.
Placer Dome hosted an analyst tour at the Cortez Hills in Nevada in September.
Placer's new president noted that the Cortez Hill discovery is open at depth
in at least two directions and we expect further news. We should also expect
news from the joint venture with White Knight on the Indian Ranch project.
Placer has allocated $10 million for Cortez. Placer has also completed a
mineral resource model at Pueblo Viejo in the Dominican Republic, which completes
the test work. Placer is expected to make a positive decision and put this
project into production. With a resource of 18 million ounces, Pueblo Viejo
is expected to be a solid producer if they solve the metallurgical puzzle
(Placer could use the BioteQ process). We upgraded our opinion of Placer
in the last quarter because of Cortez Hill and on expectations that Pueblo
Viejo will offset the negatives of Placer's South Deep albatross in South
Africa. We continue to recommend Placer's shares here for Cortez, Timmins
and Pueblo Viejo.
Meridian Gold Inc.
Meridian gold has finally started to perform, due in part to a new discovery
at crown jewel El Penon in Chile. The Dorada discovery extends Meridian's
production profile beyond 2006 and El Penon should produce 310,000 ounces
this year at a paltry cash cost of $55 per ounce. Meridian has more than
$200 million in cash and no debt. And like Goldcorp, Agnico-Eagle and Kinross
production is unhedged. The high-grade Dorada discovery is exciting and reflects
our view that El Penon has much more reserve potential ahead. The Dorada
has 800 meters along strike and 150 meters dip defined so far. Three rigs
are working on the vein. At Esquel in Argentina, there has been little progress
but then, little was expected by investors. We believe that any movement
on Esquel would be positive for Meridian since there is little discounted
in the stock price. We continue to recommend Meridian here.
Northgate Minerals Corporation
Northgate has benefited from the upturn in the copper price, which has helped
reduce the cost of the Kemess South mine in north-central British Columbia.
Kemess South produces 300,000 ounces of gold at a cash cost of $150 an ounce
plus 75 million pounds of copper at a cost of $0.90 per pound. Management
has done a good job with a tough project and will now focus on developing
nearby Kemess North, which contains 4.1 million ounces and 1.5 billion pounds
of copper. The project capital is estimated at only $160 million and technically
the project is feasible. However, while close by, Kemess North is on the
other side of the mountain, it requires permitting and public information
sessions together with agreements from First nation groups. Kemess North
is not yet a slam-dunk but any improvement in the permitting process would
assist the shares. Northgate is in need of a third leg but to date has been
unsuccessful in looking for another 100,000 ounce producer. Northgate shares
are undervalued and we recommend them here. Brascan sold its 41.5 percent
interest via a secondary in November 2003.
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John R. Ing
Maison Placements Canada
130 Adelaide St. West - Suite 906
Toronto, Ont. M5H 3P5
(416) 947-6040
Disclosures:
Rating Structure
Analysts at Maison use two main rating structures: a performance rating and
a number rating system.
Performance Rating: Out perform: The target price is more than 25% over
the most recent closing price. Market Perform: The target price is more than
15% but less than 25% of the most recent closing price. Under Perform: The
target price is less than 15% over the most recent closing price.
Number Rating: Our number rating system is a range from 1 to 5. (1=Strong
Sell; 2=Sell; 3=Hold; 4=Buy; 5=Strong Buy) With 5 considered among the best
performers among its peers and 1 is the worst performing stock lagging its
peer group. A 3 would be market perform in line with the TSX market. NR is
no rating given that the company is either in registration or we do not have
an opinion.
Analysts Certification: As to each company covered in this report, each
analyst certifies that the views expressed accurately reflect the analysts
personal views about the subject securities or issuers. Each analyst has not,
and will not receive, directly or indirectly compensation in exchange for expressing
specific recommendations in this report.
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this research report is based upon in part; the overall revenues and profitability
of Maison Placements Canada Inc. Analysts are compensated on a salary and bonus
system. Some factors affecting compensation including the productivity and
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and a member of the Toronto Stock Exchange and regulated by the Investment
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