Gold prices, exploration and the importance of China - Pierre Lassonde

Franco Nevada's Chairman speaks frankly to Mineweb about why he thinks gold prices are likely to continue climbing, the need for new exploration technology and the changing role of gold as investment

GEOFF CANDY:  Welcome to this weeks edition of Mineweb.com's gold weekly podcast and I'm very privileged to be joined on the line by Pierre Lassonde this week.  He is currently the chairman of Franco-Nevada, but is also a former chairman of the World Gold Council and former president of Newmont Mining.  Pierre thank you for joining me in what is a rather turbulent time for the gold market and indeed a lot of people have spoken about the unprecedented nature of much of what is going on in the global world at the moment.  If you look back over your career in the gold market, how different is the current situation to what you've seen?

PIERRE LASSONDE:  First of all thanks for having me - it's a privilege and hopefully we'll have a great conversation.  In your opening statement you said the gold market is in very turbulent times - also it's in the best of times.  We've never seen $1200 gold, so when you think about it we have to count our blessing and this is really fantastic price for the industry as a whole.  If you're not making any money at $1200 gold, you shouldn't be in this business, period.  That being said, the reason why the gold price is $1200 is first and foremost because the investors of the world - people who have money - have figured out that most of the governments - whether it's in the US or in Europe or in Japan - are going to debase their currencies because of the massive debt load that the countries have acquired over the last 20 years and that is translated into the purchasing of the gold ETFs, purchasing of gold jewellery but as investment in China and india, and when you combine all of that, we have a new phenomenon in the gold market - something that we haven't seen since the 1970s is where investment demand is actually much higher than the jewellery demand - and that is what is driving the gold market.

GEOFF CANDY:  There are a lot of issues there that I would like to pick up on and perhaps if I can take you back to 2003 - I was looking at old stories on Mineweb and one of them was quoting you talking at the first quarter conference for Newmont, and you said investors had missed two important factors that were going to influence the gold price.  The first being the deregulation of the Chinese gold market, and the second one was the increasing use of gold as a currency and it's something that you mentioned in your comments just previously.  But if we talk about that fact and the fact that as you say the use of gold as currency has been increasing dramatically.  How important is that as a structural shift and how long is it likely to continue?

PIERRE LASSONDE:  It's hugely important.  In fact when I became chairman of the World Gold Council, my number one priority was to develop, create a gold instrument that people would look at as an alternative to their home currency, the dollar, the pound, the yen, the euro - and that's when the gold ETF was born and we had a priority to list that gold ETF around the world and make it really easy for people to buy gold - physical gold.  And we are at a point today where that gold ETF is listed on so many exchanges around the world that you can actually purchase gold 24 hours a day, seven days a week.  So if you can start in London, you can move over to the United States, you can then go over to Singapore, Japan, Dubai, india, back into the European market and that has made an enormous difference.  The gold ETF today is I believe in terms of tons in the ground would be ranked third or fourth largest central bank equivalent reserve.  So it's a major strategic shift and with my successor, Ian Telfer of the World Gold Council will continue to emphasise the investment aspect of gold and we are going to come out with new instruments, and new ways for people to invest in gold will make it easier for people to do so as alternative to their home currencies.

GEOFF CANDY:  I suppose the next question then would be, how hot are these flows into investments - are we likely to see a drop off as we recover some of the stability in the global economy.

PIERRE LASSONDE:  For the next five to seven years what you're going to see is increasing investment in gold and not drop off.  The reason I believe that is we're still early in the pick up phase of what it means for gold - the place of gold as an investment in the spectrum of asset class and when you look at the money in circulation, when you look at the bond market which is in the trillions - 40 to 50 trillion - when you look at the equity market, another 30 trillion and when you look at how much gold represents out of all of that, we are almost at an historic low compared to the 1970s and 1980s.  So my view is that there's still a lot of legroom left in terms of the size that the gold market will fulfil in the investment spectrum.  You're looking at five to 10 years of continuing increase in investment demand.  And if you look back at that - I don't know if it was 2003 or 2004 interview, but at that point someone asked me how high do you think the gold market could go, and I said I believe in two things.  One is that the gold price will have three zeros after the first number - I just don't know how big the first number is going to be.  We are now at $1200 gold and I do not believe for one second that that's the end of the bull market in gold.

GEOFF CANDY:  How does that change the way then that people need to be looking at this and in particular, things like the fundamentals within the jewellery market and what's driving gold - if investment becomes such a big chunk of that, how does one then gauge how to read the market?

PIERRE LASSONDE:  The jewellery market and the investment market for gold are two opposite ends of the market spectrum if you want.  The jewellery market responds to economic 101 which means the lower the price, the more the demand - the higher the price the less the demand.  And the investment demand is the opposite of that because it's an insurance market, so therefore the price goes higher because you're willing to pay more for insurance and that is because you think your own currency is going to get devalued, therefore you're willing to pay more for that insurance.  So the jewellery market provides a floor for the gold price and the investment demand is essentially your ceiling, and how high that ceiling is going to be depends on essentially the stability of the currency, mostly the US Dollar currency.

GEOFF CANDY:  Will you then say that the floor is roughly where we're sitting at the moment in terms of jewellery demand because it is seemingly to have accepted $1000 gold...

PIERRE LASSONDE:  You know that's a very difficult question to answer - where is the floor probably around the $1000 - I would say - somewhere between $950 and $1050 is more than likely where the current floor is, but it's movable, as we all know.

GEOFF CANDY:  How important is China to all of this?

PIERRE LASSONDE:  Very important - the Chinese market is growing at approximately 15% per year and when you think of a population of 1.3 billion it doesn't take a whole lot of mathematics to figure out that you're looking essentially at an exponential curve.  That is driving, in great parts, the jewellery market.  China is an interesting market for jewellery as well because even though it's classified as jewellery - when you ask - and I did - the largest jewellery store in Beijing, China sells more per year than any other store in China - and it's run by a woman.  I was asking her when people buy gold jewellery do they buy jewellery or do they buy investment.  Her answer was ‘they very much buy jewellery but in the back of their mind, they're also buying investment'.  So how do you separate the two - you can't - at least not in China, nor you can in India because the two are very closely linked.  But the fact is that the demand is going up 15% per year and the Chinese Renminbi is going to continue to appreciate against the dollar and that is going to continue to drive the demand for gold in China and you're also going to see the Indian rupee appreciate - and that too is going to continue to drive demand.  So how important when you've got increasing demand of that nature and the size of the population, and appreciating currency, it is going to be huge - it is right now and will continue to be a huge factor in the gold price.  My ultimate belief is that if we get a really crazy gold price, in part it's going to be because of China and with all the deregulation we've seen in China and the Chinese gold market being so alive, it may just turn out to become a bit of a casino atmosphere over there - a gambling atmosphere and it could very well push the gold price beyond anything that we believe is reasonable.

GEOFF CANDY:  In terms of the western world, there's a lot of talk now about the people that say that gold is going to go up to the likes of $5000 or whatever it is - it is very much a question of 'be careful what you wish for' because should gold go up to that sort of level it means that there is a significant problem within the economies that people are living in.  Would you go along with that?

PIERRE LASSONDE:  No, if you look at back at the 1970s for example, we went from $35 gold to $800 gold by January 1980 and what happened to the US economy and the world economy - nothing.  Okay, so the gold market, when you think about it, the gold market is a very insignificant part of the overall world market.  It affects, if you take all the gold mining companies and all the people that they employ all around the world it is just a fraction, a minute fraction of the world population and economy, so would $5 000 gold imply that the US economy is going to collapse or whatever, not at all.  I don't believe that for one second. 

GEOFF CANDY:  If we move from the price to the companies that pull it out of the ground, for a little bit, they are struggling - a lot of them with cost pressures and generating cash is difficult at some of the operations - even with the gold price as high as it is.  What do you look for in a mining company if you are looking to invest in one?

PIERRE LASSONDE:  The rules have never changed.  The grade is everything and the issue that the industry faces today is that the exploration cycle over the last ten years are just not up to produce the kind of ore bodies that we saw in the 1980s and the 1990s.  The Hemlo - like 20 million ton of one ounce gold - the Goldstrike 100 million tons at 0.3 or one third of an ounce open pit - the Yanacocha is one billion ton of 1.5 to 2.0 grammes open pit.  Really easy to mine, that kind of ore body back in the 1980s, 1990s or even in the 1970s, we found 30 million to 50 million ounce ore body at least once every five years.  We haven't found one now since 1992.  The last one of that magnitude was Yanacocha, so where are they?  So the industry, when you look at the big guys and a lot of the intermediate companies, they are all mining stuff that was discovered 20 to 30 years ago - the grade is going down and that is one of the major reasons why there is cost pressure.  In the last year we are starting to see new discoveries and I am hoping over the next five years we will see a renewal of the ore bodies and much better grade that will give you real profitability but if we don't, the cost pressures are going to continue to mount.

GEOFF CANDY:  Do you think are such discoveries left? 

PIERRE LASSONDE:  I do believe so.  The biggest problem for the industry is that we haven't had a paradigm shift in exploration technology so we are still working from technologies from the 1970s and the 1980s and we've pretty well exhausted everything we seen with that kind of technology - so we need something new to look at the earth and that we haven't got yet and that is one of the problems. 

GEOFF CANDY:  Is that because there has not been enough investment to that sort of research and technology?

PIERRE LASSONDE:  Correct.  Absolutely!

GEOFF CANDY:  In terms of the gold miners though as they stand, are we likely to see perhaps a further shift into things like copper porphyry deposits and a lot more by-products mining if we don't see the big pure gold strikes?

PIERRE LASSONDE:  Yes, unfortunately you are quite correct.  The big companies are looking at longevity and for example a Barrick buys a Pierina for $1 billion, they spend $1 billion putting it into production and in 10 years and the mine is done.  Now they have to find another 7 million ounce ore body to replace it and they have to spend whatever it is to buy it and if they can buy it and then another billion to put it into production.  If you put a big copper mine into production, you're on for 30 years - so you don't have a re-investment problem and that's where ore if you have a Yanacocha, that's a 20 - 30 year ore body.  If you find those 30 - 50 million ounce ore bodies, you are in business for a long time but if all you find are 5 to 10 million ounce ore body what it means is every 10 years you are taking a huge re-investment risk because you don't know where the next ore body is going to come from - and you don't know what it is going to cost and then you have to spend the capital to put in the production.  So the big guys when they are looking at that they are shifting into the copper-gold ore bodies simply because the economics are far better.    

GEOFF CANDY:  Pierre, just to close off with, in terms of the difference between a royalty company like Franco-Nevada and an actual miner, what are the pros and cons from an investors point of view?

PIERRE LASSONDE:  In terms of the difference between a royalty company and an operating company, the royalty companies are a lot closer to a gold ETF, on the risk reward ratio.  It has none of the operating, environmental risk of a mining company but it has all the rewards of higher gold prices, which are translated on a percentage direct relationship with the gold price.  While the operating company essentially has all of the risk - operating risk, capital, capex risk, operating costs, upside risk - the royalty company doesn't, but it has of course higher leverage to the gold price.  So that's the easy way to describe the difference between the two.

GEOFF CANDY:  What's the difference between managing one and managing the other?  Have you found a significant difference?

PIERRE LASSONDE:  Yes, there is a significant difference - 98% of management's time in a royalty company is spent essentially re-investing the cash flow and it's about how to grow the company and the best way to grow the company.  In a mining company, 90% of the time of management is essentially spent on driving the red fire engine because there is always a problem.  At Newmont I used to say, we have 22 mines around the world, if each mine has only two problems a year, that means that every week I've got a problem and in a royalty company you don't have any of that.  All you are focused on and that's a huge blessing is how do I grow this company and that's one of the reasons why if you look back at Franco-Nevada from 1983 - 2001 when we sold the company, it grew at 36% compounded per year for almost 20 years.  So that's a major difference.

GEOFF CANDY:  Finally, what do you see the gold market doing over the next 18 months?

PIERRE LASSONDE:  One of the things that I am really surprised at is that for 10 years now the gold price has been higher every year than the previous year.  We've never seen that.  If you go back to the 1970 bull market and 1975 and 1976 we had quite a strong retrenchment in the gold price.  Now the two are quite different but we could see a year, sometime in the future where the gold price would be lower than the previous year and that one has to always keep down in the back of one's mind.  What are the odds of that?  I think they are better than 50/50 that it's going to happen.  Long term I am very bullish.  When I look at the amount of debt accumulated by the United States in particular because the gold price is quoted in US dollar, the US politicians have absolutely no guts for another depression and they will always allow the printing press to run to answer their problem and therefore when I look at the long term gold price - very bullish.

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