Jon Case, portfolio manager at Sentry Investment Management
Focus: Mining stocks

MARKET OUTLOOK

What will drive gold over the next 12 months? Three things will dictate the move from here:

1. Inflation. Inflation is poised to rise based on the leading indicators we follow, particularly the wage growth acceleration we’re seeing in the service sector. That will likely force the Fed to resume hiking. Initially this could be negative for gold, but ultimately I expect the Fed to be behind the curve. Investors are beginning to see the end to this tightening cycle, which should pressure real yields, be negative for the U.S. dollar and positive for gold.
2. Risk appetite. Rising inflation and higher rates are negative for risk appetite and bad for equity markets. Equity weakness should push gold higher as it did late 2018. Over the last dozen periods where the S&P fell by 20 per cent, gold has on average gone up 7.6 per cent. A positive end to the trade war and resumption of global growth, however, could be market-friendly and keep a lid on gold.
3. Positioning. Positioning is largely driven by technical indicators. Gold has broken out, but there’s key resistance ahead at $1,375. When gold breaches that level, I think we’ll see another leg up in the metal and gold stocks. Still, $1,375 is our short-term target until then.

As gold breaks out, the move in gold equities could be explosive with the asset class being so under-owned. A good example is multiples: the broader equity market multiple has steadily expanded since 2011, aided by quantitative easing. Gold companies, a risk-off asset class that could be viewed as portfolio insurance, continue to be cheap and trade near the lower end of their historical range of seven to 10 times enterprise value (EV) to earnings before interest, tax, depreciation and amortization (EBITDA).

TOP PICKS

SEMAFO (SMF.TO)

Semafo is a mid-cap gold producer in West Africa with production of 240,000 ounces that’s growing to 415,000 this year as they bring on the high-grade, low-cost Boungou operation, their second mine. With Boungou, Semafo is entering a period of transition from cash burn to cash build. We see free cash of $170 million before debt repayments, giving Semafo a free cash flow (FCF) to EV yield of 20 per cent, one of the best in the gold space.

Semafo has now transitioned into a multi-asset producer. Being a single-asset operating company has proven to be high-risk in recent years, with some high-profile operational disappointments. We believe this has limited the appeal of single-asset companies to generalists. Semafo is now more diversified, which we think will attract investors. The company also announced it’s buying Savary for $22 million, which we think is an interesting low-cost acquisition that refreshes their growth profile.

TOREX GOLD RESOURCES (TXG.TO)

Torex is a mid-cap producer operating the ELG mine in Mexico. Production is about 400,000 ounces per year. Costs are near the bottom of the peer group at $770 per ounce all-in sustaining costs.

The company is coming out of a capital spend period and going into cash generation/harvest mode. We believe that’s a favorable time to own a gold company. We expect Torex to generate $100 million of FCF before debt in 2019, giving it a FCF/EV yield of 7 per cent.

Torex has good potential to add high-grade ounces to its mineral inventory. We saw this happen first with the Sub-Sill discovery and again with ELD Deeps, both underground deposits. What‘s unique about these is Torex has shown that it can quickly move new discoveries into the mine plan and convert them to cash. We think there’s exploration growth potential not reflected in the share price.

MAG SILVER (MAG.TO)

MAG owns 44 per cent of the Juanicipio project (silver, zinc, lead and gold), located in the Fresnillo silver trend, one of the best silver camps in the world. MAG is partnered with an established miner in Fresnillo, which reduces development risk. The joint venture is currently developing the underground infrastructure and expects production in mid-2020.

The asset is one of the largest undeveloped silver resources (180 million ounces) in the world and is very high-grade at 550 grams per tonne silver (about twice that of most silver competitors). This is expected to result in low costs of $6.25 per ounce, around 56 per cent all-in margin at current gold prices. This is an asset I have watched for 10 years, but have never been able to get at a fair price given the long time to production back then. That changed late last year when a large precious metals fund liquidated the portfolio due to a change in strategy. The share price of MAG, along with several other holdings were crushed in Q4 by this forced seller. That position was cleaned up in mid-December and we think the stock now has room to head higher.

PAST PICKS: MARCH 5, 2018

ATLANTIC GOLD (AGB.TO)

• Then: $1.62
• Now: $2.07
• Return: 28%
• Total return: 28%

DETOUR GOLD (DGC.TO)

• Then: $12.15
• Now: $12.51
• Return: 3%
• Total return: 3%

ALAMOS GOLD (AGI.TO)

• Then: $6.88
• Now: $6.26
• Return: -9%
• Total return: -9%

Total return average: 7%

FUND PROFILE

Sentry Precious Metals (Series F)
Performance as of: Jan. 31, 2019

• 1 month: 1.9% fund, -0.5% index
• 1 year: 4.7% fund, 7.3% index
• 3 years: 3.9% fund, 2.3% index

INDEX: TSX Global Gold Index.
Returns are net of fees, distributions and annualized.

TOP 5 HOLDINGS AND WEIGHTING

1. Wheaton Precious Metals: 7.2%
2. Guyana Goldfields: 7.1%
3. Semafo: 6.8%
4. TMAC Resources: 6.6%
5. Sandstorm Gold: 6.5%

WEBSITE: sentry.ci.com
TWITTER: @SentryInvest