Iamgold’s Letwin, Yamana’s Marrone on future of mid-tier gold miners

Steve Letwin was appointed president and CEO of Iamgold in November 2010. Before joining Iamgold, Steve worked in the oil and gas sector for many years, including as an executive vice-president at Enbridge; president and chief operating officer of TransCanada Energy; and chief financial officer of TransCanada Pipelines, Numac and Encor Energy.

Peter Marrone founded Yamana Gold in July 2003, and serves as its executive chairman. Peter founded Yamana Gold in July 2003, and before that was the head of investment banking at a major Canadian investment bank while practicing corporate law in Toronto, with a focus on corporate and securities law and international transactions.

To start off, earlier this month during Barrick Gold’s first-quarter conference call, president and CEO Mark Bristow described the gold mining industry as in being in “disarray.” Would you each agree with that characterization? Why do gold miners endemically have lower return on equity than miners of other metals, or other resources?

There are too many of us with too little capital

Steve Letwin: I’m not sure I would use “disarray,” but I think the point Mark was trying to make is — it’s probably good just to give a little comparison. The 10 top gold companies in the world have a total capitalization of US$120 billion, while Microsoft alone is US$960 billion. In the mid-tier section where I live and work, there are 16 mid-tier companies. We totalled 25% of the total market cap and the market is shrinking the capital pools. It’s a lot more challenging to raise money. The five top cannabis companies in Canada now over two years have a total market cap of more than $80 billion.

Mark Bristow and John Thornton did a very good deal there for the industry, as did Newmont and Goldcorp.

We do need to consolidate. I’ve been saying this for two years, at least: there are too many of us with too little capital.

And that may change, but right now, we’re competing for the same dollar, and unfortunately, those dollars are shrinking. We literally have a lot of general and administrative expenses spread across — in my opinion — too many companies with too few new investors.

So I would agree with that part of Mark’s comment.

TNM: Peter?

Peter Marrone
Executive chairman
Yamana Gold

Peter Marrone: How to follow from that? If I remember correctly what he said, the new Barrick — I hope I’m not paraphrasing too much — is capable of rising above the fray, above this disarray. So that lends itself a bit to hyperbole, a little bit of exaggeration. I’m not saying that Mark lends himself to hyperbole and exaggeration, but that comment certainly does.

I have a little bit of a different take. I will say that the consolidation of Barrick and Randgold is a smart transaction, I equally think that Newmont and Goldcorp is a smart transaction.

There are those who disagree.

But if it’s capable of rising above the fray, it suggests that it’s not sure.

If you’re going to engage in that type of a transaction and you’re going to create something that is supposed to be different, then you should be sure. Because if you’re “capable” only, that suggests to me that there is an uncertainty, it’s still not clear.

I recently described it as a three-act play, where we’ve seen the first act. We don’t know what the second and third act is — we haven’t seen the synopsis. We don’t know how the play ends, and yet we’re already coming to the conclusion that there should be consolidation. We’re coming to the conclusion that it’s the only the way forward, and I’m not sure I agree.

We’ve done a better job in communicating what the thesis is for investing in gold, but not necessarily in the gold equities, and we have to get better at it

On the question of disarray, again, I hope you can appreciate that you mentioned that I was a lawyer then an investment banker, and then I took this company public. Taking a company public and being an executive of a mining company is being a promoter. And those of you who are in the room who have run mining companies recognize that there’s an element of being a promoter in everything that we do, and so you have to be optimistic.

I’ve gone from the dark side to the darker side to the very darkest side, but in being a promoter you have to be a little bit optimistic, and this is an industry where you have to be a little bit optimistic.

I don’t take what is happening today as the end of days. We’re going through a cycle. It is at a point in the cycle that … it’s the worst I’ve seen in probably 25 to 30 years. I’m 15 years with this company, but have been on boards of directors of public mining companies and represented those companies as an investment banker or as a lawyer. So it isn’t particularly good — but let’s not give up on it yet.

The industry is not entirely in disarray. We are finding things. We’re replacing ounces. We are consolidating, as those companies have done. We are producing.

The gold price seems to be range-bound, but it’s range-bound within an area that for many companies — perhaps the majority, certainly the plurality — are making money. We’re generating free cash flow, we can demonstrate that there’s a value proposition.

Where there’s a disconnect, perhaps, what creates disarray, is that we haven’t done a very good job — in fact, we’ve done a very poor job — of communicating to the investing public the thesis for investment in a gold mining company.

We’ve done a better job in communicating what the thesis is for investing in gold, but not necessarily in the gold equities, and we have to get better at it.

If I go back 25 years ago, and those of you who are in the audience who have been around that long, we remember that we used to model companies based on net asset value, and then it became cash flows.

Now it’s free cash flow and the generation of earnings before interest, tax, depreciation and amortization, and there seems to be an uncertainty of what it is that makes the difference in investing in a mining company, and in a gold mining company in particular. I personally think that it’s a combination of many of those things.

Yes, you should generate free cash flow, but … if you’re returning only money to shareholders and overlooking that investment in the ground, that creates a little bit of disarray.

So I have a bit of a different take on that comment of the market, or at least the industry, being in disarray. I don’t believe that consolidation is the only path forward. Bigger is not better — better is better.

The sweet spot to be is the intermediate mining companies.

And if I’m right that we will enter a cycle where gold prices improve, an investment in the equities will prove that the best place to be is in the intermediate-sized companies.

Consolidation for the sake of becoming bigger is a mistake: replacing ounces becomes more difficult, and we have to go to more far-flung places. And that creates an imbalance between the risk and reward equation.

TNM: It’s fair to say, though, that many companies in this business are not being profitable at the current gold price. So what do you think is the true break-even price for gold miners? What price does gold have to be to make gold miners profitable or provide them with same margins as an integrated producer like Glencore?

PM: Profit — and I know that there are many in other industries that will disagree with this comment — but profit is different than cash flow and free cash flow, and I appreciate that we should be measured based on profitability.

But, boy, profitability is tough in an industry that doesn’t attract a lot of attention, and where there are rules that are not designed to accommodate what the industry is about.

An excellent example — an almost real-life example — is on a mine that we owned that we sold several years ago. Imagine the following: If you discover a million ounces of gold and it cost you US$50 million to develop that million ounces into production, then you discover a second million ounces, and it cost you a million dollars to develop that and put it into production.

The businessman in me would say, “Well, then that’s 2 million oz. over US$51 million and that’s what you should be amortizing.”

Whereas accountancy rules — I’m not an accountant, and I hope I’m not offending accountants in the room — would say that you’ve got to amortize that first US$50 million over the million ounces, before you get to that second million ounces over the US$1 million.

That seems skewed to me a little bit, and it leads to a different financial result, a different profit result.

I agree that we should generate cash flow, and free cash flow.

Where it is not clear to me — and this is where as an industry, perhaps as an industry participant the World Gold Council as a representative of this industry should start to define it a little bit better — is what is free cash flow?

Because if it is after-investment, for example in expansionary capital, then the industry will be doomed, because we cannot expand, we cannot build new mines, we cannot find new ounces, and then develop those new ounces if the Holy Grail is only free cash flow.

On your question of profitability or generation of free cash flow, probably US$1,250 per oz. gold is a good sweet spot. I’d say that at US$1,250, perhaps as low as US$1,200, most of the companies — certainly the intermediate-sized and larger-cap companies — begin to generate free cash flow.

Below that, it starts to become a little bit more difficult, but so many factors go into it that it becomes very difficult to consider.

In the absence of being able to raise equity, we are going to have to go to a self-funding model.

Steve touched on a few moments ago that we can take steps to improve our general and administrative expenses, and the answer is yes, we probably can. Certainly, we’re taking those steps now.

The impact of currencies can have a very significant impact. The Brazilian real four years ago was at 1.6 to one U.S. dollar, and today it’s 4.09. And then it’s a huge difference, in terms of the margin that we generate from operations in one country or another.

So it’s difficult to gauge, but I’d say a good point would be US$1,250 — perhaps as the lowest, US$1,200 — where we start to generate free cash flow.

But what is more interesting to me is the sensitivity. We as an industry, we as a company in this industry, are highly sensitive to metal prices. So a US$50 movement in gold price takes what is perhaps a modest level of cash flow and free cash flow, and makes it a multiple of that.

We’ve been range-bound for a while, and that range is probably US$1,200 to US$1,350 thereabouts. And between US$1,200 and US$1,350 this industry is generating good free cash flow, and in my view that is not supported by the share price. The share prices are low by comparison of the cash flows that are being generated, and the free cash flow that’s being generated.

SL: Einstein said: if you want to look at the definition of insanity, it’s doing the same thing over and over again, and expecting a different outcome. There’s a bit of insanity in the gold space where if we don’t do something differently, we’re going to continue to wither away.

When I joined the industry from the oil and gas business in 2011, precious metals alone raised US$8 billion in equity. Do you know what that number is today? It’s less than US$100 million this year.

The market is tired of the way we run our business. So we need to wake up and listen to the market, and do something different. In the absence of being able to raise equity, we are going to have to go to a self-funding model. The oil and gas business had to do the same thing.

We can disagree about our valuations, but for the last seven years, the gold price has averaged US$1,250 an ounce.

People are tired of it. People haven’t seen the catalyst. We were supposed to go to US$1,400 this year, even Goldman Sachs said that — who had said gold was going to go to US$900 just three years ago.

We can’t keep doing the same thing over and over again, and expect that the market is just going to wake up one day and say, “Oh, we love you again.”

Look, I’m as optimistic as the next guy. I wouldn’t be in this business if I wasn’t.

I was in the oil and gas business 28 years. I saw six cycles.

We need to pull up our socks and generate free cash flow to fund our businesses, or we will disappear. And the mid-tier sector is a sector where we really need, as Peter said, to get our act together and start generating enough free cash flow to move the growth ahead. Because the market isn’t there for us to raise the money. Go try to raise equity today. It isn’t going to happen.

TNM: What more is it going to take before investor sentiment improves, beyond a higher gold price?

SL: You need a catalyst. I don’t like saying it’s got to be price, but we do need the gold price to move out of that range-bound.

We have a hard time sticking above US$1,300 an ounce. Have you watched it? It hits US$1,301, hits US$1,302 — I get all excited. I know the rest of you do, too: you get up in the morning, gold is above US$1,300.

And then over the next three hours somebody sells gold in the market and it’s US$1,275. [In mid-May], it’s having a hard time hitting US$1,270.

Peter announces fantastic results, we announce a fantastic gold discovery, and our stock falls. It drops. Look, I’m not negative about it. I’m 63 years old, I’ve been around a long time and survived, and we’ll survive this.

I’m just saying, we can’t keep doing the same thing over and over again, and expect that the market is just going to wake up one day and say, “Oh, we love you again.”

We need to change, or we will suffer the consequences. So I’m not being fatalistic, we just need to make sure that we are in touch with the market, and that self-funding model right now is what the market demands.

PM: Where I agree with what Steve has said is that there has to be some change … perhaps if I can pick up on something that Steve said about the size of the industry. So the 10 largest companies have a market capitalization of US$120 billion, and the entire industry is somewhere in the range of US$200 billion. At its height it was probably US$400 billion, and at some point over the course of the last decade, that’s about the amount of cash that was on Apple’s balance sheet. So it’s not a very big industry.

But allow me to be a bit optimistic — this is important. Gold equities are trading at all-time lows to gold price, even with a range-bound gold price. And we have a small industry and we have a very big market — a very, very big market that has become much bigger than it was.

The market has overlooked what is always true, which is that you have to look at risk-reward, you have to look at volatility. And it is also true that markets overshoot and undershoot.

We’re in a classic situation today where the broader market is overshooting. And it is disregarding volatility. It is disregarding risk — geopolitical risks, socioeconomic risk.

It’s trite for me to say what you already know: world debt is more than double what it was in 2008, and I know I’m not up on current events, but we had a financial crisis in 2008. So world debt is very high, we have geopolitical conflict in at least three really hot, hot spots in the world, and, yes, gold seems to be range-bound. And if I can step back for a moment, if Goldman Sachs said it was going to US$900 and it didn’t, why did we believe that it would go to US$1,400? Yeah.

So let’s be countercyclical a little bit. And part of countercyclical is that the catalyst, in my view, is not the gold price doing something or the gold companies changing something. The catalyst is the broader market. A recognition that the broader market is at risk.

And if that broader market is at risk, money will have to find a home. And when money tries to find a home in this very small sector, as you were describing, it will be the corporate equivalent of the volume of water of a Niagara Falls through a garden hose. It will be unparalleled. We will see new heights.

I hope I’m not being overly optimistic, and I know it’s very difficult today.

Our share price was [recently] down significantly, and our CEO Daniel Racine and I were scratching our heads, and wondering what exactly changed from the morning to the night, because we can’t really see anything that would account for that type of a drop during the day.

So it hurts, it hurts me personally. I’m invested and I continue to buy shares. It hurts you as investors, it hurts executives of companies, it hurts all of us.

But we need to keep an eye on the reality that the broader market is attracting and sucking so much money into it that there isn’t anything really left in this industry. But when that changes — and it will change, because everything goes through a cycle — it will be that equivalent of the volume of a Niagara Falls-amount of water coming through a garden hose, because this industry is so small, and we will see new heights.

We’ll have this conference a year or two from now, and we will look back and wonder why we were worried in the first place.

TNM: What mistakes do you think mining companies keep making, and what mistakes do investors keep making when investing in gold companies?

SL: I wrote a paper three years ago looking at the reserve situation in the gold space. I’d done some work in oil and gas, and I happened to be right in the oil and gas sector in the nineties, and I made a lot of money.

But I was wrong this time in the gold sector, because I thought last year we were probably going hit peak gold this year. But in 2018, we actually produced more gold than we ever have in our history. We produced 109 million oz. and we seemed to be able to because of the emphasis on near-mine exploration, which was smart short-cycle economics.

I underestimated how much of that we could do in my formula, so I made a mistake.

Because of the focus on free cash flow, as Peter was talking about, we’re seeing actually more gold being produced than we ever have.

So although the reserves are falling long term, there will come a point where this will cross. The question is when. When will we wake up in the morning, where somebody says: “Gold production is actually falling relative to last year.”

And we have a situation, because of this small industry — where this “Niagara Falls” situation occurs and the gold price goes up to what Rob McEwen loves to talk about as US$5,000 an ounce, or US$10,000 an ounce. That truly would be a party.

But right now we haven’t seen that math, so we continue … and then the market is saying, “We’re not going to give you any money to invest. Stop. Stop doing that. Because guess what? We’re not going to give you any more money to do that. Your history around building mines with rates of return that are acceptable hasn’t been there.”

We may challenge the market and say the market has got it wrong, but the market is what pays our bills, so we need to listen to the market.

And the market is saying: “Too much gold, not enough reserves.”

We all know that reserves are falling, but our actual production continues to rise.

So we do need to react to that in some form or fashion. I don’t know if we could form an OPEC for gold producers. I’ve thought about that because we’re throwing too much gold in the market right now, relative to what the market wants.

What happens to gold price is going to depend on the demand side, and that is where we should place our focus.

PM: I am not smart enough to really understand peak gold. One of our executive officers has an excellent thesis. He was an analyst in the financial community, and he has an excellent thesis on peak gold.

My gut tells me, however, that the supply side is never as good on driving value in price as the demand side. And so we could get to a point where we actually throttle back on production, but I’m not sure that that’s going to be determinative over the longer term of what happens to price.

What happens to gold price is going to depend on the demand side, and that is where we should place our focus.

Now, on the demand side, what’s interesting to me is where a lot of the buying occurs. A lot of the buying occurs in Asia with certain central banks … I don’t know if I can talk in 20-year terms or 10-year terms, or even five-year terms, and certainly markets are more focused on something that is more immediate than that.

But if we look at a longer-term trajectory, we see something that is unique, which is the de-dollarization of some parts of the world, and there is a re-emphasis amongst certain countries, companies, industries and central banks on investment and gold.

And so I would encourage all of us to focus on the demand side rather than the supply side to determine what happens to gold price.

We’re manufacturers of gold, but we’re not as interested in the gold price as we are in our share price.

On the price of our shares, what is interesting is that as an industry and as a company in that industry, this is one of the lowest points of price of shares to metal price in at least the last couple of decades.

This represents a real value proposition, which is what the market perhaps is misunderstanding that there’s a real value proposition in owning stock, and not just owning gold, when gold prices are in that range of US$1,200 to maybe US$1,350 — that range it has been in for the past several years.

— Listen to this panel in audio form in Episode 141 of The Northern Miner Podcast, at the link below or at www.northernminer/podcast.

This story first appeared in The Northern Miner on June 10, 2019.