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FRANCO-NEVADA CORPORATION – A GOLD ROYALTY PLAY TO PONDER

Franco-Nevada Corporation (FNV)

Gold has kicked off 2016 with the strongest rally in 25+ years,

Franco-Nevada, has a market cap of > $10bln and is up 45% in the last quarter (56% of Barrick’s $18bln market cap and 72% of Goldcorp Inc.’s $13.75bln) . Those looking to basis trade in the gold space, or those vetting new exposure to the precious metals space should dig deep into the 26 page slide deck by Pierre Lassonde, Franco-Nevada’s Chairman, which was just presented at the most recent Grant’s Spring (April) Conference in New York. Much of the information contained was in their March 2016 Corporate presentation, but the manner in which all naysayers are neutered via this enlightening presentation is impressive indeed. For one, few will be aware the degree of demand emanating from Europe, now the largest bar and coin market in the world. China and India are typically all that anyone hears in terms of the demand equation.

The case for FNV versus ETF’s like GLD are perhaps most compelling where a running ETF fee of 0.40% (40bp) is upgraded to an instrument with a dividend of > 1.2%. Like the GLD ETF, FNV investment protects investors from the risk of operating companies as Franco-Nevada achieve their exposure to the space via securing royalty streams. In terms of focus FNV is 95% precious metals (73% gold and 16% silver) and would not likely deviate much from this level to retain “pure play” status. Geographically 84% of their royalty income if from the America’s, lessening the risks inherent in frontier markets. FNV currently carries no debt and when they opportunistically do take on leverage, like the most recent $500mm Precious Metals Stream purchased from Glencore (Antapaccay, Peru gold mine output underlying), it is typically paid back promptly from free cash flow. A total of $1.2bln in facilities are at their avail which allows FNV to scout for the best opportunities in terms of both price and fit with their broad existing portfolio.

Lassonde, Pierre Spring 2016 (1)

As discussed in prior post, the merits of precious metals as a component to a diversified investment portfolio can be argued, but are compelling overall. Personally, I tend to trade in the asset class on a tactical basis, rather than as a core holding. A 10% allocation (via Fidelity Select Gold, FSAGX) in one of my larger accounts allowed other equity beta risk to be retained through a rough Q1 resulting in a 6.45% ytd return (versus 1.9% for the S&P through Friday).

The gold, gold miners, and gold royalty trajectory has been near straight up for a quarter, hence caution is warranted on allocating fresh monies. Both GDX and FNV are up 46% ytd including dividends. FNV is within 4.34% of its all-time high. Even a modest retracement of the recent USD weakness could see gold trade down to sub $1,200 an ounce, which could create an entry point. FNV’s Exodus hybrid score is a neutral 2.32 at present. When the time is right to re-enter, I think I have found my instrument of choice. JCG

Note: Other players in the gold royalty space include Royal Gold Inc. (RGLD) which is about one third the size of FNV and has a matching Exodus hybrid score of 2.36. Osisko Gold Royalty (OR.TO) trades on the TSX (trades in Canadian Dollars) and has a market cap of about US$1.2bln. FNV trades on both the NYSE and the TSX, but with more volume of the USD denominated NYSE counter.

 

 

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INDIA BUDGET – GOOD AS GOLD

This week brought the highly anticipated Union Cabinet budget 2016 in India. Most were pleased, as India’s Finance Minister, Arun Jaitley largely kept to the fiscal deficit reduction roadmap previously outlined to the market.

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Note: Trending in the right direction

In India, the government financial year runs from 1 April to 31 March (like Japan). Increased spending plans include agriculture reforms, infrastructure spending, healthcare reform and rural development. Government workers got some love with a much overdue pay raise slated in the most recent budget, after a decade of flat pay. Corporate taxes were cut by 5% to 25% in the latest budget. Little coverage has been dedicated on this point, but defence spending was up 13% in the budget, with India already the 5th largest defence budget globally. India was the largest importer of arms over the 2011-15 period as outlined graphically below.

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USD/INR (US Dollar to India Rupee) stands at 67.69 at present. The SENSEX is up nearly 2% today, but remains down almost 12% year to date in 2016. 10 year bond yield have rallied smartly this week on the fiscally restrained budget.

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India’s primary imports are crude oil, cooking oil and gold. The drop in oil prices provides a sizeable lift to India which already is growing at a near world leading 7.6% (2015/16). Gold imports have proven to be a tough one to manage for India. The populace has a near unsatiable demand for gold (42% jewelry demand, 50% investment driven and 8% industrial), consistently importing 1/4 of global production (>$50bln per annum). China and India have similar demand profiles, but China is also a major gold producer, hence the effect on their current account is less troublesome (along with the 5X+ bigger GDP thing). India would not be as concerned with running a current account deficit if it were from foreign direct investment, but gold (a non-essential) importation is something they have limited patience for and have shown little success in curtailing.

Duties and taxes have been the abatement weapons of choice. The import duty on refined product with purity > 0.995 is 10% and 8% for dore (unrefined) bars. Some expected India to cut import taxes on gold in this year’s budget, but they did the opposite, much to the chagrin of the many Indians. The tax on dore bars goes to 8.75%, lessening the tax arb with refined at 10% and a 1% tax on all gold sold in India was instituted (last removed 4 years back).

A lot of work goes into avoiding these taxes, as one might imagine. One alleged means is to import lower purity gold (i.e. 0.994) free of duty and refine it onshore back to 0.995 (good delivery standard). The India government has a Gold Monetization Scheme (GMS) and a Sovereign Gold Bond program where they are attempting to have greater numbers of retail holders and rich temples surrender their physical gold in exchange for gold-backed interest bearing investments. What one pledges get melted, hence not ideal for treasured heirlooms. As noted, a big segment of the gold market is held in jewelry form.

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Note: Looks like about 600 grams or so

Prime Minister Modi also announced in November 2015 the intention of launching an Indian Gold Coin (and Indian bullion). The 24 karat purity (0.999 fineness) coin has the national symbol Ashok Chakra on one side and Mahatma Gandhi on the reverse.

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As a point of reference, the American Eagle (USA) and Krugerrand (South Africa) are both 22 karat purity (0.9167 fineness) whereas the Panda (China) is 24 karat (0.999 fineness), with a new coin design on a annual basis since 1982 and the Maple Leaf (Canada) is also 24 carat with “quad 9”, 0.9999 fineness. Conjecture will begin on when Trump might “Make the Eagle Great Again” and move to 24 karat as well. In it’s current form the American Eagle gold coin is 91.67% gold, 3% silver and 5.33% copper.

After all, “Life is too short for 22 karat”. JCG

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USD/JPY 100 – KATY BAR THE DOOR

As a barometer for “risk off”, a rally in the Japanese Yen is spot on.

From the 121.70 USD/JPY euphoria level achieved post rate cut, we elevator shafted through 111 and even got into the 110’s before bouncing to the current 112.35. While 10 big figure moves in the world’s 3rd largest economy should be alarming to all, there is a good chance we get more. Barclay’s today forecast a further rally to 100 by the end of Q1 2016 and 95.00 by year end 2016 (prior YE 2016 estimate 120).

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Central banks have officially run out of runway.

Bank-of-Japan

The Fed, EBC, BoJ, ECB, Riksbank (Sweden cut to -0.50 yesterday, submerged by 5bp more than the market expected and expanded QE purchases through reinvesting monies from maturities and coupon payments) & SNB’s goal of achieving 2.0% inflation in unison is not going to happen.

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Gold has something different to infer from these moves it would appear. My modest allocation to gold miners will be tweaked (higher weighting) and DXJ (currency hedged Japan) jettisoned as wrong-footed folly. You have to trade what you see, not what you know (think you know).

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Japan Topix financials were down 24% since the very recent rate cut in Japan (the market is further dissolving today as they return back from vacation). Mitsubishi UFJ entered the jaws of today’s market trading at 49% of tangible book, Mizuho 66%, Sumitomo Mitsui 52%. For reference Bank of America trades  at 80% of tangible book. What is the liquidation value of a Japanese bank? Where does that bid come from? Not even Citi could make a go of it and sold their Japan franchise for less than $1bln. Even Ford is packing up their Japan tent and going home.

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The reasons for such apparent “distressed” bank valuations is clear, the lifeline of higher rates is further beyond the grasp of banks globally. Yellen, Gundlach, Bass, JP Morgan, etc. talk about and research negative rates as if it is a “normal” conversation to be having.

There is an ebb and flow to the relative valuation of financials, but historically the equity markets struggle without the participation of financials. Going forward, bank balance sheets will more fortress like, less levered, and more conservative in their make up. CoCos (Contingent Convertibles) will make up a bigger proportion of the capital structure as there will be no “put” to their respective governments. Credit ratings will be lower, as no “lift” from implicit government support should be implied or expected.

Coming back to the car analogy, gone are the days of the V8, 4 cylinders, hybrids and full on electric are in vogue. Adjust your return expectations accordingly. JCG

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