Pierre Lassonde is President of Newmont Mining, the world’s largest gold producer, a role he assumed in 2002 following the merger of Newmont, Normandy Mining, and Franco-Nevada. Franco was founded in 1982 by Lassonde and his partner, Seymour Schulich, and the three-way merger they helped craft was a direct response to the hedging posture of AngloGold, which had bid for Normandy, a company in which Franco had a large investment.
While Schulich remains an active director and spends much of his time on Newmont Capital business, Lassonde is Newmont’s day-to-day operator, the public point man, and widely acknowledged as the gold industry’s foremost spokesman.
An engineer by training, Lassonde began his career as a cost engineer at Bechtel, and later was a Sr. Planning Analyst with Rio Algom. In 1980 he started managing money and was a highly successful fund manager, running the mining assets in Beutel Goodman’s Dynamic Fund, making that fund the top performing North American gold fund in 1987 and again in 1989.
Pierre and I have known each other about 20 years and have traveled together several times, including a three-week trip to China in 1992 (our Gang of Five also included now Goldcorp CEO Ian Telfer, analyst Terry Ortslan, and mining executive J.C. Potvin). As several of the stocks followed in my letter also found their way into Franco-Nevada’s investment portfolio-most notably Aber Diamonds and Diamond Fields (Franco purchased a royalty on the latter’s Voisey’s Bay project)-Pierre and I have always had plenty to talk about. The following conversation took place in Seattle, just over three weeks ago, two days before hurricane Katrina struck.
GMSR: The last time we did an interview was July of 1991, with the gold price at $367 and oil at roughly $22/barrel. When we spent some time together about 18 months ago you were passing around a Matt Simmons study projecting much higher oil prices, $80-$100, at a time when the oil price was about $37/barrel. We seem to be closing in on those targets-what kind of challenges does this pose for Newmont, and where does oil go from here?
LASSONDE: Matt Simmons’s book (Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy) is a seminal work on oil and energy prices, certainly for the next ten years. By going over all of the papers presented at the Society of Petroleum Geologists, he has shown that the Saudi oil fields are about to pass their peak.
Since 1950, over 90% of Saudi production has come from only five fields. The lesson is that if you go back to Hubbert’s Peak for the U.S., which was predicted and did occur in 1972, 33 years later the U.S. has not run out of oil, but it is producing only one million barrels/day-20% of the five million barrels that were being produced in 1972.
If you look at the Saudis, they’re producing about nine to ten million barrels/day. The lesson is that once the peak has passed, production begins to fall by 2-3% per year. In the case of Saudi Arabia it could be a lot faster.
The long and the short of it is that there is nothing in the world that is going to replace the Big Five Kings and Queens as Simmons calls them, the Ghawar, Sanofi, and the other oil fields. And yet demand continues to rise. It’s a bit like the mining business: it takes about 8-10 years to find and bring on new production. The reaction time between high oil prices and the economy adjusting, new fuel requirements, energy efficient cars being designed and built, it’s also about 8-10 years.
A year and a half ago we took the view that oil prices would go well past $60 and that they were going to stay there for ten years, and we asked ourselves how we can insulate Newmont from these high prices. In all of our operations we burn three million barrels a year, which represents about 20% of our production costs. The way we elected to hedge was to purchase 7% of a Canadian oil trust, Canadian Oil Sands, which owns 35% of Syncrude.
At the time we made the purchase the reserves in the ground were being valued at $26/barrel. We did that in the summer of ’04 and today the stock is $125. Our $200 million investment is worth about $635 million. At $50/barrel oil next year, we anticipate that the dividend would be about $10/share; at $65/barrel, we think it would pay about $14/share.
We expect that the dividends on this investment will essentially cover all of the increase in the oil price that we’ve seen, providing us with a hedge for the next 50 years, because this reserve will last without having to drill another hole. To make a long story short, we’ve taken very aggressive action to hedge our long-term operations against the adverse cost impacts of rising oil prices.
GMSR: Oil is the most obvious example of the Commodity SuperCycle, or what is sometimes referred to as the Longer and Stronger outlook on commodities. You’ve long been a huge proponent of investors looking to the 1970s for a precedent for what we’re seeing today. Amidst a backdrop of many trying to call a top on the major trend of our time, what are you telling people today about where we stand in the current cycle?
PL: In the 1999 Franco-Nevada annual report we published a chart of the Dow Jones Industrial Average divided by the gold price. That represents the performance of paper asset versus hard assets over time, that there are times to own paper assets and there are times to own hard assets. It is very, very telling because hard assets have had two major supercycles in the last hundred years. One was from 1929 – 1934, and the gold price at that time was fixed so the hard asset cycle was shortened because of that.
If you look at silver, which was free floating in those days, I think what you would have found is that the supercycle probably started in 1924-25 and ended about 1937-38. If you look at the Homestake share price, it peaked in 1937. So you would have had about a 13-14 year bull market in hard assets. The next bull market in hard assets was from 1966 – 1980, 14 years as well. The rest of it is all a bull market in paper assets.
The current bull market in hard assets started in 2001, as per this chart, so we are four years into it. As the last two were 12-14 year bull markets, this tells me we are at the beginning the bull market, not at the end. When you look at the rise in price of gold in the 1970s from $35 to $850 dollars that is more than a 2000% increase. So far in this cycle we are up about 80%.
There are a lot of similarities, oil went up 5 times in the 1970’s, from $2 to about $12 in 1973 and then finally it went up to $50 by 1980. This time we have gone from $12 to $60 so we have had the first five, but I think we are going to see more than that. The biggest difference and where the music sheet is a little different is on the inflation rate. I think this cycle is more akin to the 1930s from an inflation standpoint. In fact what we are seeing in some parts of the economy is deflation.
GMSR: Because China is exporting it?
PL: Yes, because we are seeing Asia not only exporting deflation in goods but also in services. There is no pricing power on anything. So, you see the oil price increases fivefold and people say ‘inflation’s gotta come, inflation’s gotta come,’ but what we are seeing is the producers of goods and services absorbing a lot of the price increase, because they have no pricing power. The Chinese don’t want to lose market share, so they are cutting their margins to the bone to compete with the Koreans, Indians, Vietnamese and other emerging Asian economies. So we expect to see inflation maybe go up to 4 or 5%, but we are not going to see the 15-18% inflation of the 1970s.
GMSR: It’s pretty clear that the debt pyramid can’t stand those rates anyway.
PL: That’s right. On the other side of the coin, deflation is lurking right around the corner and that is why long bonds are so low. There is such overcapacity in everything that there is no good investment anywhere, so people are parking their money in long bonds. We saw the same thing in the 1930s. Those are the major differences.
GMSR: Too much money with no place to go is not a good rationale for bull markets, but it does seem to be a key part of the story. Where is this all going?
PL:If you look at what the U.S. has done with its current account deficit, over the last six years it has created a huge amount of liquidity that is sloshing around the world in the form of foreign exchange reserves. If you take just the four major Asian central banks (Japan, China, Korea, Taiwan), they have accumulated over two trillion dollars of foreign exchange.
These U.S. dollar balances are way beyond their requirements. That is money the U.S. sent over to these countries that the banks have had to buy back, but to do so they have printed their own currency and that money is now back into the market system, just sloshing around the world. It was the same phenomena that caused the boom in the 1970s and the 1920s. There’s just too much liquidity.
GMSR: Monetary inflation, and only selective price inflation?
PL: It’s more like asset inflation versus general inflation. It shows up first in the current account deficit, as we, the American people, can’t seem to buy enough of the cheap, wonderful products Asia has to offer. And since we don’t have the money to pay for all of our purchases, these kind strangers provide us with the financing to buy their products.
If you go back to the 1970s, for the first time in about 100 years the U.S. had a current account deficit. It was two billion dollars for the whole year, the whole year! Today it is about $60 billion a month, $2 billion a day. That money ended up in the French, German and Italian central banks because they were our main trading partners. The president of France, Charles de Gaulle, looked at his foreign exchange and he could see that the dollar was basically going to depreciate because the U.S. was printing too much money.
He is the one who said (in those days the dollar was backed by gold at $35 per ounce) ‘I am going to send you your dollars back, send me the gold.’ Nixon realized in about two nanoseconds that if he was to oblige, he would have no gold left in Fort Knox. What did he do in 1971? He closed the gold window, and then gold took off. Today we are not on the gold exchange mechanism, but it will react the same way in private hands.
GMSR: Why do you think there is such a delayed response? It seems that the handwriting on the wall is awfully clear, and that this will end badly and to the benefit of gold. That said, why is taking so long for what seems like an obvious reality to sink in?
PL: As humans, we are all prisoners of our past. For the last 10 years, we kept dreaming. I think the movie is playing a little differently now because one, we have not seen inflation. In the seventies the cry was inflation and the gold price (along with real estate and oil) was one of the major beneficiaries.
Again, today we are more akin to the 1930s. Because oil has risen so much and 30% of our costs as an industry is energy related, we have been hit pretty hard. I think that the analysts look at that and say even though the gold price is up $35, your costs are up $35 so why should your stock price be higher? It has really held back the stocks. They are not wrong, our costs have gone up. We see it, you know three million barrels a year of diesel, diesel goes up $0.50 that’s $150 million, that’s real.
GMSR: The lack of earnings makes it quite obvious the industry is cost challenged in the extreme, as you say, there is no pricing power. In August of last year you said that $350 gold was necessary to sustain the industry. Obviously a lot has changed since that time. You see it with all the input costs, and my end of the business too, it seems that everything is slowed down, obstructed, or faced with a legal, environment, or legal challenge.
PL: That’s a good point. Supply/demand fundamentals are really good. Last year total world mine supply fell by 5%. That’s the biggest decrease since 1939. At the same time demand increased 7%, led by a 12-13% increase in demand in China and something like 10-11% in India, and the Middle East has shown similar gains. We have also seen increases in industrial and investment demand. What we see for this year and the next three years is more of the same. We don’t see mine supply worldwide turning up even though the gold price is $425.
GMSR: Except for a handful of companies, gold mining is not a good business at $425 gold. What kind of price is required for this to change?
PL: If you have already spent the capital it is not a bad business at $425. You can do like 7-ish% returns on your existing capital. But if you have to build new mines, $425 is marginal in a lot of cases. The cost of steel is double and if you start to look at the other components that go into building a mine, the prices have gone up by 20 or 30% or more. Your operating costs have also gone up so at $425 gold, you have to have a great mine.
GMSR: And there aren’t many of those around. For the industry, not the exceptions, what does the gold price need to be?
PL: If you want to earn a 10% return on capital in today’s world, everything else being equal, you need $500.
GMSR: Another reason that the number has risen so much is because this slow industry has gotten much slower in recent years. Lead times on projects are much longer and the cost of projects being opposed is also high. The hurdle rate for projects has risen, but could you put some perspective on the other changes the industry has seen?
PL: In the 1980s we saw the introduction of several brand new technologies: heap leaching, autoclaving, roasting. If you look at the percentage of gold produced today from these three technologies I would say they represent close to 30–40%; that’s a guess, but I don’t think I’m too far off.
At Newmont roughly 30% of our gold comes from heap leaching. If you add roasting and autoclaving it is probably another 20%, about 50% overall. Worldwide, let’s say 30% comes from new technology. There were huge gold deposits that could not be mined in the 1950s, 60s, and 70s, and all of a sudden they could be mined.
Another thing that happened in the eighties and nineties is that the world opened up. Back in the eighties you could not go to Africa. Africa was communist and you could not go there. Up to 1993 Peru was a “forget it” country, Shining Path territory. But the winds of change blew over the world and whole continents suddenly opened up to business.
If you look at the amount of discoveries, in the 1990s, every year up to 1998 we had three-to-five new five million ounce discoveries. In the last seven years we have had two: Cortez Hills (Placer Dome) and Alto Chicama (Barrick Gold). I am talking greenfield “new” discoveries. You could argue Kupol is a brownfield discovery; there was already a discovery of about a million ounces. In Ghana we now have sixteen million ounces at Ahafo, but that is a brownfield discovery, as there was already a two million ounce discovery.
What is happening today is very different. One, we have not had any new technologies that have come into our market in 20 years. Two, our world is actually shrinking. There are places today where you either can’t go anymore or mining companies are no longer welcome. If you look at the mineral laws being promulgated in Indonesia, they are not mining friendly. They are raising taxes and royalties in Peru, Chile, pick a country.
GMSR: Like a lot of investors or outside observers, countries seem to be operating on the fallacy that if gold is up 80% over the last four years, gold mining must be a good business.
PL: To continue this thought, Venezuela’s a really difficult place to go these days and so is Colombia, or any of the FSU countries. So from a mining company perspective the world is actually shrinking. On top of that the minute you go into a developing country the NGOs are making life a lot more difficult. Through eco-activism, they generate fear among the local population to create the perception that only they can help to resolve the problems.
GMSR: Newmont has an interest in Gabriel in Romania, which seems a good example of NGOs coming in and imposing their will on local people. There, 85% of the local populace voted in favor of the mayoral candidate who supports the Rosia Montana project, and yet one woman flies in, stirs the pot, and wins the green Nobel prize [Ed., the Goldman Prize] for her work.
PL: That is very true. It takes an awful lot today to be able to develop projects where the NGOs become active. You have to gain the trust of the population; it takes time and you have to have the government backing. If you don’t, you are dead in the water.
GMSR: It seems that you’ve got to be there first. If you can make your impression before they’ve made their impression, you are at least ahead of the game.
PL: In developing countries it’s so easy to create fear because the NGOs are working with a population that generally does not understand what mining is all about. We have seen it in every developing country where we operate. Interestingly enough, in a place like Ghana the NGOs have not had anywhere near the traction that they would have in a place like Honduras or Peru, mostly because they have been mining gold there for 300 years. The people understand mining.
Where you have a full understanding by the population, and where you have governments that are seen as proactive in the enforcement of the law, the population is far more relaxed about mining because they know the government would not allow any bad things to happen. In those places the NGOs have very little, if any, traction.
That is why at the end of the day the best place to find a mine and operate is still the U.S., Canada, and Australia. People in those countries know that government will enforce their standards, and they know they are first world standards. The company can operate, you can permit-it takes time, but you can get your permit-and you have a justice system that works. To my mind, these are still the best places in the world to find and operate mines.
GMSR: Newmont’s problems in Indonesia have been widely publicized. Some serious accusations have been made, but isn’t this really all about the sanctity of contracts?
PL: Yes, in great part. The fact is criminal charges never should have been brought. The contract is very specific about any environmental issues/disputes that have to be resolved, either internally or by third party arbitration. The government never made use of that. Our people never should have been charged because there was never any substantive evidence. Every study that has been done at Buyat Bay, whether by the World Health Organization, the Indonesian Ministry of the Environment, or independent third parties, none of them ever found any pollution. Period.
GMSR: In terms of that particular issue and the trial, what is happening right now? Am I correct in understanding that it is being challenged for being procedurally lacking?
PL: The government presented their charge two weeks ago. We submitted what I believe are called exceptions. What we are saying is that there should have never been a trial in the first place, because there is no evidence to support any criminal charges.
GMSR: Being the biggest gold miner also means that Newmont has the biggest target on its back. This has obviously hurt the stock in the last twelve months. Some investors believe that if Newmont is going to be a magnet for problems, they will look elsewhere in the market. How do you go about convincing investors that Newmont is still the go-to gold stock?
PL: Being Newmont today is like trying to hide from lightning on top of a 14,000 foot mountain. Get real. Everybody is fair game, you look at Glamis in Guatemala, Meridian in Argentina, even a smaller company like Manhattan at Tambo Grande. This was a junior company, but everybody is fair game. Newmont is the biggest target and we have people that respond to these issues more than anyone else mainly because of that. Unless you have your head in the sand, these problems go with the territory.
GMSR: We talked earlier about the industry being margin-challenged right now, and it is also well known to be reserve-challenged. In the nineties the major mining companies seemed willing to buy now before prices went higher. In this cycle they appear to be lying back and seem willing to pay more to know more. The majors are also taking small steps into juniors, much as Newmont has done with Gabriel and several other junior companies. As the majors need some of the discoveries being made by juniors, how do you see the consolidation story playing out?
PL: I am very optimistic in terms of reserve increases over time. The exploration effort basically stopped with the Bre-X crisis. It shut down the raising of money by junior companies, and the gold price fell down to $250 in 1999. At that price the world was telling the industry ‘we don’t want any more gold.’
The big companies shut down their exploration departments and we have now had a drought for seven years. Still, in 2004 the junior companies were able to raise $2.3 billion in Toronto alone. It takes a couple of years before they get the people, before they get the land, and they are able to really start putting money in the ground.
I think we will see new discoveries in the five million ounce range over the next 18 months to two years. Most everything that is in the market is stuff that has been around for ten or twenty years already. One reason we’re not seeing more consolidation is because a lot of these properties are quite challenged. They have been around for a long time for a good reason.
GMSR: It would seem that we are also going to see a concentration of the industry where a company like Newmont has some franchise value attached to it. It can persist through all these obstacles, whereas the little guys just can’t begin to stand up to the barriers of entry. Is that a fair conclusion?
PL: The barriers of entry are rising. Capital costs are rising so you need to find a lot more money. Even a small project today, a 3,000 tonne per day project, costs $400 million dollars and that is just the beginning.
If you start to look at projects by the bigger companies you are looking at billions fairly easily. At the end of the day I think our industry will never be as concentrated as the iron ore or copper industries, mostly because 30% of the discoveries are still made by juniors and also because a lot of small mines that the large companies are just not going to buy, but they can be economic for small companies. So I don’t think you’ll ever see the same amount of concentration.
GMSR: It would seem that we’re also not going to see a growth industry for juniors such as we saw in the eighties and nineties.
PL: I do believe that the 30% of discoveries by juniors will still be made. Because of that the juniors will continue to have access to the public markets. They will make discoveries and they will be acquired if they make great discoveries. I don’t think that is going to change very much.
GMSR: One of the investments that NEM has made in the last year is on the diamond side, a $50 million investment in Shore Gold (SGF.T/$5.88). You and I have talked a lot about diamonds going back to the early nineties. For the benefit of my readers, why diamonds?
PL: Diamonds are just a great business. If you look at the three largest mining companies in the world, BHP, Rio Tinto, and Anglo American, guess what? All three of them are in the diamond business. They are the only three of any consequence. I think there should be a fourth one, Newmont. When you look at the exploration statistics in the diamond business, the stats are horrendous. The gold business is like 1 in 1,000, the diamond business is more like 1 in 10,000. So we made the decision that we are not going into exploration, but that if we were to see an early stage project that we felt had a chance of really getting to production, we would take a position.
That is what we did with Shore and now with the proposed merger with Kensington, it represents the largest kimberlite field in the world. It is low grade, and when we talk about low grade it is like 0.15 +/- 0.02 carats per tonne so it is very low grade. The quality of the diamonds, however, seems to be quite good. The last valuation for Shore for the parcel of diamonds was $135 per carat.
We look at that and if we combine that with Newmont’s ability to mine big open pits at very low cost, we think that the project there has a real shot. Over the next 18 months as Shore continues to drill out the resource and produce a feasibility study we’ll know whether or not it’s going to make it. Actually, I just like the size of the darned thing. But I’ve also been known to be wrong!
GMSR: Given the price Newmont paid and the absence of diamond mines coming onstream, it would seem that your risk is rather well defined.
PL: That is right. DeBeers’s stockpile is gone, and there is almost no recycling whatsoever in this business. The diamonds don’t go away, much like gold doesn’t go away, but in the gold business there are 600-700 tonnes of what we call scrap, recycled gold coming back into the market every year. There’s no such source of supply in the diamond business. A secondary market will probably come at some point, but in the meantime, it is all fresh product.
GMSR: In terms of fresh product, the gold ETF (exchange traded fund), GLD, came out almost a year ago, and you are now president of the sponsoring World Gold Council. Some people think that the industry has finally made it easy for their product to be purchased. Others seem to think that the industry has created a new product that can be used to place bets against the gold price. GLD was obviously a hugely successful launch, but what are your thoughts on how the product has evolved? Is it doing its job?
PL: In terms of the gold business it is the single most successful new product since the launch of the Kruggerand in 1970. Our view is very simple. If you make it easy to for people to buy a product they will start to look at the whole chain of product.
Some pension fund managers look at gold stocks and they don’t understand the valuations. So they are not going to buy gold stocks because they can’t get themselves to valuations of two times NAV. They don’t understand that gold stocks trade on optionality values. So for them the bullion is a very simple way to get into gold as a hedge on their dollar or other currency positions. God bless them, they would have never bought equity in the first place.
But they are buying bullion, which is good for the industry. So it is a new product, and has a very different attraction than for someone who wants to buy equity. Gold bullion has no leverage, gold goes up 10%, that’s what you get: 10%. You buy a gold equity, gold goes up 10%, the stock will go up 20% if it has two beta, which they do. They are very different products.
What we think we have done is basically enlarged the pool of money that will look at gold as an asset class. If you go back to marketing 101 one of the exercises you will do is this: a McDonald’s will open on a busy corner and it gets 10,000 meal traffic days, and then a Tim Horton’s opens on the next corner, a Subway opens on the third corner, and a KFC on the fourth.
The question is ‘is McDonalds traffic up or down once the four corners are busy?’ The answer, it’s up. Why? Because it has become a food destination corner. People say ‘I don’t know what I am going to have for dinner tonight, let’s go to such and such a corner’ because they have a choice. It is the same with a gold product, the more products you have the more people are going to say ‘I don’t know what I am going to buy but I need an asset diversifier, let me go to this corner and let me pick something.’ In creating GLD, that is what we have done.
GMSR: The one criticism that I see most often is that the gold price might run up $20 or $30 dollars but the amount of gold held does not seem to change. How do you explain this?
PL: One of the structural issues of the GLD, because of the way it was created under SEC rules, GLD is what they call a perpetual offering, which means you can’t promote the product. Because of that the brokers cannot solicit their clients, it has to come from the clients. That is a real issue.
We have a million brokers out there that could sell the product, but they can’t solicit. We are looking at what can we do to change that. Our goal is to make the population aware, the big players aware, and I think you will see demand come into the market. On the launch we were able to go around and do that and we were very successful, but it takes a continuing effort. We are working with the listing broker and the SEC as well because they are ones who regulate the product.
GMSR:Asian demand has helped the gold price in recent years, but are the Asians buying this product?
PL: We are planning to list the product in Hong Kong and there is also a plan to list it in continental Europe. The idea is to have it on enough exchanges that it will trade 24 hours a day/seven days a week. It takes time but I think the product will continue to be very successful. In six months GLD took down 250 tonnes.
GMSR: You’re known for talking four digit gold prices and that is something that seems to throw a lot of people, who seem to think that $1000+ gold sounds like a big number. Given the amount of monetary creation since gold hit $850 25 years ago, $1000 gold seems to me more like chump change.
PL: If you go back to that chart I talked to you about, the Dow Jones/gold price chart, one of the points I touch on is that every hard asset bull market has ended with a low, low, single digit ratio. In 1980, gold was 800 and the Dow was 800. In 1932 the Dow touched 37 and the gold price was $35 in 1934, there was a bit of a disconnect in terms of prices. It ended up at less than two to one.
I do believe that when you look at the financial imbalance in the US system, a 6% current account of GDP deficit, you look at the amount of debt being created in the private and public sectors, to unwind all of these excesses will take time. I don’t think it is going to happen in the next one or two years; it is going to take a lot longer than that.
If you look at a low single digit number, I don’t think the Dow is going to crash through 1,000. In 1966-67 the Dow lost about 40% of its value going from 1,000 to about 600. In the 30s it lost 90% of its value but then you had deflation, outright deflation like we’ve seen in Japan the last 15 years. I do not believe we are going to see outright deflation in the United States, I think it is going to be more like a muddle through, so I still think the Dow is going to be 6000 to 8000 +/- something.
When you look at the amount of money that has been created, what I see is a gold price that will have three zeros after the first number. But I don’t know what that first number is going to be. Yes, over $1,000. Is it going to be in the next year or two, I don’t think so, I think it is going to be a 5-8 bull market that we have in front of us. So the place to be over the next 5-8 years is hard assets. That’s what it is, gold, oil.
GMSR: As your partner Seymour is fond of saying, ‘If you want to make money, find a secular trend and ride it.’
PL: This is a major, major secular trend that only happens once every two generations. You get on it and just stay with it. That’s how you are going to really make money.
GMSR: Pierre, thanks for helping my readers in that cause.
This interview originally appeared in Robert Bishop’s “Gold Mining Stock Report”. With 22 years of circulation, GMSR is one of the world’s oldest and most trusted letters on resource stocks investment. For more information, or to subscribe, visit www.goldminingstockreport.com.