Tuesday, June 14, 2016

Bull Market in Australian Gold Mining Shares

It has been a long time since I've written about gold mining shares, but thought I would touch on them briefly given the explosive upside action we've seen over the past 6 months.

I posted the following on Twitter late last year highlighting the bull market in gold stocks:
I put my money where my mouth is having bought Silver Lake Resources (SLR) in July and Medusa Mining (MML) in September (first two since adding Norther Star Resources, NST, in 2013):
These have paid off nicely with MML's share price sitting at almost double my entry price and SLR over triple (both still being outperformed by my position in NST which is up more than 7 fold since I bought in 2013).

Decent gains already, so is it too late to buy now? Andrew Mudie of The Motley Fool thinks so:
"Call me crazy, but with the numbers above, I think it’s too late to jump into gold stocks. Of course, the major risk to that theory is that any of the six issues above has a big impact and results in a huge flight to safety for money all over the globe. If this does happen, however, I believe equity markets as a whole will retreat (even gold stocks) so placing all your eggs in the gold basket could be risky too."
And looking at the performance of the XGD (S&P/ASX All Ordinaries Gold Index), suggests the bull run may be getting long in the tooth...

2008 - 2011: XGD increased around 200% over 2.5 years.

Click Chart to Enlarge
2014 - 2016: XGD increased around 180% over 1.5 years.

Click Chart to Enlarge
It is understandable that some would look at the recent performance of gold mining stocks, especially the past 6 months which has seen the XGD increase over 105% compared with the XJO (ASX 200) which has barely broken even, and consider it an opportunity missed.

Click Chart to Enlarge
However, my view is that this bull market in gold stocks is only just getting started. That doesn't mean I think you should go and dump your entire life savings into gold stocks tomorrow (all your eggs in one basket as Mudie puts it), but I do think it's worthwhile having a healthy allocation to precious metals in the current environment and a portion of that allocated to the more speculative miners. You could stagger your entry, as Houses and Holes put it on Macro Business today...
"The prospect of a convergent Brexit and Chinese slowdown should leave Aussie gold investor breathless given it will both boost the yellow metal and trash the AUD.

All pull backs on gold now are buying opportunities with the usual caveat that if risk really does get trashed at some point then the flight to safety to the US dollar may hit gold short term. In that even it’s buy with both hands time given it is also the signal for imminent QE4."
Here's some further points to consider:
  • The XGD is still 44% below the highs of the 2011 peak (mind you, many companies in the index would have seen shares on issue rise), while the Australian price of gold is less than 5% lower than it's all time high.
  • While the XGD has been trending higher for 1.5 years, gold miners elsewhere (e.g. HUI Gold Index) only bottomed 6 months ago. XGD is likely to follow global sentiment in gold miners.
  • Gold is likely in the early stages of a new cyclical bull market, which I still expect will culminate in a bubble phase (to the secular bull market) at multiples of the current price. Gold shares will follow.
  • The XGD spent longer basing before this recent move higher (compared with the 2008/2009 bottom which was a sharp 'v' spike lower and higher).
While the XGD doesn't go back that far (it was only launched in 2006) we can see that over the course of the bull market in gold there have been longer and strong runs in gold stocks. For example the HUI rose more than 6 fold over 3 years in the early 00's and there are many indicators which suggest gold and related stocks reset to (oversold) sentiment levels from that era. Also, Australian gold mining companies such as Newcrest Mining (NCM) have shown in the past that they can run strong for more years than a couple:

Click Chart to Enlarge
I was a very active speculator in gold and silver explorers and miners over 2009 to 2011. I made a small fortune, then lost a good portion of my profits in the downturn that followed. Some of that is documented here on my blog as well as the Hot Copper forum where I was a regular poster at the time. Some examples of success included, riding Cobar Consolidated Resources (CCU) from 6c and selling out between 60c and $1 (my first 'ten bagger'), trading in and out of Silver Lake Resources (SLR) several times from 30c to several dollars, riding White Cliff Minerals (WCN) from around 8c and selling out near 30c... and that was just a few (of many multibaggers I had). Sadly toward the end of the boom in gold/silver miners I got burned by several that reduced my net profit in the sector substantially, these included Castlemaine Goldfields (CGT), which lost over 50% of it's value very quickly when the mine startup didn't go to plan and I sunk some capital into Bassari Resources (BSR) options, which expired worthless.

I am playing the market a little more conservatively this time around and have concentrated on mid-caps which are already producing gold profitably, but are leveraged to the price of gold should it continue to rise. I am considering adding some juniors, particularly those with exposure to silver.

I don't know that I will get back to writing the long research articles I have in the past for those companies I am buying/own, but here are a few tips for those looking into the sector (learn from my successes and mistakes):
  • I found Gold Nerds an invaluable resource for sorting through prospective gold shares a few years ago. Not subscribed currently, but likely to re-subscribe in the near future.
  • For juniors, focus on those which are proving up resources/reserves rather than those about to start production (poor grades through a new mill poses much greater threat to share price than a few bad drill holes).
  • Look for companies with low or no debt, tight capital structure and avoid those using speculative financing strategies (such as issuing shares for capital), see Gold Anomaly (GOA, now CGN) for an example of what happens...
  • Don't hold the gold miners once you think a medium term top for gold prices are near or in, no matter how solid you think the company fundamentals are.
  • A gold bar won't ever be worthless, but a gold miner can be, don't invest capital in miners which you aren't prepared to lose in it's entirety.
& finally, keep this old nugget in the back of your mind at all times:

"A gold mine is a hole in the ground with a liar standing on top of it."

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Wednesday, June 1, 2016

Screw the Taxpayer: ATO Compels GST on Bullion

Iceblue's (pseudonym) face screwed up as he read the letter in front of him. It was early March and the Australian Tax Office (ATO) had just written advising of an upcoming audit they intended to conduct on his business, South Gippsland Bullion (SGB). They noted their intent to inspect transactions covering the last several years of trading. He was probably thinking "Why me?" (wouldn't we all under such circumstances), but he may also have been aware that many other bullion dealers have faced similar scrutiny over the past 12-18 months with an industry wide series of audits being performed.

When the audit results arrived in mid May, advising that goods and services tax (GST) should be applied to the bullion products SGB sold, it would leave Iceblue with no choice but to close his doors (figuratively speaking given it was primarily run as an online business). The wording of the letter is ambiguous to say the least. It throws into question an assumed understanding in the bullion industry of what products should have GST applied, as industry veteran Bron Suchecki put it "..the arguments that the ATO now seem to be putting forward do not adhere to the understanding the industry had about what was bullion vs collectible."

GST is not applicable to bullion when sold in investment grade form. "What does that mean?" I hear you ask. Well, it's complicated and the results of this audit make the answers even less clear. You can read the Goods and Services Tax Ruling (GSTR) 2003/10 on what constitutes 'precious metal' for the purposes of sections 38-385 and 40-100 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act). In the letter sent to Iceblue finalising the audit the ATO highlighted the following passages of the above ruling:
In paragraph 8 of GSTR 2003/10 (The Ruling) the definition for precious metal identifies the metals and fineness that is set down in section 195-1 of the GST Act. Namely, 'precious metal' means:

(a) gold (in an investment form) of at least 99.5% fineness; or

(b) silver (in an investment form) of at least 99.9% fineness; or

(c) platinum (in an investment form) of at least 99% fineness.

The tradeable form is identified in paragraph 22: Bars, wafers and bullion coins are the physical forms in which the metals gold, silver and platinum are traded on the international bullion market for those metals. These are therefore forms of those metals that are capable of being traded on the international bullion market.

The term 'investment form' is considered in several paragraphs of the Ruling. In paragraph 29 a summary is provided:

- To summarise the above, for gold, silver or platinum to be in an investment form for the purposes of the GST Act, it must be in a form that:

- is capable of being traded on the international bullion market, that is, it must be a bar, wafer or coin;

- bears a mark or characteristic accepted as identifying and guaranteeing its fineness and quality; and

- is usually traded at a price that is determined by reference to the spot price of the metal it contains.

Paragraph 12 of the Ruling refers to items where: 'The price is not determined solely by the metal value of the coin. The price is determined by reference to the spot price and by reference to the quality of the physical characteristics of the coin. The latter indicates that proof coins are not traded for the metal value only and therefore 'indicates that they do not have the character of the metal, but rather the character of manufactured articles, that is, coins made from the metal. This means that proof coins are not precious metal.'

Paragraph 42 of the Ruling differentiates between the retail market and bullion markets: There are coins, such as some commemorative coins, that are marketed in the retail market as 'bullion' coins because they are made from bullion. Such coins are not bullion coins for the purposes of this Ruling. Whether a coin is precious metal does not depend on whether the coin is called a bullion coin or a proof or numismatic coin. The relevant test is not what the coin is called but whether it has the character of the metal. This will be determined, as noted above, by whether it is traded for its metal content or for other reasons.
The ATO's primary focus was on the 'Series of Dissent' (SoD) silver rounds of which SGB had several issues minted through manufacturer SBA Amalgamated. They zeroed in on the marketing used by SGB to sell these rounds, specifically referencing the wording around a strict mintage limit, that they won't be reproduced (with dies destroyed once the mintage was complete) and professionally commissioned artwork which adorned the pieces (among other characteristics).

The ATO also quoted something Iceblue had written on the forum Silver Stackers, pointing out he had called the round a 'collectible piece', however this was done so in the context of explaining that Aussie made rounds can't really compete with bullion pricing (i.e. with bullion products manufactured overseas or in larger quantities).

SGB sold the rounds on an individual basis for around $14 over spot, with a $9 manufacturing cost. The $5 profit was reduced to $1 per round when a buyer purchased in quantities of 100 or greater. The price of the rounds was adjusted in reference to the prevailing spot price. The rounds were priced as bullion, not a proof or collectors coin even if the characteristics or marketing made it attractive to collectors. They just had a higher premium due to the local manufacturing costs.

In my view the SoD rounds met the three criteria required to be considered investment form (and exempt from GST). They were capable of being traded on the international market (once you take the size of the transaction into consideration it's likely many small bullion dealers would purchase the round), they were marked with fineness and quality and traded at a price that was referenced to the spot price.

Perhaps the most worrying aspect of the letter was not even the initial focus on the SoD rounds, but what reads like an afterthought highlighting other products which the ATO does not consider to be GST exempt (explicitly quoted below):
"Coins and bars produced by different mints which also have added characteristics and are in the retail market would not satisfy the definition of 'precious metal'.

Likewise other items sold by [SGB] are sold in a retail market and are differentiated by mint brand and various characteristics including themed year of productions, animals, religious periods, lunar year characters, country."
The ATO goes on to highlight a particular lunar product which is typically sold on the retail market for twice the prevailing spot price, but their wording seems to suggest that any product with 'added characteristics' such as a themed coin may in fact not satisfy the definition of 'precious metal' and be exempt from GST.

Long term readers of my articles would know that I specifically highlight many of the Perth Mint bullion coins as worthwhile investments due to their pleasing designs, low mintage and being individually capsuled. These are many of the same characteristics that the SGB SoD series had. It appears to be these and other characteristics which the ATO is now suggesting should result in GST being applied to bullion products.

In my mind it would make much more sense for the ATO to simplify these rules and remove all ambiguity. Reducing the test to purity of the metal (which should be lowered or exceptions made for 22k gold coins and government issued silver coins) and a maximum premium that can be charged (e.g. less than 100% markup over spot), along with the basic form being a wafer, round/coin or bar. Though my fear is they go the other way and increase the scope of GST on bullion.

There's a good chance this industry crack down and audits stem from the GST gold fraud which has been rife through Australia for some years. I am told (on good authority by industry insiders) that this practice is not only ongoing, but likely the number of people taking advantage of the loophole has increased.

Instead of seeing tangible results from the ATO on the investigation into real fraud costing the country hundreds of millions in lost revenue at a time of focus on fiscal responsibility, we see them putting a small, legitimate and innovative business under the microscope and then crushing them under their proverbial boot. Really the message from the ATO can be summarised from a slogan which was coincidentally minted on one of the SoD rounds... screw the taxpayer (well at least those who are investing in or selling physical bullion).


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