By The Gold Report, on March 3rd, 2011
 Independent investor Chen Lin takes advantage of high metals prices by investing in companies with the financial strength to stay the course until the resource is in production or can be expanded, making the company an attractive takeover target. For metal miners, the sustainability factor is critical because it can take years to get a mine to cash flow-positive status. Chen shares several of the companies he owns that he believes will return significant capital appreciation in this exclusive interview with The Gold Report.
The Gold Report: How important is technical analysis for you? Is it more useful as an entrance or exit point for a stock? Or, do you use technical indicators as a longer-term approach?
Chen Lin: That’s a very good question. I know technical analysis pretty well, and I watch a lot of indicators. Technical analysis probably helps most when entering or exiting a stock. You can also see some pretty good entrance points. Technical analysis also helps when the technical indicators improve and a lot of new technical buyers come into the picture; you can predict the stock will do well. But fundamental analysis is always most important for me, and value is the most important factor.
TGR: What indicators do you use—moving averages?
CL: I don’t follow those too closely; I look at the chart and I can see the trend. I set up an alert at my Fidelity account to email me whenever gold is crossing certain moving averages, such as the 200-day moving average. I use these as reference points to see the general trend for the stock. I also use Relative Strength Index (RSI) as a good indicator to see how a stock is overbought and oversold.
In general, you want to start selling when a stock is overbought and buy when it’s greatly oversold. But the company’s fundamentals are the most important. If it’s undervalued, it may still rise—like one stock I own that recently had a 90 RSI—which is extremely overbought—but is going higher still because the stock is undervalued from any perspective. It just rose so sharply, I had to sell some; but I’m keeping a lot of shares.
TGR: After a stock is fully valued, do you attempt to ride it as a momentum play to squeeze out more juice? Or are you just happy to take your money off the table and use it to enter another value play?
CL: Usually when a value stock reaches its valuation, it rides higher than its valuation and tends to get overvalued. Day and momentum traders rush in; so, stocks actually appreciate a lot in a very short period. Then I just start selling and taking profits gradually. Sometimes it will get a very big pop in one day when I’m selling, and I use those indicators to sell more. But in general it’s very hard to catch a peak. So, taking profits is a process instead of a one-day event.
TGR: You play anywhere from penny stocks in the single-digit millions up to the $3–$4 billion market-cap level. That’s a real advantage for an independent or non-institutional investor. Even most hedge funds don’t have that luxury. Obviously, liquidity issues don’t scare you. How do you manage those situations when a stock may not be marketable?
CL: I generally follow different rules, but first you have to know where the market is going. If the market has just started to rise, you can get into illiquid or risky stocks because, as the market rises, liquidity will come and illiquid stocks will become more and more liquid. But if the market is getting more mature and dangerous, you might want to sell them; for example, back in summer 2008, I sold all my junior stocks. For every stock, I set a rule for when I would sell. When they got to a certain level, I got out. By the end of 2008, I started to buy junior stocks—illiquid stocks.
TGR: You buy when you see activity in very small stocks?
CL: Activity is a good indicator, but it’s not the only indicator. I’m a value investor, so I look mostly at the valuation. But in general you want to invest in companies with rising volume and increased trading activity. That means more people are interested in the stock. So, if you believe that liquidity will be on the rise, then you can take a heavy position in a small-cap stock.
TGR: How do you start when you’re looking for a metals stock versus, let’s say, an energy stock?
CL: Metals stocks are very different in valuation from energy stocks. I generally like a metals stock with a world-class asset or potentially world-class asset. For an exploration company with 5 million ounces (Moz.) gold or gold equivalent in a desirable location that a major might be interested in taking over, you can put a value on the company. That’s because we know what price majors are paying for the gold.
The most recent takeover was for almost $1,000/oz. in the ground. Of course, there’s a potential to expand the resource too. For production companies, you look at the production profile. You look at the average cost, the cash flow and the balance sheet. A production company can immediately leverage to higher gold and silver prices. Use those numbers to calculate cash flow, and you have an objective valuation of the company.
TGR: Chen, do you currently favor silver over gold? Is there more upside, percentage-wise, to silver than there is to gold?
CL: Yes, I think so. I probably have a little more silver than gold because silver started relatively late and is just coming up. Gold starts first, and silver always outperforms gold in the second half of a bull market. That happened in the ’70s, and I think it could happen in this round.
On February 18, the margin of silver reserve requirements for silver contracts was increased by the exchange. Silver exploded because funds were betting heavily against silver, and they had to cover their shorts. It could easily go to $40/oz. and to $50/oz. There’s still a big short position in silver, and it could outperform gold.
TGR: Where would you be investing today if commodities weren’t in an upswing?
CL: If the underlying commodities were not in an upswing, I would be more focused on stocks with high liquidity—those with strong balance sheets and strong cash flow. When they generate cash flow, they don’t need to come to market to raise money. So, then they’re relatively insensitive to commodity prices. Another very important factor to consider is the cost of producing the commodity. That’s also in the cash flow model. If the commodity price stopped rising, or started to go down, I would invest in those stocks.
TGR: Do you have a metal stock you want to mention?
CL: I like Pretium Resources Inc. (TSX:PVG). That was my pick in early January. I met CEO Bob Quartermain at a conference, and we had a discussion. Quartermain was the founder of Silver Standard Resources Inc. (TSX:SSO; NASDAQ:SSRI); he retired, and then came back to run this company, which is a gold asset spinoff of Silver Standard.
When we met the stock was in the low $6 range, and I believed it was very much undervalued. So I put it in my newsletter, and it’s appreciated a lot. You can see it’s up about 50% in the past two months. But it’s still a very undervalued stock.
So why do I like it? One factor is that it has a very large gold deposit next to a large Seabridge Gold Inc. (TSX:SEA;NYSE.A:SA) deposit. Seabridge has 50 Moz., Pretium has 40 Moz. gold, is drilling and has more results coming. Its 40 Moz. low-grade deposit has already given the company some valuation. If you compare Pretium to NovaGold Resources Inc. (TSX:NG; NYSE.A:NG), it’s very much undervalued just on the low-grade part. But on the high-grade part it’s all blue sky. There is some basic valuation, and a lot more upside yet to be seen. They recently did an IPO, and the company is well funded for the next two years.
TGR: Is there another metal stock you want to mention?
CL: In our last interview, I mentioned a couple of silver stocks. One was Alexco Resource Corp. (TSX:AXR; NYSE.A:AXU), a very high-grade silver deposit in the Yukon. They own the whole district, they have started mining operations and they have a mill running. They’re beginning to produce 3 Moz. silver per year, but they can gradually increase to 5 Moz. and eventually to 7 Moz. What’s so special is that it’s a very high-grade silver/lead/zinc deposit, and if you apply lead and zinc credit, the silver cost is below zero. So, you’re talking 3 Moz. at zero cost. It’s free silver. If they go to 7 Moz. at zero cost, $30/oz. silver means a huge cash flow. So, it’s becoming an amazing cash flow generator.
TGR: Another silver play?
CL: Yes: Golden Minerals Company (TSX:AUM; NYSE.A:AUMN). Golden Minerals and Alexco have similar characteristics, namely that their silver is extremely high grade. El Quevar is Golden’s flagship property in northern Argentina. It’s in the high Andes, and there’s nobody living there. There’s plenty of water. The company has only explored a small area, but has already found very high silver content, and it’s expanding its resource.
Early on, the company was talking about 6 Moz., but it can build a much larger silver mine and increase capacity. Because of the grade, today’s silver price gives the company a huge margin. Plus, Golden Minerals owns huge properties throughout South America and Latin America, including Mexico. It’s a spinoff from Apex Silver, which went into bankruptcy, and all the exploration properties came to Golden Minerals. Apex put in their claim very early, and they own a lot of very good and important properties throughout South America.
TGR: Another company?
CL: I have owned a gold stock called OceanaGold Corp. (TSX:OGC; ASX:OGC) for a fairly long time. In early 2009, I got in at around $0.40, and I still own a very large position in it. The stock has not been doing very well over the past few months because the company raised money to build a Philippine mine, and the market didn’t take it well. That brought down the stock quite significantly in just a few months.
I have been adding a little more stock to my already large position, partly because they have a very stable 270,000 oz. (Koz.) per year operation in New Zealand. Potentially, the cash costs can come down next year, but at current gold prices they are generating a huge cash flow. Plus, it has this new mine in the Philippines coming on, and the company can dramatically increase its gold production and reduce costs because the cash cost is below zero if it’s getting credit for the copper.
TGR: You invest in very small stocks. Can you mention one?
CL: Majescor Resources Inc. (TSX.V:MJX) is a tiny company, and so liquidity is quite limited. I met the CEO late last year. The main property is in Haiti. The fascinating thing is, the company already has a huge historical resource drilled by the United Nations and verified by German engineers. It has over 1 billion lbs. of copper and very high-grade gold—about 250 Koz. gold at about 14 g/t.
The Haiti property is right next to a property of Newmont Mining Corp. (NYSE:NEM). Newmont’s CEO did an interview recently, and he mentioned that the Haiti operation is the most promising up-and-coming project for Newmont. The market cap right now is just $9 million, and that’s why I see potential. If successful, this can be a home run. Of course, if it’s a failure, you lose all your money.
TGR: Majescor is obviously a takeover candidate with a $9M market cap. Somebody can probably have it for $20M.
CL: Exactly, and hopefully a lot more. If Newmont wants to build a mine, it’s going to pour maybe a billion dollars into a world-class flagship mine. Majescor already has the mining permits, while Newmont is still applying for them. I think people will eventually find this company; we’re trying to get in there first.
TGR: Something else you wanted to mention?
CL: It’s a rare earth company—American Manganese Inc. (TSX.V:AMY, OTCPK:AMYZF). Manganese is a very important metal used to make steel and batteries and China controls about 97% of the electrolytic manganese metal (EMM) market. This could be the next rare earth trade. If you compare American Manganese side to side with Molycorp Inc. (NYSE:MCP), there are very good similarities, but its market cap is still just 1% of Molycorp’s. I think there’s a lot of upside here.
TGR: If this stock doubles, it gets large enough for small-cap mutual funds to buy it.
CL: Exactly. That’s the beauty of this stock. Right now, the mutual funds couldn’t buy it. So, once it rises, mutual funds get in and push the stock to much higher levels. I got in at half of today’s price. The company recently did a private placement, and I heard some funds were fighting to get in on that. Even though it’s already doubled from our initial purchase price, those kinds of stocks may not initially have a lot of liquidity. Once they get to a $100 million market cap, the mutual funds get in and more investors realize that this could be the next Molycorp. Liquidity will increase, and you ride the liquidity and rising volume; the stock can go much higher from here.
TGR: Chen, do you have another gold stock that you want to mention?
CL: Colossus Minerals Inc.’s (TSX:CSI) stock didn’t do anything in the past year. That’s typical, because traders only care about a mining stock until about a year before it’s in production. The company’s mine is going into production next year, so the stock can break out from here. Colossus has very high-grade gold. It also has platinum and palladium credit, and so the cost of gold will be below zero. They have 200–300 Koz. gold coming out. Production costs are always rising, but this is a world-class, low-cost producer. That should attract a lot of majors who fight for low production costs. A major could take it over. It’s only an $800 million market cap.
TGR: Thank you, Chen. This has been very informative.
 Listen to Analyst Chen Lin on Jay Taylor Radio (2/22/11)
Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc., publisher of J. Taylor’s Gold, Energy & Technology Stocks newsletter and Roger Wiegand’s Trader Tracks. Using his wife’s Roth IRA account, Lin invested $5,411 in December 2002, and by December 31, 2010 it was worth $1,188,993—with no cash added. You can see his portfolio chart here.
By Thomas Knapp, on March 3rd, 2011
A book chosen at random from the coming week’s New York Times mass market paperback fiction best-seller list: The Midnight House, by Alex Berenson. Haven’t read it. Don’t know if I ever will. That’s not what this is about. Here’s what this is about:
Mass market paperback cover price: $9.99
Amazon Kindle e-book price: $8.99
Borders e-book price: $8.99
Barnes and Noble e-book price: $8.99
Materials cost of an e-book: $0
Printing cost of an e-book: $0
Storage/warehousing cost of an e-book: $0
Shipping cost of an e-book: $0
Okay, not exactly $0. There’s hard drive storage space, bandwidth, etc. But the efficient cost of storing/downloading a single copy of an e-book is damn close to $0.
Another difference between paperbacks and e-books is returns. Send 50 copies of Midnight House to Wal-Mart, and the publisher may get 25 ripped-off covers of copies that didn’t sell sent back for a refund of the wholesale price. An e-book that’s sold generally stays sold.
And yet e-book prices hover around (and sometimes exceed!) paperback prices.
Why? Because you’re willing to pay those prices. If you weren’t willing to pay those prices, those prices would come down.
How far down? Well, as far down as they can come and still bring in a profit for the seller. And the seller would continue to produce e-books as long as they continued to produce a better profit than he thinks producing something else would.
A little Googling says that the average author’s royalty on book sales is somewhere in the range of $1 to $1.20 per copy. I don’t know anyone who doesn’t want authors to get paid for their work. I’d like to see them get paid more than $1-$1.20 a copy, actually.
And yes, even absent dead-tree considerations, a publisher still has costs. An editor has to evaluate the book, decide whether or not to publish it, and work with the author to make such changes as are required to get it “there” for publication. The author usually receives an advance on royalties, which means some of the publisher’s money is put at risk. There are overhead and administrative costs (data entry/formatting/cataloging, etc.). And that storage and bandwidth and such. There are affiliate commissions. And so on, and so forth.
Still, it seems to me that as a stand-alone operation — i.e. if the e-book sales are not expected to subsidize hardcover and paperback losses — an e-book that sells at all well for $5 a pop should produce a fat profit.
The obvious exceptions are titles like textbooks: Books with a limited market but whose readers really, really have to have them and will pay whatever it costs to get them.
For “normal” e-books, the $8-$11 pricing scheme that seems to prevail at the moment looks like it was intentionally designed to encourage bootleg/pirate epubs.
Assuming that DMCA, DRM and all the other schemes to crush that phenomenon fail miserably — and that’s a very safe assumption — I predict a $4.99-$5.99 price point (in March 1, 2011 dollars) for “current catalog” mass market e-books within two years.
By B.P.T., on March 3rd, 2011
The Monster Employment Index for February was released today, and the index moved up 8 points to a value of 130, which is 4% higher than last February’s value.
The monthly Chain Store Sales report will be released today. This report on sales in chain stores gives a look at the health of stores that make up about 10% of all retail sales.
At 8:30 AM EST, the U.S. government will release its weekly Jobless Claims report. The consensus is that there were 395,000 new jobless claims last week, which would would be 4,000 more than the number released last week.
Also at 8:30 AM EST, the Productivity and Costs report for the fourth quarter of 2010 will be released. The consensus is that non-farm productivity increased by 2.6% in the last quarter and labor unit costs decreased 0.3%.
At 10:00 AM EST, the ISM non-manufacturing index for February will be released. The consensus estimate is that it decreased 0.4 points last month to a value of 59.0, and will continue to signal economic growth as it remains above the mid-point of 50.
At 10:30 AM EST, the weekly Energy Information Administration Natural Gas Report will be released, giving an update on natural gas inventories in the United States.
At 4:30 PM EST, the Federal Reserve will release its Money Supply report, showing the amount of liquidity available in the U.S. economy.
Also at 4:30 PM EST, the Federal Reserve will release its Balance Sheet report, showing the amount of liquidity the Fed has injected into the economy by adding or removing reserves.
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By Doug Gentry, on March 2nd, 2011
 The acclaimed radio/TV series, This American Life, aired a piece titled, “The Invention of Money”, in early 2011. There are two excellent stories – or “Acts” as TAL’s Ira Glass calls them – one on how a group of economists restored the public’s faith in the Brazilian currency, and another on how the Federal Reserve creates money. The piece starts with a story about aboriginal cultures using large, hard to move stones as money. I heartily recommend listening to this piece. You can find it here. The whole piece is just under an hour.
From the web site:
Prologue.
Ira Glass speaks with several members of the Planet Money team, who all found themselves—in the course of their reporting—independently asking the same stoner-ish question: What is money? Ira and Planet Money producer Jacob Goldstein discuss a pre-industrial society on the island of Yap that used giant stones as currency.
Act One. The Lie That Saved Brazil.
A trip to a country where the fiction that is money completely fell apart. And in this same country, through a truly incredible piece of policy making, the government tricked a 150,000,000 people into believing their money had value again. Chana Joffe-Walt reports. (16 minutes)
Act Two. Weekend At Bernanke’s.
Though the name of the Federal Reserve includes the word “federal,” it’s not actually part of the government. It’s an independent institution tasked with something very simple, but very huge: Creating money out of thin air. And during this last financial crisis, the leaders of the Fed did things that they would never have considered doing in the past. Alex Blumberg and David Kestenbaum report on what the Fed usually does, and how, since 2008, it’s taken a trip to what amounts to Fed Crazytown. (26 minutes)
By Ajay Shah, on March 2nd, 2011
Cross-border exchange mergers are in the news. See Indian exchanges must go regional and then global and Global mergers and Indian exchanges, by Jayanth Varma, who points us to LSE and TMX merge by Jeff Carter on Points and Figures. Also see Stock exchange mergers: the fight for global dominance in the Telegraph.
An article in the Economist, Back for more: Has the global exchange industry lost its marbles again?, is skeptical about various stories that are being told about exchange mergers, but holds forth the possibility that there might be cost savings:
Joining forces does not in itself realise revenue gains or alter this
decline. But it may make it possible to combine the technology and
back-office platforms being used by different exchanges, cutting
costs. Efficiency savings are the one element of the last round of
consolidation that did arrive as promised.
Cost savings are being emphasised again now. The Deutsche Borse and
NYSE-Euronext combination should yield annual savings of ?300m
($412m), the two firms say, equivalent to about a fifth of the
combined entity’s pre-tax profits, while the LSE-TMX deal should
produce savings of about 7%.
In this article, I focus on the question: Is there a big opportunity for reducing cost through exchange mergers?
Getting a sense of the magnitudes
An exchange is an IT system that matches orders. The computational complexity of an exchange is all about taking in a lot of orders per second and computing a lot of trades per second. The output of the IT facility is purely measured by the number of orders that were produced. In the public domain, we see the number of trades, and not the number of orders. Hence, the number of trades is the best public domain source of the size of each exchange, from the viewpoint of cost.
To illustrate the magnitudes involved, last Friday, BSE got 34.1 million orders and did 1.94 million trades. This is an orders-to-trades ratio of 17.6:1 — for each trade that BSE produces, they have to have the IT capacity to process 17 orders. The only way to get up to these kinds of values is by having a good deal of algorithmic trading.
The revenue per trade is, of course, very different across countries. In India, the average trade size on the equity spot market
is $500 and the tariff for the exchange is hence tiny: NSE or BSE earn Rs.0.65 or $0.014 per trade. Using the above numbers, BSE’s earning Rs.0.04 or $0.000795 per order on average. These low low tariffs imply that the revenue, profit and valuation of an exchange in India is tiny when compared with what’s seen abroad. But on the question of cost, there is direct comparability: it costs as much to produce a billion trades in India as it does anywhere else.
From this perspective, let’s look at the biggest factories in the world that produce trades. This is data from the World Federation of Exchanges, for equity trades on the limit order book, in January 2011:
| Rank |
Exchange |
‘000 trades |
| 1 |
NYSE Euronext |
1,52,922 |
| 2 |
NSE |
1,18,200 |
| 3 |
NASDAQ OMX |
1,13,753 |
| 4 |
Shanghai SE |
1,04,965 |
| 5 |
Korea Exchange |
1,00,221 |
| 6 |
Shenzhen SE |
76,268 |
| 7 |
BSE |
35,157 |
| 8 |
Tokyo SE |
27,557 |
| 9 |
Taiwan SE |
20,313 |
| 10 |
London SE |
19,132 |
Saving money through unification of data centres?
I do believe that in this business, there are economies of scale. To build a factory that produces twice the trades costs less
than twice the money.
Does this mean that exchange mergers can create value? Not necessarily.
Let’s take one plausible merger from the above. The London SE is a small exchange: they did 19.1 million trades in January. The BSE did 35.1 million trades.
Can one save money by producing 55 million trades in a single data centre? Yes.
Will a BSE+LSE merged entity drop down to one data centre? Of course not! The problem is the speed of light. Today, the
conversations between securities firms and exchanges are reckoned in milliseconds. And in one millisecond, light only travels 300 km. So even without reckoning for switching overheads (which are huge!) it is not feasible to unify data centres apart from local mergers such as CME and CBOT.
Since light moves at a glacial pace, it is simply not feasible to beam orders from London to a data centre in Bombay. So even if BSE
merged with London SE, there would be two data centres. This limits the cost saving. Until we find a way to speed up light, there is going to be no data centre consolidation in this business, other than within small geographical areas (e.g. within Chicago or within New York).
Saving money on software development?
Okay, let’s look further. Could there be cost saving by building one software system and deploying it twice? We’d still spend money to
run two data centres, but we’d have only one expense of building software. Could this work?
It’s much harder than it sounds. It is not often that one gets to fully transplant an exchange software system in a new location: all
too often, the systems have to be significantly different. Regulatory differences, local preferences, history, what users prefer and are
used to: all these shape immense diversity in exchange systems. There can actually be diseconomies of scale, with engineering and
political problems of handling multiple versions.
Another key problem lies in the sizing of the software system. An exchange system that works for BSE will generally involve a different set of engineering tradeoffs when compared with the LSE setting. So ground-up implementations could be more efficient. By this logic, there may be a useful role for cooperation between similar-sized exchanges (e.g. NSE and Shanghai), but not across divergent sizes which are more than 2x apart.
When decision makers think `a system’ can be readily transported across highly diverse order intensities, without regard for the
inefficiencies introduced in this process, I think this has something to do with the lack of engineering backgrounds among these decision makers. On a related note, there isn’t much of a role for exchange software as a software product, other than in the zone of tiny exchanges where an android phone will suffice for order matching. By the time you get to anything in the top 20 exchanges of the world, an efficient implementation will involve large amounts of ground-up development.
A skeptical perspective
NYSE merged with Euronext. Did we see cost reductions? A lot was said about cost reduction at the time of the merger, but I haven’t
particularly seen evidence of this filtering out post-merger.
ASX-SGX: Will they drop down to one data centre? Of course not. Will they unify systems? What will be the cost of system
unification? Does it make any sense to unify systems? It helps that both are similar-sized small exchanges, but the institutional settings are highly different.
NSE and NASDAQ produce a similar number of equity spot trades. In the latest year, NSE spends roughly $150 million a year doing this, while NASDAQ spent $850 million. (NSE produces derivatives trades also, and the NSE number includes the cost of the clearing corporation, so the cost-per-trade edge at NSE is probably of the order of 10x when compared with NASDAQ). The two exchanges are similar in size in terms of the trades per second. Yet, this is not an easy merger opportunity. There will certainly be no data centre
unification. NSE’s knowledge can be used to run the NASDAQ data centre more cheaply, but complex organisational dynamics would have to be navigated in achieving the transition, and this could take decades to pull off. It is hard to get management teams that are
able to play for such long-term gains.
Also see Are exchange mergers always good? by Mobis Philipose in Mint.
There is one kind of exchange merger which I have become increasingly skeptical about: one in which a parent foists computer
systems upon the recipient. I have started worrying that this is a bit of a con, a method to generate revenues from system sales under the garb of partnership or strategic alliances. This is done to some extent by firms that are primarily in the business of selling software and not in the business of running exchanges. Or, to the extent that high-cost exchanges are able to do this, the systems/software revenues are able to mask the deeper problem of a high cost structure.
I have watched the grand global deal-making between exchanges for a long time. In my reckoning, most of it has been a waste of time and money. As one specific example, in my observation in India, some foreign investments into Indian exchanges has been irrelevant, others have directly done damage. None has as yet helped improve product offerings or cost efficiency.
One contract that comes to my mind as one that really worked was Mutual Offset (MOS) between CME and SIMEX, which was done way back in 1984. This was one deal that really mattered and was a good idea. But it was useful in the age before capital account openness – such connections are less important today when capital flows freely anyway. And, remember that it was a mere contract, it involved no complications of ownership and management. So I do think there will be value if the Nifty futures on SGX, CME and NSE are all unified through a mutual offset system: but this does not require anything more complex than signing a contract.
Jayanth Varma says:
It is tragic that at this point of great opportunities and strategic challenges, the energies of Indian exchanges and their regulators are entirely consumed by the debate about whether exchanges should be regulated like public utilities
I disagree. The global exchange M&A story seems to be overrated, apart from the extent to which systems like MOS which can
alleviate home bias (and only require contracts). There isn’t much to gain there. On the other hand, the problem of sound regulation and supervision of exchanges in India is a GDP-scale issue. Indian experience and evidence does not support a complacent approach that the regulation and supervision will work out.
Acknowledgements
My thinking on this was improved through conversations with Ravi Apte and Ashish Chauhan.
By B.P.T., on March 2nd, 2011
The Mortgage Bankers’ Association purchase index was released at 7:00 AM EST, and there was a week to week decrease of 6.1% in the Purchase Index and a week to week decrease of 6.5% in the Refinance Index.
The Challenger Job-Cut Report will be released at 7:30 AM EST, providing an estimate of the number of layoffs in February.
At 8:15 AM EST, the ADP Employment Report will be released. Investors will be watching this number to get advance notice on the state of the job market in advance of the government’s report on Friday.
At 10:00 AM EST, Federal Reserve Chairman Ben Bernanke will give his semi-annual monetary policy report to House Financial Services Committee.
At 10:30 AM EST, the weekly Energy Information Administration Petroleum Status Report will be released, giving investors an update on oil inventories in the United States.
At 2:00 PM EST, the Beige Book report will be released, giving us more information about economic conditions in each Federal Reserve district in advance of the next Fed meeting.
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By Christopher Briem, on March 1st, 2011
So if you believe the news, the City of Pittsburgh and its oversight board, the semi-euphemistic Intergovernmental Cooperation Authority (ICA), are duking it out. Trib: State pushes Pittsburgh to keep better financial records and PG: Act 47 panel rejects city’s financial system proposal
If two bureaucracies flail at each other on letterhead, do they make a sound? Hey, at least the poor beat reporters show up for those ICA meetings.
At issue appears to be $13 million the ICA is withholding from the city. Who knew? The issue seems to be the city’s lack of cooperation in a nominal agreement to merge its accounting system with Allegheny County’s accounting system as a cost-savings measure. The city wants to instead merge its accounting with the unerring financial wizardry of the Pittsburgh Water and Sewer Authority (PWSA). Maybe I mean sophistry?
Unmentioned is some of the odd story behind the PWSA’s own accounting system. Mentioned here 6 months ago, was some passing news that the PWSA wanted to ditch its use of software from SAP (that would be the largest business software company in the world by the way), for a company with 1/10th of 1% the number of employees, and it seems an even smaller proportion of experience in this market. Beyond the elusive logic of that, remember the city fully supports city-county consolidation.. something that getting some synchronicity between the two governments’ accounting would necessitate.
If the PWSA software does subsume the city’s accounting systems, I just can’t imagine what that Malaysian company will do with parking tickets that get sent out.
By The Gold Report, on March 1st, 2011
 Toronto-based Ubika Research is making a name for itself on Bay Street. The firm launched its Gold 50 Index in February 2010 and by year-end, the high-potential gold juniors on that list were up a combined 99%. Ubika Cofounder and Analyst Vikas Ranjan returns to The Gold Report for a discerning look at the ongoing turmoil in the Middle East, its possible effect on metals markets and several promising junior explorers and producers in this exclusive interview.
The Gold Report: The Middle East is always a hotspot for geopolitical tension. Those tensions escalated recently when Israel announced Iran was sending warships through the Suez Canal, which hasn’t happened since 1979. And Egypt’s new military rulers decided to let the ships pass. Is it safe to say that this situation has the potential to radically move the gold price as a result of the safe-haven bid?
Vikas Ranjan: The situation in the Middle East is very fluid right now with many protests against autocratic governments. Opposing parties will attempt to seize the moment, and that will likely make the situation more volatile. This is creating a new risk in the market, particularly due to its impact on the price of crude oil. But could the situation have a dramatic impact on the price of gold? I doubt that. The Middle East situation will probably continue to help the gold price because risk is increasing—and it’s a new set of risks. Some people always take refuge in gold as a safe haven, and this will push gold prices higher in the short term but probably not radically higher unless there is an all-out war, which I doubt will happen. So, yes, there’s support for gold already and we’ll see some near-term rise in the gold price.
TGR: Another factor on the demand side is inflation. Consumer prices in the U.S. rose about 0.2% in January, which is the fastest rise in more than a year. And China recently published some data that suggest inflation is rapidly taking hold there. What is Ubika’s position on gold as an inflation hedge?
VR: Yes, inflation is definitely becoming a major concern—at least in emerging economies like China, India, Brazil, Russia and Argentina. Gold has traditionally been a strong hedge against inflation as investors seek to hold hard assets like gold when paper currencies depreciate due to higher inflation. If inflation takes hold, our position is that it will be very beneficial for gold. Now, the question is: Is there a real threat of inflation? It’s absolutely a threat in emerging markets.
In our opinion, the numbers are actually understated. In many of these countries, the real inflation rate is much higher than the official figures because emerging markets are growing rapidly and are not seeing any let up in demand growth. However, developed countries, especially the U.S., Eurozone countries and Japan, are struggling still. In the short term, perhaps one or two years, we don’t see a real threat of inflation in developed countries because there’s no real threat of wage-induced inflation. Having said that, these countries have pumped up a lot of liquidity into the system; so, ultimately currency-induced inflation likely will take hold in a couple of years—that will be very beneficial for gold.
TGR: So gold has significant demand drivers both in the short and long term?
VR: Yes.
TGR: Gold recently brushed up against its 50-day moving average on the Comex. Where do you see the next resistance level? Will it be above $1,400/oz.?
VR: Yes, I think so. If you look at the trend over the last few months, gold is making a strong base at higher and higher levels. Even after swift selling in the new year, after gold had made a late run in 2010, it did not break below $1,300 on the downside and has now made a nice comeback. If that level above $1,350 is sustained for a little more time, I think the next move would be to test the levels around $1,500. I wouldn’t be surprised if gold breaks $1,500 by midyear.
TGR: That would certainly be good news for our readers and most junior gold explorers. Ubika Research covers a number of gold juniors. In your last interview with The Gold Report, you talked about La Quinta Resources Inc. (TSX.V:LAQ), which at the time, was rebranding itself as a Nevada-focused junior with its Easter property. What’s happening with La Quinta now?
VR: La Quinta has made some good progress since we last spoke. The company completed a summer drilling program last year at the Easter Gold Project. The drilling program focused on the area where there is an historical resource. La Quinta hit gold in every hole it drilled and successfully determined the direction of the mineralization. I visited the site in November last year and I was pretty impressed by the size of the land package.
Current drilling is exploring only one known vein system, and there is potential for others. We think La Quinta has a strong technical team to carry out its well-defined exploration program that should significantly increase the current NI 43-101 resource. Another very interesting thing about the company is that the Easter Project is in a joint venture (JV) with Fronteer Gold Inc. (TSX:FRG; NYSE.A:FRG), with La Quinta earning its option to own a 65% interest. Now, Newmont Mining Corp. (NYSE:NEM) just announced a takeover bid for Fronteer. The gold sector continues to see lots of mergers and acquisitions (M&A) activity, and a company like La Quinta can do very well if it successfully executes its strategy and proves up a sizeable resource base of, say, 500,000 to 1 million ounces (Moz.).
TGR: Do you expect Newmont to take a closer look at La Quinta given that relationship?
VR: Yes, it’s possible. Newmont also announced it would spin off some of the exploration assets into a subsidiary called Pilot Gold. We’re not sure if it will spin off its Easter Project interests once the company acquires Fronteer. But, even if it did, Newmont still owns about 20% of Pilot Gold. Newmont would obviously have an eye on these assets; it’s very aggressive. Newmont is looking for ounces in the ground. If the company finds a good-sized deposit it can mine economically, why not?
TGR: La Quinta recently got a permit to do some trenching on the Easter Property from the Bureau of Land Management (BLM). Ultimately, that work will lead to more drill targets and more drilling. When could we see a revised resource estimate from La Quinta?
VR: Our understanding is that La Quinta will engage in a follow-up drill program very soon. I think the company should have some results from that by May. Once La Quinta takes into account all of those results internally, it will probably do an evaluation and include that drill data. That would be an opportunity to revise the resource estimate. If everything goes as planned, we could see a resource revision by late summer or early fall.
TGR: I want to ask you about your target price for La Quinta but you don’t call it a target price. Ubika calls it a “model price.” Please briefly explain that.
VR: The Ubika “model price” is based on our valuation methodology. We do not say that is our “target price” because we are not in the business of offering targets or recommendations. We just say that, based on our analysis, the company model price should be $X.
TGR: So what’s Ubika’s model price for La Quinta?
VR: Our model price for La Quinta is $0.23. The stock trades about $0.08 currently, so there’s a bit of upside based on a very conservative assumption of the company’s current resource and what we think the resource could be in 12 months.
TGR: Another company you talked about in that same interview was VG Gold. Since then, VG has merged with Lexam Explorations. What did you make of that deal?
VR: We started coverage on VG Gold back in July 2008 when it had a $20 million market cap. Once the merger with Lexam Explorations was concluded, the new company emerged as Lexam VG Gold, Inc. (TSX:LEX; OTCQX:LEXVF; Fkft:VN3A) and now the market cap is close to $225 million. More and more investors are warming to the idea that Lexam VG Gold is moving in the right direction. Mr. Rob McEwen, who is the former chairman and CEO of Goldcorp Inc. (TSX:G; NYSE:GG) and probably one of the best gold mining investors on the planet, owns close to 30% of the company. He is also the non-executive chairman. By making that investment and being on the board, he’s basically saying that this is one of the most-promising companies in the Timmins Gold Camp.
The merger allows Lexam VG Gold access to more than $15M of Lexam’s capital. This will really change the game for Lexam VG. Now, it can significantly expedite its exploration program. This company could become a company of choice for many people to get exposure to the Timmins gold exploration play.
TGR: Lexam VG’s focus is the Paymaster property, which is part of the past-producing Paymaster mine. Do you think that’s a possible takeover target by a company like Lake Shore Gold Corp. (TSX:LSG), which is operating near Timmins and generating a lot of cash flow?
VR: Probably not because we think VG has similar potential. Lake Shore’s market cap is $1.5 billion and it has a little more than 3 Moz. in known resources and reserves. VG already has gold resources of roughly 1.5 Moz. Lexam VG has four properties that it’s going to drill vigorously this year; it’ll add a lot of value at these gold prices. VG is getting about $140/oz. in the market in terms of market cap, whereas a company like Lake Shore gets about $550/oz.
Now, I acknowledge that Lakeshore has 1.8 Moz. in the measured and indicated (M&I) categories and has already commenced small-scale production, which is fueling strong interest in the company. However, there’s still a big valuation gap in terms of VG going to the next stage. I think this company’s market cap has the potential to go to $1 billion in a couple of years if it successfully executes its exploration strategy and expands its gold resource base.
TGR: Really?
VR: Yes. The potential is there, considering the vast support it has and all the exploration potential of its four properties—all of which are close to past- or currently producing mines. You couldn’t ask for a better address than Timmins.
TGR: What about Goldcorp as a potential suitor?
VR: Goldcorp is more likely, but I think a company like Lexam VG Gold would probably hold out for a longer time and build more value before agreeing to be acquired.
TGR: So, in the meantime, Lexam VG will continue to derisk Paymaster and its other properties through drilling and further exploration.
VR: Yes, exactly. It’ll keep exploring, building resources, moving resources from the inferred category into M&I and, potentially, move resources into reserves as the company evolves. That will build value because, on average, you may get $75–$100/oz. in the market for inferred resources but $150–$200/oz. as you move those resources into the M&I category.
TGR: And we know Goldcorp is willing to pay high prices for ounces in the ground given the $3.5 billion it paid for Andean Resources. What’s the Ubika model price for Lexam?
VR: Lexam breached our model price handsomely. We’re reviewing that price because a lot has changed since we first came out with it two years ago. Our new model price on LEX is $1.87.
TGR: Let’s move on to the Ubika Gold 50 Index comprising 50 high-potential junior gold explorers. The companies on that list were up a combined 99% in 2010. Why did you start your index?
VR: We had quite a few very promising junior gold explorers and companies under coverage, so we decided to launch an index. As you know, it’s not easy to find a list of 50 promising companies in the junior gold exploration space. We launched it in February 2010 and it has done very well.
TGR: Could you give us a few of the Index’s more promising names?
VR: There are quite a few, we have extensive coverage on some of these companies. HY Lake Gold Inc. (CNSX:HYL; Fkft:HYK) is a good example. It’s a small-cap junior explorer active in Ontario’s Red Lake District, one of the most prolific gold belts in Canada and home to Goldcorp and Rubicon Minerals Corp. (NYSE.A:RBY; TSX:RMX). Some of the other companies in that area include Claude Resources Inc. (TSX:CRJ; NYSE.A:CGR) and Premier Gold Mines Ltd. (TSX:PG).
We believe Hy Lake has one of the best properties packages in Red Lake and is one of the most undervalued and unheard stories out there. The company trades on the CNSX Exchange—an exchange for juniors in Canada—but it filed a listing application with the TSX Venture Exchange and is expecting that listing very soon. That will change the company’s profile. The market is taking notice already and Hy Lake’s market cap actually tripled during the last year to about $20M. But perhaps the most interesting thing about Hy Lake is that its flagship property, Rowan Property, is a JV with Goldcorp. Hy Lake has already earned its 60% option and soon it will be announced that Hy Lake is the operator of that project with Goldcorp having a 40% stake. There aren’t many junior gold explorers that have Goldcorp as a JV partner. We think it’s a very neat story with strong projects and a strong management team. The company’s worth watching, as it charts a new course in its corporate evolution. We think the year 2011 could be a transformational year for Hy Lake and a year of strong growth.
TGR: What’s your model price for Hy Lake?
VR: It’s $0.81 and it trades around $0.45–$0.50 right now.
TGR: What are a couple of other Index names?
VR: Another company we recently started coverage on is Gowest Amalgamated Resources Ltd. (TSX.V:GWA)—another very promising junior working in the Timmins area. Gowest has a high-potential property called the Frankfield Easter Gold Project, located near current and past-producing gold mines. It already has an NI 43-101-compliant resource base of 0.5 Moz., which we expect will increase significantly once the company gets a revised resource estimate based on recent drilling data. What we like about the Frankfield project is that the mineralization shows very impressive continuity. You won’t often find deposits like that. The grades are very consistent, 6–7 grams per ton (g/t), and it’s open at depth in all directions. We really like the company. Gowest has real potential to build the resource base and move those inferred resources into the M&I category. That will really build value.
TGR: Who’s involved in management there; anyone noteworthy?
VR: There are some people who came from a company called Castle Gold, which was sold about two years ago. But those guys started Castle Gold from scratch and ended up selling it to Argonaut Gold Inc. (TSX:AR) I believe for $150M or close to that. Greg Romain is Gowest’s CEO and Darren Koningen leads the exploration team. We like management’s no-nonsense approach, which focuses on building ounces and exploring the right way.
TGR: What’s the Ubika model price on Gowest?
VR: It’s $0.80, and it currently trades at around $0.32–$0.33.
TGR: Perhaps one more before we let you go, Vikas?
VR: Sure, I’ll give you two. One is a Colombia-based junior gold explorer called Seafield Resources Ltd. (TSX.V:SFF). We initiated coverage in November 2010. The interesting thing about Seafield is that it’s the largest landholder in the upcoming gold exploration belt called Quinchia District. Its Quinchia gold-copper project is within the Mid Cauca porphyry corridor, the site of a number of large new open-pit gold discoveries. There is an up-and-coming gold belt there with several very promising companies in that region, including Medoro Resources Ltd. (TSX.V:MRS). And Seafield has a land package that is kind of in the same neighborhood. Quinchia is becoming increasingly important. Last month, Seafield announced a major intercept of 449 meters of 1.3 g/t on the Miraflores target. That’s like half a kilometer of 1.3 g/t, which is fairly good grade.
TGR: Is that true width?
VR: Actually, the intersection was 449 meters of 1.3 g/t. Obviously, it included some sections that were very high grade but the average grade was 1.3 g/t. Just last week, Seafield announced some follow-up drill results from other holes on the same target and, again, very encouraging results. That is just one of the targets; it has several others on the property and already has an NI 43-101-compliant resource of close to 800,000 oz. (800 Koz.) Based on the recent drill results, we believe there could be a multimillion-ounce deposit at various targets on this property. Seafield trades at a very low level versus its peers, but we think that will change as the company expands its resource base and moves further along the exploration curve.
TGR: What’s your model price on Seafield?
VR: For Seafield, our model price is $0.79; but based on the recent drill results and the other things that have happened in the last few months, we may come out with an updated model. It’s currently trading around $0.45.
TGR: And one more?
VR: Another company we have been following for some time is Paramount Gold and Silver Corp. (TSX:PZG; NYSE.A:PZG). This high-profile company has multimillion-ounce, advanced-staged projects in Nevada and northern Mexico and already has more than 4 Moz. in NI 43-101 resources.
TGR: Are those inferred resources?
VR: Its resources are in both inferred and M&I category. Paramount is not under full coverage but we’ve been watching this company and know a fair bit about it. It’s exploring in an area populated by established gold companies like Goldcorp, Alamos Gold Inc. (TSX:AGI) and Gammon Gold Inc. (TSX:GAM; NYSE:GRS). We think Paramount has the potential to become the next big thing, in terms of an advanced-stage gold explorer. It already has a $500M market cap, and we think it’ll likely go to the next stage of becoming one of those high-profile companies like Lake Shore Gold, for example. The management team is very strong and has been doing a great job of understanding the geology. Paramount’s immediate neighbor is Coeur d’Alene Mines Corp. (TSX:CDM; NYSE:CDE).
TGR: Coeur d’Alene is a silver miner, so if it’s next door there must be silver in the deposit.
VR: There is silver in the deposit but Paramount’s project is more a gold-silver than silver-gold property in terms of potential. But if you look at current silver prices, it’s becoming a very attractive play in itself.
TGR: Generally, when you find a gold-silver deposit it contains significantly more silver than gold.
VR: That’s correct, in terms of volume. The known resources for Paramount are 4.5 Moz. gold and 12 Moz. silver.
TGR: And the model price for Paramount?
VR: Actually, we don’t have a model price for Paramount because it’s not under full coverage. But, as I said, we are watching this company closely. It’s part of our gold index.
TGR: What should our readers expect to happen with the gold price over the next 6–10 months?
VR: Gold is in a sweet spot right now—it’s a hedge against risk, a refuge for people who are worried about risk. Then, down the road, you have inflation. I wouldn’t be surprised if gold keeps growing by 10%–15% on a yearly basis for the next few years as it has for the last five or so. We started this year at $1,350/oz. and the gold price could very well go to $1,500/oz.–$1,550/oz. by year-end. Then, it could be looking to build on those gains. Don’t be surprised if you see gold around $1,800/oz. in a few years.
TGR: Thank you for talking with us today, Vikas.
Vikas Ranjan is a management and investment professional with over 15 years’ experience in diverse areas of investment management, finance, customer analytics and investment research. He is a principal of Ubika Research, a specialized research and analytics company with a wide range of small-cap clients and operations in Toronto and Vancouver. His previous experience includes various management positions in companies such as TAL Global Asset Management and Bank of Montreal. He has a strong knowledge of financial markets and has researched and analyzed companies in diverse industry sectors and markets. He holds a bachelor’s in economics (Hons.), masters in management studies from University of Mumbai, India and an MBA in finance from McGill University. Prior to cofounding Ubika, Vikas cofounded P2P Systems Inc., which was acquired by Toronto-based technology company, Microforum Inc.
By Ajay Shah, on March 1st, 2011
By B.P.T., on March 1st, 2011
The figures for motor vehicle sales in February will be released today. The consensus estimate is that 9.5 million domestic autos were sold last month, which would be an decrease of 100,000 from the previous month.
At 7:45 AM EST, the weekly ICSC-Goldman Store Sales report will be released, giving an update on the health of the consumer through this analysis of retail sales.
At 8:55 AM EST, the weekly Redbook report will be released, giving us more information about consumer spending.
At 10:00 AM EST, the Construction Spending report for January will be released, and the consensus is that there will a decrease of 0.8% in spending compared to the previous month.
Also at 10:00 AM EST, the ISM manufacturing index for February will be released. The consensus estimate is that it decreased 0.3 points last month to a value of 60.5, and will continue to signal economic growth as it remains above the mid-point of 50.
Also at 10:00 AM EST, Federal Reserve Chairman Ben Bernanke will give his semi-annual monetary policy report to the Senate Banking Committee
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