By The Energy Report, on April 13th, 2011
Portfolio Manager and Founder Josh Young of Young Capital Management (YCM) looks for value in oil and gas exploration and production (E&P) companies. In this exclusive interview with The Energy Report, Josh discusses some of his best ideas—strategies that could well deliver the significant upside and reduced risk investors might not expect from natural gas producers.
The Energy Report: Are you overweighted to natural gas right now?
Josh Young: Yes, at the moment, I am. It’s challenging right now because natural gas prices are low, so companies aren’t making a lot of money drilling for gas. In such an environment, there are strong incentives for nat gas companies to diversify their product mix and improve margins by drilling for oil; and the market is rewarding companies that manage to increase oil production and improve their margins with substantially higher stock prices. As gas companies have transitioned a portion of their production to oil, their stocks have outperformed significantly; in fact, they’ve been the highest-performing stocks across this space over the last year or two. And, generally, the ones that have transitioned have retained their upside potential from exposure to gas prices, which, historically, are cheap versus other energy sources like oil. That is part of what has driven their stock price outperformance.
TER: I hate to overuse the term “value,” but I’m guessing that your investment theory here is that gas is a value-rich universe.
JY: Yes. Actually, it’s sort of interesting because there’s been a bifurcation in valuation based upon the size of the company. The larger companies that are followed closely and are better understood have started pricing in fairly high natural gas prices, and that correction is already priced in. The market is already expecting gas at $5–$6 per thousand cubic feet (tcf)—and higher in some cases, depending on the stock. So, for me, it’s almost like getting a free ride on the backs of smart, large investment funds that are bidding up the stocks of these big companies based on expectations of the natural gas curve. Typically, these large investment firms can’t invest in the smaller companies that I follow.
Smaller investors have been slow to follow this investment trend, so the shares of smaller natural gas companies haven’t gotten bid up in a same way similar to the larger ones. That’s part of what’s created this tremendous, and I think temporary, dislocation. Also, despite superior performance versus the market and other larger hedge funds, it is a very challenging time for small funds to raise capital—especially in the oil and gas (O&G) space.
As capital has flowed to larger funds, it has been deployed to buy stock in larger-cap companies. This has helped feed the current valuation discrepancy. It has been a temporary phenomenon, as allocators to funds are beginning to overcome their inhibitions toward investing in smaller funds in favor of the (generally) higher returns and lower risk available in those funds. Between additional funds flowing into smaller funds that invest in smaller companies, and larger funds “stretching” and starting to buy stock in smaller-cap companies, there is the chance for a substantial correction in this valuation gap. Of course, many of the companies I’m invested in are going through a transition process, which should drive substantial value creation and share price improvement regardless of fund flows into the space.
TER: The whole area of natural gas sounds counterintuitive to me. That must sound like a bullish signal for you.
JY: Well, that’s the interesting thing—natural gas isn’t out of favor, really, only certain smaller nat gas stocks are out of favor. If you look at companies like Ultra Petroleum Corp. (NYSE:UPL), Range Resources Corp. (NYSE:RRC), Southwestern Energy Co. (NYSE:SWN), Cabot Oil & Gas Corp. (NYSE:COG) or EQT Corp. (NYSE:EQT), they’ve all traded up. These stocks are trading with rich earnings and cash flow multiples and are at or near their 52-week highs. So, it’s more of a big versus small arbitrage than it is oil versus gas. I don’t even have to be a contrarian; I get to make a bet that other smart investors with substantial research resources are already making and I get to take advantage of their inability to invest in smaller company stocks.
TER: Josh, you worked in a private equity firm in Los Angeles where I’m guessing you crunched a lot of numbers. There were no quarterly reports, conference calls, analyst days or 8-Ks for reporting unscheduled material events. What did you learn in doing due diligence, and how did that experience inform what you do today?
JY: It definitely had an impact on my research process. Between my experience in private equity and subsequent experience investing money for a multibillion-dollar single-family office, I learned to do detailed research. I was identifying and quantifying value drivers and risk factors to develop an independent and, sometimes, contrarian view of a company.
TER: Original research is what you have to do.
JY: Yes, original research and also applying appropriate valuation methods. But, you know, I’m not reinventing the wheel. I’m applying what I’ve learned, in an innovative way, to these smaller- and micro-cap companies. I pay attention to what both the market and Wall Street want, from a financing perspective. I’m also focusing on what the larger companies want, from an acquisition perspective, and translating that knowledge over into investments in the smaller-cap space. Then, obviously, I’m interacting with the smaller company executives to understand what they’re thinking and how they approach things. It’s a multifaceted approach to find value in a niche.
TER: Where can value be found?
JY: I’m interested in finding really significant mispricings. And in the smaller cap O&G space, there are some great value opportunities—particularly in companies going through transition processes. One example is a company I’m investing in that’s in this process of transition; in fact, it’s practically a textbook case for transition. Most investors who have heard of it haven’t looked at it in a few years because it was a mess—it was overlevered and was forced to sell one of its core assets to pay down that debt. It was asset rich but did not have a lot of production, and it was forced to take meaningful write-downs on the book value of those assets. And it was producing 100% natural gas in a rising-oil-price/falling-gas-price environment.
Today, the story is different and the market is just beginning to recognize that. The company sold an asset and, virtually, has no debt. It joint ventured (JV’d) an asset and is in the process of ramping-up production. It has major liquids discoveries in both of its core assets and will be increasing the percent of its production coming from liquids and oil substantially and is the most levered company on an acreage versus enterprise value (EV) basis to the Marcellus Shale. The company is trading for a fraction of the valuation of other Marcellus companies and the market misunderstood its recent oil discovery, which could move the needle significantly.
The company, Gastar Exploration Ltd. (NYSE:GST), also has 17,000 acres of the lowest-cost onshore dry gas play in the U.S.—80,000 net acres in the Marcellus and a JV that will be funding the majority of the 8–10 net wells it is drilling primarily in the liquids-rich area of the play in 2011. Gastar has an oil discovery in East Texas with 30 locations and substantial potential value from the development of that play, which the market does not seem to understand and has yet to price in. And it has 17,000 net acres prospective for oily Eagle Ford and Deep Bossier gas, which is widely recognized as one of the lowest-cost natural gas plays in the U.S.
Gastar trades at a big discount to its Marcellus-levered peers, such as Cabot, EQT, Range Resources, EXCO Resources Inc. (NYSE:EXCO), etc. In fact, it trades at almost one-quarter the price per acre, despite having similarly prospective acreage. This value gap should close as the company drills numerous wells this year, most of which will be funded by a JV agreement it entered into last year, and ramp-up its production and cash flow.
That doesn’t even consider Gastar’s recent oil discovery in East Texas, which could contribute substantial additional value. The company recently announced a Glen Rose well producing 250 barrels of oil per day (bpd) and 1,300 barrels of completion fluid, with inclining oil production. Generally, as a well produces, the amount of completion-fluid production declines and the oil production inclines. From some of the wells I’ve seen, the initial production (IP) rate on this well could be over 500 bpd with an implied EUR (estimated ultimate recovery) of more than 250,000 barrels of oil. For a $4 million per-well cost on the 30 remaining locations, this could significantly shift Gastar’s production toward oil and lead to a substantial revaluation of the company after the official initial production rate of this well is announced.
TER: Gastar is up 25% over the past six months but flat over 12 months.
JY: It is; and despite the recent move, it hasn’t come close to my estimate of its intrinsic value or where I think it could trade at in the near term. When I think about the transition Gastar is making, I think about companies like Approach Resources Inc. (NASDAQ:AREX), which was very similar to Gastar. Approach was in a conventional natural gas field and was having trouble growing production and making the economics work. Although the well economics were great at the well level, it was just hard for a company of its size to really make it work. Then, Approach figured out that it had some oil under the areas it had been drilling for gas; so, it started drilling for oil and the wells came on great—similar to Gastar.
As Approach started showing good wells, its stock went from $7 at the time to the current price of around $29—in just over nine months. You can look at Gastar’s history, metrics and chart and see that it has a lot of characteristics in common with Approach and some of the other companies that have gone through similar transitions, such as Brigham Exploration Co. (NASDAQ:BEXP) or Magnum Hunter Resources Corp. (NYSE.A:MHR), or companies in the process of transition like Double Eagle Petroleum Co. (NASDAQ:DBLE). Gastar’s stock has a high probability of outperforming in a similar manner.
TER: Is Gastar your favorite play?
JY: It’s one of my largest positions, and it’s among my favorite investments at the moment. Another favorite investment at the moment is Molopo Energy Ltd. (ASX:MPO), which has the distinction of owning assets in some of the best-known plays with some of the best-known economics while being one of the least-known stocks. It has over 50,000 acres in the Bakken formation and over 17,000 acres in the Permian Basin. It’s actually right in the middle of Approach’s Wolfcamp oil play and has over 750 billion cubic feet (bcf) of 2P gas reserves in Australia, ready to meet the growing energy needs of Asia. Activist investors came in, kicked out the old management team and installed a new team and a new board—but only after prior management monetized the only existing production it had. Molopo owned the Spearfish play in Canada, which it sold to Legacy Oil & Gas Inc. (TSX:LEG). The company’s known for that but, otherwise, few people have heard of it.
TER: Why has it been so unloved by the market?
JY: One reason is that the old management team got kicked out, which led a number of shareholders who were close with the old management to sell. Secondly, it’s an Australian-traded company with Australian, U.S. and Canadian assets, and management has not done a good job in approaching the Canadian or U.S. investment communities. I know almost no one who has heard of the company here in the U.S. or in Canada. But the company’s in an interesting situation because it has a market cap of just over $220 million, with around $200M cash and marketable securities, and no debt. So, it has all these assets all in the right places and, historically, has gotten great returns on investment (ROI) in identifying, developing, and then monetizing plays.
TER: Molopo is among your largest positions, right?
JY: Yes, it is. I like it because it has all this asset value and upside. I try to figure out how I can lose money owning the stock, and I have trouble seeing significant fundamental risk in the company. Gastar and Molopo are my favorite investment ideas. I think they both meet this template of companies in transition. And they’re both trading at very large discounts to their peers in their respective plays, as well as to their intrinsic values. Both companies have the potential to be multibaggers over a relatively short period of time.
One other aspect to Molopo’s story worth discussing is its exposure to Asian energy demand. Specifically, in the aftermath of the terrible tragedy in Japan, demand for liquid natural gas (LNG) has shot up; and the value of LNG feedstock in politically stable countries in close proximity to end markets has likely also increased substantially. Look at companies like INPEX Corp. (OTCPK:IPXHY), which supplies LNG to Japan, or Sentry Petroleum Ltd. (OTCBB:SPLM), which has no proved or probable reserves but has acreage near Molopo’s and a valuation of over $150M. Its recent, significant stock price movements should give you an idea of how Molopo’s significant 2P reserve base should be valued—and it’s effectively getting zero value in today’s stock price.
There are a couple of Canadian companies that are also interesting and aren’t very well understood or closely followed here in the U.S. There’s Equal Energy Ltd. (TSX:EQU; NYSE:EQU), which is in some of the most interesting unconventional oil plays. It’s in the Viking and Cardium oil plays, the latter of which is a play that’s very similar to the Bakken in Canada. It’s also in the Hunton Dewater play here in the U.S., which is sort of hard to explain, but it’s a liquids-rich play. In addition, Equal has exposure to about 15,000–20,000 net acres in a Mississippi play that is becoming famous now through SandRidge Energy Inc. (NYSE:SD) and Chesapeake Energy Corp.’s (NYSE:CHK) activities.
Equal is growing cash flow by about 15%–20% per year. Production is flat this year, which is part of the reason I think it’s so cheap. It is trading for its proved reserve value, which is odd because, if you look at the value of its unconventional acreage, which is not included in its reserve value, it’s pretty easy to see that acreage being worth as much as it’s trading for. So, basically, Equal Energy is trading at one-half of its asset value and at a significant discount to comparable companies. The company is further along in the transition process than are Gastar or Molopo, but it still has substantial upside. I learned from exiting my position in Approach Resources early that there is often substantial upside to companies in plays with leading economics. Approach almost tripled after I sold it for a big profit, and I think Equal has a lot of room to trade up significantly and be priced appropriately relative to its peers.
The other Canadian company that’s particularly interesting is Galleon Energy Inc. (TSX:GO). One of the more fascinating things that I’ve seen in my investment career is what happened to this company when the Galleon Group got indicted by the SEC. As it started getting press around this indictment and the ensuing trial, you could see GO start trading down with no fundamental news, and then not participating in the upward stock moves of many of its peers as oil prices moved up over the past few months. Obviously, the company has no association with the Galleon Group hedge fund management firm in New York. Galleon Energy has fewer specific catalysts versus these other companies I’ve mentioned; so, it is possible for GO to trade at a lower valuation for longer. But on the flipside, it has so much cash flow and trades at such a low multiple compared to that cash flow that, ultimately, it will get rectified.
TER: How have some of these names performed since your last interview with The Energy Report?
JY: A few of the names I discussed in the last interview worked out really well. One of the companies I talked about was Lucas Energy Inc. (NYSE.A:LEI), which is a micro-cap oil and gas company. Through its residual or historical activities, the company built up an interesting land position in the oily part of the Eagle Ford Shale.
TER: I realize this is a true micro-cap company, but it’s up three-and-one-half times from 12 months ago. Do you still see value?
JY: Well, I didn’t say I still own a lot of stock. I said that it’s worked out really well. The company has great acreage at this point. It has real production and is growing that production. But I think it’s a little bit further along in its transition and is being valued in line with its recently increased production and the improved value of its acreage.
Cabot was another company I talked about in the last interview that worked out really well. It had traded down because of an error. It’s almost like the Galleon story where it traded down for a reason that was almost unrelated to the company.
TER: Do you still own shares in Cabot?
JY: No, I don’t. I sold my Cabot stock and I used the proceeds to buy additional shares of Gastar, which I think is trading at a much more compelling valuation. I also talked about RAM Energy Resources Inc. (NASDAQ:RAME), which was pretty interesting and did very well. It was around $1.60 when I told The Energy Report about it. It traded up to $2.50 and is now around $2.04. I still own some but I sold most of my position as it approached $2.50 and got closer to fair value.
TER: Any new ideas you’d like to share with our readers?
JY: There’s one other company I wanted to talk about that I own now that I haven’t talked about before. It’s U.S. Energy Corp. (NYSE:USEG). It did the original JV with Brigham in the Bakken, which helped Brigham unlock the value of its acreage. Right now, it’s trading at a big discount to a lot of the other Bakken companies on a production, cash flow and per-acre basis. In addition, it owns a molybdenum mine, which makes things a bit complicated for oil and gas investors. That’s because people who invest in mining companies don’t typically invest in O&G and vice versa. But, it looks like that moly mine is worth a lot of money, and it looks like the Bakken acreage and production are worth a lot of money. If you add the two together, it seems to be worth much more than what I’m paying for at the current stock price.
TER: Josh, I’ve enjoyed meeting you very much. Thank you for taking the time.
JY: Thank you.
Josh Young is an honors graduate of the University of Chicago, where he majored in economics. Before founding his own investment management partnership, he worked with Mercer Management in Chicago, after which he joined a private equity firm in Los Angeles. He also worked as a buy-side analyst and money manager in a single-family investment office with more than $1 billion under management.
By Doug Gentry, on April 13th, 2011
As of February 2011, the Consumer Price Index has gone up 2.1 percent in the preceding 12 months. Core inflation (All items excluding Food and Energy) went up just 1.1%. Inflation is certainly not beating at the door. On the other hand, global food commodity prices have been rising suddenly as have oil prices. In class we talk about how the All Items CPI is important, but that the Core CPI is a better measure of broad-based changes in prices.
The modest inflation measures will change in the future. We almost certainly should expect prices to rise more rapidly. We just don’t know when, or for how long.
 Aggregate Demand and Aggregate Supply This blog post by economist Tim Duy has a very thorough and clear explanation of some of the forces gathering on the inflationary front. He presents this as a way to help understand the decisions and debate within the Federal Open Market Committee (FOMC) in the months to come. Though clear, his explanation requires an understanding of aggregate demand and aggregate supply curves. So, for my students, mark this post and come back to it once we’ve covered those subjects.
For any reader, here are the summary conclusions that Duy reaches:
We can track the path of the prices and output and explore the positions of Fed officials within a fairly simple framework. That framework suggests that the economy will experience a temporary period of accelerating inflation as it returns to potential (we should be so lucky, quite frankly). There doesn’t seem to be much debate at what speed this will occur; Fed officials appear comfortable with growth expectations around 3.7% this year. What does seem to be an issue of debate is the size of the unemployment gap. If we are close to the natural rate of output, excess monetary stimulus is close to triggering the fabled wage-price spiral. If far away, there is plenty of excess capacity and thus no need to tighten quickly. Indeed, tightening policy too soon would only entrench disinflationary expectations. Fed officials appear to be splitting along these two basic views of the world, with one side seeing recent price increases as consistent with their inflationary nightmares. I tend toward the other, which I also think will be the dominate view at the FOMC.
And here is my translation:
- The Fed expects economic growth to continue, and even at a somewhat faster pace.
- Our regular models suggest that this continued growth will put upward pressure on prices.
- One big unknown is whether there is a lot of unused capacity in our economy – particularly among workers.
- If there are a lot of workers who can be put back into production, without much training, we have plenty of unused capacity which will soften inflation.
- If those workers who are still unemployed have the wrong skills or geographic location, our unused capacity is smaller.
- As we use up our capacity and get closer to full economic production, we get closer to the danger of a wage-price spiral that would cause inflation to increase significantly.
- Some members of the FOMC fear we are close to capacity and that any more moves to stimulate the economy will trigger that wage-price spiral.
- Other members of the FOMC are less worried about inflation and instead fear that a cutback in stimulus efforts will stall the recover.
- Duy predicts that the inflation hawks (the first group) will be outvoted by those worried about recovery.
For my students – this is a bit more complicated than we handle in a Principles class, but a good way to test your understanding of aggregate demand and aggregate supply.
By B.P.T., on April 13th, 2011
The Mortgage Bankers’ Association purchase index was released at 7:00 AM EDT, and there was a week to week decrease of 6.7% in the Purchase Index and a week to week decrease of 7.7% in the Refinance Index.
At 8:30 AM EDT, the Retail Sales report for March will be released. The consensus is that retail sales increased 0.5% , after a 1.0% increase last month.
At 10:00 AM EDT, the Business Inventories report for February will be released. The consensus is that inventories increased 0.8% from the previous month.
At 10:30 AM EDT, 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 EDT, 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 The Gold Report, on April 12th, 2011
How has the increase in government in the last 150 years driven precious metal prices? In this exclusive interview with The Gold Report, Leonard Melman, editor of The Melman Report newsletter and the author of Reverse the Way In, discusses why he recommends precious metal stocks, but advocates changes in monetary policy that could diminish the price of gold.
The Gold Report: Your report is a hot commodity in the mining space. You also recently published a book, Reversing the Way In. Can you tell me about it?
Leonard Melman: It amounts to this: I believe the world has too much government. I don’t think too many people would argue about that, except the dedicated leftists. Two phases have occurred in the last 300 years to create our present situation. The first, from 1700 to 1850, was immensely positive because the principles of real liberty became established. Authors like John Stuart Mill wrote about the tremendous benefits of economic liberty combined with individual liberty. Freedom became dominant and life improved dramatically.
But then people like Charles Marx came in and provided the social justification for increased government intervention. Politicians began to try to create happiness through laws and regulations aimed at improving peoples’ lives. Woodrow Wilson almost singlehandedly transformed the U.S. government from free enterprise into government controlled. John Maynard Keynes gave the economic justification for larger government. Franklin Roosevelt took Keynes’ philosophies and translated them into political action to enlarge government.
For the last 150 years, we have been enlarging government. I believe the solution to the problem is to reverse that way in, to start diminishing government and reduce its stranglehold over commerce.
TGR: You obviously see this as a major problem. Is that what prompted you to write the book?
LM: The biggest passion in my life is individual liberty. I don’t think a person is free when his whole life can be dominated by government. We are subject to government laws in so many directions. All of these laws require money to enforce and operate. The government has to extract more taxes. It’s creating tremendous economic difficulties because government has no way to tax people sufficiently to support itself. That’s why debt levels around the world, for governments in country after country, are exploding. It’s an unhealthy environment. I think we need a restoration of freedom. That was the purpose of writing the book.
TGR: One theme you discuss is that our freedom will continue to erode if U.S. monetary policy continues down its current path. But that path is ultimately good for gold and other precious metals. How do you on one hand recommend gold and precious metal stocks in your newsletter, and on the other hand advocate change in monetary policy that, if successful, would diminish the price of gold?
LM: It’s an unfortunate reality. A precious metal investor who expects the price of gold and silver to go up should also be expecting an increase in social and economic problems.
The investment side of me says, “Yes, gold and silver prices will go up because the trends moving in that direction are so powerful.” The libertarian, freedom-loving side of me says, “I would rather have a world of freedom if it’s possible to achieve it.” There is a direct contradiction in those two statements and I’m aware of that.
Just think back to the Ronald Reagan era. In 1980, the world was headed into ultimate calamity. Gold shot up from $106/oz. in 1976 to more than $800/oz. in 1980. Reagan came along and tried to crunch down, limit the growth of government, reduce inflation and reduce monetary growth. He was relatively successful, and a period of stability was obtained. Of course, gold and silver did horribly during that time, even though the country was generally becoming a better place to live.
There is a contradiction between the two. But I am advocating gold and silver because the forces behind monetary expansion are so strong that they’re going to continue. The forces for expansion of government still remain powerful because of its ability to create money. The public believes that we can keep adding social programs to the list and the government will find a way to finance them as long as it can print more money. As long as that mentality remains in effect, gold and silver are going to achieve great heights.
TGR: Last spring, Greece needed a bailout from other eurozone countries. It created panic that sent global markets into volatility. Now, Ireland requires an extra $34 billion in bailout cash from the European Union. Portugal seems headed for a bailout, too. But this time, there’s little panic. What’s your view on what’s happening there?
LM: The European monetary crisis is in its early stages. Portugal is headed toward a calamity. Italy is also very weak. Spain is showing real signs of deterioration. In fact, its bonds were downgraded by both Standard & Poor’s and Moody’s. There is no question there is a growing crisis.
There have been many panic calls from the media and mining investment gurus saying, “This crisis is the end, head for the hills!” None of those calamities have ensued. It’s going to take one of these calamities to actually evolve into a catastrophe before people will really pay attention.
Underlying it all is this residual faith that the government can still handle calamities as they come along by some legislative manipulation or by monetary creation. Until that underlying faith is broken, I don’t think we’ll see the worldwide panic some are predicting.
TGR: The June COMEX gold chart says there’s support for gold at $1,411/oz., but there’s technical resistance above $1,450/oz. Do you put much faith in the technical charts?
LM: Absolutely. Charts tell what people are doing. I’m always much more interested in what they’re doing than what they’re saying. If there is a rush to buy something, it’s going to show up on the charts. Charts create a clear determination of what real action is taking place. Of course, I choose my investments through thorough fundamental analysis, but charts are a tremendous aid in my investment strategies.
TGR: Do you agree with COMEX’s forecast?
LM: In my annual forecast, I actually call for gold to be relatively static during the first half of the year, but to move toward $1,850/oz. by the second half of the year. I think faith in government is starting to deteriorate. It’s evident in the tremendous gulf between unionists and anti-unionists, the failure of QE1 and QE2 to produce prosperity, the tremendous tower of debt that’s growing around the world. However, it hasn’t yet reached the tipping point. In the second half, there is going to be a breakout and it’s going to be a powerful one. Gold could move toward $1,800 to $2,000/oz. by the end of the year.
TGR: What’s your range for silver over the same period?
LM: The range is between $35.50 and $38/oz. Silver may trade with a little more volatility on a percentage basis than gold. In the second half, silver could move towards $45 to $50/oz..
TGR: Faith in government may be deteriorating, but there were 216,000 new jobs in the U.S. in March—the sixth straight month of increases. It seems like the recovery continues to gain momentum.
LM: I don’t know how much I trust government figures. They keep changing the parameters and adding special factors, so the figures get a little mushy. Since 2008, the U.S. government has undergone stimulative programs far beyond the scope of anything that has ever occurred. Frankly, if this is the only result from literally trillions of dollars of stimulus, then it’s not much of an achievement.
The government has not yet proven the effectiveness of its programs. I will certainly acknowledge that the results that have come in the last six months are better than what went before. But the world is still vulnerable to a sudden downturn in the economic picture. I think that’s going to happen. And that’s what is going to break the faith.
TGR: In a recent edition of The Melman Report, you recommended investors take flight to the safety of precious metals if such an economic downturn occurs. What percentage of an investment portfolio do you recommend ought to be in precious metals?
LM: It depends entirely on a person’s objective. If an investor is interested in preserving wealth in case of a catastrophe, they want physical gold, and silver and copper coins hidden in a secret place that only their family knows. They might want to leave gold coins on deposit in a bank or another secure facility. They might simply want to buy and sell gold futures and get a dollar-for-dollar play through non-leveraged investments. It just depends on how much risk an investor is willing to accept, and there’s always the reality that the greater the profit, the greater potential for risk.
For myself, I enjoy trading long term in the money call options on stocks, which appear to have a sound future. I think that gives the best bang for the buck, while still maintaining a good degree of safety.
TGR: The Melman Report focuses a lot on mining equities, mainly in the small-cap space. Could you talk about some of your favorite small-cap names in precious metals?
LM: I like companies that have already moved projects toward productivity. For example, there are two companies operating side by side in Guanajuato, Central Mexico: Great Panther Silver Ltd. (TSX:GPR; NYSE.A:GPL) and Endeavour Silver Corp. (NYSE:EXK; TSX:EDR).
Both of these companies acquired projects between five and seven years ago. They explored them. They developed the resources. They built production facilities. Now both are in actual production. With the price of silver exploding upwards, they are bringing in substantial cash flow. That cash flow is financing additional exploration and they are building reserves.
At the same time, they’re producing positive cash flow and profits. That’s a wonderful combination. That can take a company from tiny to midsize and advance it towards a large size. The stocks of both companies have been exceptionally rewarded.
TGR: Since Great Panther listed on the NYSE Amex, its market cap has doubled to almost a half-billion dollars.
LM: At the bottom of the 2008 markets disturbance, Great Panther shares dropped to as low as about $0.25. It’s trading this morning at $4.02. That’s a multiple of 16 times over. At the same time, Endeavour Silver shares have moved from similar low levels to $9.53.
TGR: Endeavour has another project in the pipeline as well.
LM: It also has the Guanacevi Mines project in Northern Mexico. It’s also a good cash flow provider and a significant profit contributor.
TGR: What about the management of Endeavour and Great Panther?
LM: I visited both companies, and I was very impressed with the caliber of the management. Both have years of experience. And not just a small amount of previous success. Everything I could see told me these are quality operations.
TGR: Any other interesting companies?
LM: Kent Exploration Inc. (TSX.V:KEX; OTCPK:KXPLF) has a multi-faceted story and projected cash flow is coming into the picture. Kent has three properties. Its barite project in Washington State is only about two months from production. It has a silver project in waiting in British Columbia. It also has a New Zealand gold mine that is under exploration.
The company also owns the rights to an Australian project. Kent spun out a new company called Archean Star Resources Inc. (TSX.V:ASP) that just started trading about a week ago at around $0.15 per share. Its project has great potential. It’s just getting underway with new rounds of exploration.
The barite project will provide it with a cash flow to continue exploring in New Zealand and to start developing the British Columbian silver project. It may spill over into the Archean Star project in Australia as well. The barite project will enable Kent to advance its other projects as quickly as possible without undue dilution.
TGR: The project that they have in New Zealand is near Reefton, a former producing gold mining district. Something like 10 million ounces have come out of the ground.
LM: Exactly.
TGR: Any other promising opportunities?
LM: I’ve grown very familiar with Commerce Resources Corp. (TSX.V:CCE; Fkft:D7H; OTCQX:CMRZF) through the years. Commerce’s main project was almost strictly limited to tantalum and niobium development in Blue River, British Columbia. However, the company has also advanced the Eldor Property in Québec as a rare earth elements project in the past year. The popularity of rare earth elements has generated a great deal of new interest in Commerce. The shares have advanced from about $0.25 to as high as $1 during the past year.
The Eldor Property is under the supervision of geologist Jody Dahrouge. I met Jody on a trip to Blue River. He strikes me as a serious, well-grounded geologist. I think the glowing reports that he signs can be trusted.
TGR: Commerce got some decent early results from Eldor. In the Ashram zone, which is part of it, it hosts an inferred resource of 117 million tons grading 1.74% total rare earth oxides. That’s a pretty good start.
LM: From the reading I have done on other projects, both the extensive amount of material and the grades are very high compared to other North American projects. The most attractive feature to me about rare earth elements is that China has been the great provider of these elements to the world market for the past several decades. China just said it is going to being reducing exports, which is going to leave several important industrial applications short in North America. Companies are going to be looking for supplies from North America. That should bring in purchase commitments and excellent financing to advance these projects as fast as possible.
TGR: Another advantage Eldor has is that it’s not nearly as remote as some other rare earth projects. Hydro-Québec infrastructure could limit costs compared to other players.
LM: Absolutely. The company is also ideally positioned near the St. Lawrence Seaway, so its products can be immediately shipped around the world. We’re only talking a few hundred kilometers between its site and cities such as Saginaw on the St. Lawrence River. Commerce is also very close to the huge industrial markets of Ontario, Québec, and the northeastern U.S. There are inherent advantages in the Eldor Property.
TGR: Do you know David Hodge, Commerce’s president?
LM: I’ve known Dave Hodge and several of his assistants, particularly Chris Grove, for going on 10 years. I meet with them regularly. Dave is a very enthusiastic supporter of mining. He is putting together a quality company that will be around for some time to come.
TGR: Could you give us a forecast of what you see happening in the precious metals and mining commodities spaces over the next four to six months?
LM: I have never seen a period of time in which there have been so many cross turns. The fires of inflation are starting to rise. I chart all the major grains, such as wheat, corn and soybeans. Those charts have headed higher over the last two years. Increased ethanol production is monopolizing huge acres of corn and leaving the rest of the world short of basic corn supplies. Because so much acreage is going to corn, it’s diminishing the acreage of soybeans and wheat, sending those commodity prices higher.
There’s also petroleum price inflation. The world uses 85 million barrels of petroleum per day. We are depleting the resource. The Ghawar Field in Saudi Arabia supplies about 6% of the world’s petroleum. It’s only still in production because water is being floated under the oil to raise it up. That can’t go on forever. Plus, there are the problems of debt around the world. The U.S. national debt is $14.2 trillion. It’s all very unstable. It’s coming closer to a point at which government simply will not be able to resolve these problems. We could have a truly chaotic situation. For that reason alone, I believe investors should be in gold and silver, not only for insurance, but for potential profits.
TGR: Thanks, Leonard.
Leonard Melman has been writing about precious and base metals for more than two decades as monthly columnist for California-based ICMJ’s Prospecting and Mining Journal and Vancouver’s Resource World Magazine. He focuses on how political and financial considerations impact the world of mining and the prices of the metals. Melman has also contributed commentary and corporate studies to other publications, including the Aspermont group of publications in Australia and DEL Communications in Winnipeg. Leonard is a speaker at Cambridge House conferences across Canada. He has visited and reported on mining operations on four continents, and his articles appear on numerous mining company websites. Previously, Melman was a manager of multi-million dollar consumer lending operations and a securities and commodity broker. Melman recently wrote his first book Reversing the Way In. He lives in Nanoose Bay with his wife, Thama.
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By Simon Grey, on April 12th, 2011
Later this year, the Obama administration and Congress will seek bipartisan votes to pass free trade agreements with South Korea, Colombia and Panama. With 87% of global economic growth over the next 5 years taking place outside of the United States, trade supporters believe these agreements will create jobs and prosperity by helping American companies tap into fast-growing export markets.
Opponents disagree. They argue that “NAFTA-style” trade agreements hurt rather than help the U.S. economy — and polls show that much of the public agrees.
But is this conventional wisdom correct? Or do trade deals work? As Washington gears up for hard-edged debates about trade, it’s worth exploring some common misconceptions about free trade agreements.
This line of argumentation reminds me of Milton Friedman’s attempt at defending central banks. Friedman took the approach that the free market was the bees’ knees at everything, except money. Likewise, trade proponents take the approach that the market is good, but then somehow manages to conclude that we need the government to step in and a) create an artificial legal entity (the corporation) and b) enter into trade treaties with foreign nations.
Somehow, all this government interference is defended in the name of the free market, and those who don’t accept this new gospel are branded as ignorant or worse. There is good reason to be wary of governmental interference, seeing as how virtually all interference is destructive, inefficient, or counterproductive.
If trade proponents are truly concerned about free trade, they would first oppose the massive tax and regulatory burdens placed on domestic production and trade. Then maybe their message of increased foreign trade would seem more sincere.
By B.P.T., on April 12th, 2011
At 7:45 AM EDT, 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 8:30 AM EDT, the Import and Export Prices index for March will be released, providing some data that can be used to monitor the threat of inflation.
Also at 8:30 AM EDT, the International Trade report for February will be released. The consensus is a deficit of $44.0 billion, which would be $2.3 billion less than the previous month.
At 8:55 AM EDT, the weekly Redbook report will be released, giving us more information about consumer spending.
At 2:00 PM EDT, the Treasury budget for March will be released. The consensus is a deficit of $189 billion, which is much larger than the historical average, and about $123.6 billion more than last March.
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By Simon Grey, on April 11th, 2011
Oh, and since only Republican talking points are subject to strict scrutiny from the “objective” press, let me quickly rebut Nancy Pelosi & Co.’s nonsense about “big oil.” Oil companies get the same business tax breaks as every other company. These are mostly what Democrats mean when they talk about giveaways to big oil. The Ryan plan would rightly eliminate many such breaks, while lowering the corporate tax rate to a level competitive with other industrialized nations. The only “road to riches” for the oil companies in the Ryan plan is its call to allow more oil drilling on America soil, which, yes, would generate profits for oil companies — and tax revenues for the government and jobs for Americans and lower gas prices, too. The villains. [Emphasis added.]
Congress closing loopholes and lowering rates is no guarantee of being competitive or getting revenue. Does anyone think GE will not try to hide even more money and capital overseas once it starts having to actually pay taxes? And what about any and all other companies that would see an effective increase in their tax bills?
The best thing for congress to do would be to eliminate corporate taxation (remember, it accounts for 4% of federal revenue) and close income tax loopholes. This would promote systemic efficiency while eliminating some corporate favoritism and welfare. It would also ensure that more people have skin in the game when it comes to spending, which should encourage more people to demand fiscal prudence. Quite simply, there is little point in trying to reform something that is trifling and inconveniencing at best, and destructive and counterproductive at worst. Ryan means well, but he has to stop getting caught up in trivial details. The problem isn’t that the corporate tax code isn’t refined enough; it’s that it’s pointless.
By Bron Suchecki, on April 11th, 2011
Very interesting article showing a good correlation between the author’s M3 Inflation figure and the gold price. His M3 Inflation is M3 growth minus 90 day bank bill rate. It seems the gold price lags the M3 Inflation figure by a few years, making it a potential macro gold price forecasting tool.
By The Gold Report, on April 11th, 2011
Vanadium, a gray metal mainly used as an additive to steel, could see a jump in demand as new technologies emerge in energy storage. In this exclusive interview with The Gold Report, Jonathan Lee, a battery materials and technology analyst with Toronto-based Byron Capital Markets, talks about which vanadium producers are ready to grapple with the prospect of increasing demand from the adaption of “green” uses.
The Gold Report: What are some development stories in the vanadium space that you’re covering?
Jonathan Lee: Largo Resources Ltd. (TSX.V:LGO) is one of the most advanced of all the juniors. At a 1.34% grade, Largo has the highest grade deposit of vanadium that is known right now. We currently have a Strong Buy on Largo Resources.
TGR: And that’s the Maracas project in Brazil?
JL: It is in Brazil. That deposit is one of the highest grade deposits in the world at about 1.34% vanadium pentoxide. We really like that story. Apparently, a lot of the banks do, too. The company already has debt financing in place. It already has an off-take agreement with Glencore International AG, the private metals trader that is planning on going public sometime this year.
Largo is currently doing an equity financing to raise the rest of the cash to build the open-pit mine. The construction is a two-year process, so the company should be ready to produce in 2013.
TGR: I guess only time will tell.
TGR: Have you met with the management of Largo?
JL: Yes, the company has a very strong management team. Mark Brennan, its chief executive, has been through the ropes before and has been successful.
TGR: He was part of Desert Sun Mining before it got taken out.
JL: Yes. The company also has Tim Mann as its chief operating officer, and Les Ford, who’s overseeing much of the metallurgical work. He has worked at Highveld Steel (Evraz Highveld Steel and Vanadium Ltd. (JSE:EHS), Xstrata Alloys (a subsidiary of Xstrata PLC (LSE:XTA) and Precious Metals Australia [now Atlantic Ltd. (ASX:ATI)], and has looked at the Windimurra project, so he definitely knows the vanadium industry. He’s very bullish on the Maracas project as well. The company has a lot of the ducks aligned in a row to get to production. I am not even sure it’s considered an exploration firm any more. I would consider it to be a mine developer at this point.
TGR: Okay. What are the other players in the junior space?
JL: Energizer Resources Inc. (CVE:EGZ) is another name we cover, but we have a Sell recommendation on it. It’s out of Madagascar and there is no question that its deposit is very large. But it’s not a typical magnetite deposit. The in-situ grade is about 0.70%. Typically in many of these projects that are magnetite projects, a company would upgrade the ore prior to the heat process. There’s a heating process where one has to heat it to anywhere from 700 to 1,200 degrees Celsius.
Energizer is unable to upgrade the material, so it can’t increase the grade going into the furnace. If the grade is increased, that decreases the amount of material needed to be heated for three hours. Energizer’s feed grade is 0.7%, whereas Largo’s feed grade is around 3.4%, so Energizer’s energy costs are going to be significantly more than many of the other projects. That’s one of the biggest reasons why we really don’t like the story.
The second reason is that the company could have additional costs because of a lack of infrastructure. It is dependent on the Sakoa coal project succeeding by coming on-line and building out the infrastructure that will supply a lot of the energy to run Energizer’s facility and rail to transport material. The company will have to negotiate a price to use the infrastructure. With those constraints, we are unsure about the prospects of the project right now.
TGR: Are you looking to pick up coverage of any other vanadium plays out there?
JL: We are always looking at companies in this space, but we don’t officially have coverage on other vanadium names. Two vanadium names out there include American Vanadium Corp. (TSX.V:AVC) and Apella Resources Inc. (TSX.V:APA; Fkft:NWN).
Apella Resources has a magnetite type much like Largo, but the grade is much lower, around 0.40%. There might be some problems with it being economically viable because the grade is lower. Apella has an iron-vanadium-titanium deposit. As a standalone vanadium deposit, it might be tough, but it might work as something more like an iron-vanadium-titanium project.
American Vanadium could be a very low-cost producer of vanadium pentoxide. It has a sedimentary deposit east of Reno, Nevada, called the Gibellini project. It’s interesting because it would use a heap-leach process, which is very different from other projects. The capital costs and operating costs are significantly less with a heap-leach project.
The company currently has somewhere around 6 to 10 years of mine life depending on its production rate. It is expanding exploration to increase mine life, partly by acquiring old drill core, and are making sure the additional resource is similar geologically so it can continue using the cheaper heap-leach process. It’s very encouraging that the company is able to have a low capital-expenditure project and a low operating-expenditure project.
Only time will tell. The company is expected to expand that additional resource shortly, which will undoubtedly increase the value, or extend mine life at least.
TGR: Do you have some words of wisdom for investors in the vanadium space?
JL: Vanadium is definitely tied to steel. If investors have faith in a bullish economy, increased construction, and therefore increased demand for steel, there will also be a need for vanadium. Investing in vanadium projects is almost like a call option on green technologies and clean applications that we hear so much about. I guess the sex appeal pushing vanadium is its limited downside risk. Demand for vanadium in batteries is nearly nonexistent now, so any new uses in green technologies would drive increased demand with no downside risk.
TGR: Thanks, Jonathan.
Jonathan Lee is a battery materials and technologies analyst with Byron Capital Markets in Toronto. As a member of Byron’s research department, Lee applies his beliefs, skills and investment acumen to evaluate and select equity securities and then recommend investment ideas to the firm’s proprietary traders and institutional clients. Lee’s primary focus is on the battery materials sectors, which includes lithium, vanadium and cobalt. Prior to joining Byron in 2010, Lee had more than seven years of professional industry experience in the manufacturing and engineering sectors. He previously worked in an engineering capacity preparing feasibility studies for economic assessments and engineering designs for construction projects. Lee has an MBA from the Leonard N. Stern School of Business at New York University, BSc in chemical engineering from Tufts University, and is a chartered financial analyst Level III candidate.
By Claus Vistesen, on April 11th, 2011
With (sincere!) apologies to La Roux;
Going in for the Hike
(lead singer JCT with refrain by Axel Weber)
We can fight our crises
But when we start seeing prices
We get ever so cross
And must show we’re the boss
They say we shouldn’t care about the headline
But we believe it’s just fine
One council with a common goal
To protect the PPP of European souls
We’re going in for the hike
We’re doing it to quell a spike
Oh I’m hoping you’ll understand
And not let go of my hand
(x2)
We hang the PIIGS out to dry
And we’ll see how hard they’ll try
We can help their banks no longer
They’ll have to be stronger
Full stops to monetisation
To be ahead of the curve
How far can we stretch the Euro?
We’ll see but we aren’t sure though
We’re going in for the hike
We’re doing it to quell a spike
Oh I’m hoping you’ll understand
And not let go of my hand
(x2)
Let’s raise the rate
to kill the headline
Let’s test our fate
with a Por2y at 8
We hope in darkness
The market can see
That we are trying to set them free
We’re going in for the hike
We’re doing it to quell a spike
Oh I’m hoping you’ll understand
And not let go of my hand
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