By The Energy Report, on August 10th, 2011
Renewable energy stocks have not been the darlings of Wall Street, but that’s just the angle Senior Vice President for Research John McIlveen of Jacob Securities is playing for his institutional investor clientele. He sees renewables as the classic unloved value sector that could pay off big for investors over the next decade. In this exclusive interview with The Energy Report, John shares his best ideas, including some that could offer surprise upside given the right set of deals, power purchasing agreements and joint ventures.
The Energy Report: After the earthquake and tsunami in Japan on March 11, we saw a spike in alternative and renewable energy shares. But that was short-lived. Even before the situation stabilized and radiation contained, shares of these securities began to weaken again. What’s it going to take to get investors into these renewable energy stocks?
John Mcllveen: First off, the rapid rise in renewable stocks was really due to momentum players as opposed to players taking a long-term position. So they were strictly in it for the quick turnaround. What we really need to see is some long-term positions taken. What would that take? We need more success stories among the junior renewables. We have had too many dropped balls on execution, projects over budget or past their timelines or not delivering the amount of power as advertised. And we need more consistent government policy. Policy keeps changing and money hates uncertainty. Rather than these expiry dates or constantly changing tariff rates, we need a policy that can stay consistent for a long period.
TER: Are you referring to policy in the U.S. and Canada?
JM: It’s pretty much worldwide. Even in Europe, where they’ve had these policies for many more years, they still keep changing the rules.
TER: It’s a combination of fundamentals such as going over budget and problems with projects, but also government policy. Does one of those weigh more heavily on renewable stocks than the others?
JM: Government policy definitely creates more volatility in the market than the success rate of the project companies. When project companies not executing well fall out of favor, it tends to be for a longer term. In contrast, changes in government policy can cause rapid movements of capital in and out of the sector.
TER: When we last spoke, you talked about an approximate breaking point where if oil reached roughly $150/barrel (bbl.), alternative and renewable power sources might become more attractive. How is that looking today?
JM: The price of oil only impacts renewable power prices in areas where power is generated by oil. This includes much of the developing world where oil-fired power is costing well over $200/megawatt hour (MWh). That’s about three times the normal North American rate. So those countries, the Caribbean or Latin America for example, are certainly pushing toward renewable power because just about any form of renewable, except perhaps solar, is costing less than $200/MWh.
TER: In the renewable sector, do you have a favorite source of energy from an investor point of view?
JM: Geothermal. It is the only 24/7 renewable. You cannot close a coal plant and use wind or solar. Those two are too intermittent. Geothermal runs 24 hours a day, 365 days a year; however, geothermal carries high drilling risk, and we need to improve our targeting technology to reduce the risk of dry holes. So it carries more risk but is the only 24/7 renewable that can support base-load power.
TER: So it’s comparable to nuclear or coal?
JM: Yes.
TER: In capacity?
JM: Comparable in capacity and competitive in cost.
TER: We know how important diversification is in owning securities. But, how important is it for investors to be diversified among the various power source stocks?
JM: You’d want to be diversified by geography as opposed to technology. With wind, run-of-river and solar, weather can have a large impact. And, if you’re a single-geography company, you’ll feel that impact much more heavily. So you should be diversified across geographies. For example, in British Columbia they’re having a record hydrology year due to a record thickness in the ice pack over the winter. The ice pack starts melting in May and freezes in December. During that time they’re going to have record run-of-river power generation. That may not be the case on the East Coast where we’ve seen poor hydrology.
TER: Are institutional investors beginning to look at these renewable plays more seriously and not just as a curiosity?
JM: They’re looking at that now. I don’t think it’s a matter of a curiosity. It’s still, “What kind of return can I get from this investment?” They are focused on the companies that generate free cash flow so that if one has poor results from one site, it will have enough other sites that can compensate. Or if it’s a project company in geothermal and it drills a dry hole, does it have enough cash flow that it can absorb that loss without having to raise equity?
TER: Can we talk about some of your best ideas for investors?
JM: Among my stocks, my two top picks are Ormat Technologies Inc. (NYSE:ORA) and Western Wind Energy Corp. (TSX.V:WND). Ormat is a geothermal leader with over 500 megawatts (MW) and generating $75M (million) in free cash flow. In geothermal terms that means you can expand by 75 MW per year without raising new equity, although, that’s probably faster than Ormat can actually drill. The stock is near $17, which is near its 52-week low, and some recent positive announcements have not been priced into the stock. Our one-year price target is $34.
Western Wind is an early stage developer, but it is about to turn free cash flow positive. It will bring 130 MW of wind online this year. That should generate free cash flow of $8M in 2012, which will be enough to start developing the next site. It can then expand with internally generated cash. The stock is at $1.37 and our one-year price target is $2.35.
A higher risk option is Ram Power Corp. (TSX:RPG). Ram has not executed well at its Nicaraguan geothermal site and had to dilute itself severely to cover $70M in cost overruns. The project looks like it is back on track now. However, that’s still not certain. That is where the high-risk component comes in. If it’s successful, the Nicaraguan project should generate free cash of $15M in 2013 and $25M in 2014. The stock is at $0.37, which is also near its 52-week low, and our one-year price target is $0.74.
TER: You are very positive on Ormat. Back in June the company won a $350M loan guarantee from the U.S. Department of Energy. Is that one of the reasons that you raised your target price from $31.50 to $34?
JM: It is, but that’s a smaller component.
TER: Is the catalyst the turbine sales?
JM: That would be the main catalyst. The second catalyst would be Ormat’s North Brawley Power Plant. This plant has been operating at about half its capacity, which means it is operating at a loss. It is the only one of over 20 plants that Ormat has that is not operating at capacity. I believe this situation will be fixed over the next few quarters, so we will see an improvement on the power generation side as well.
TER: I couldn’t help but note that Western Wind shares have behaved much better than most of the renewable energy companies, and it’s held on to its gains from the summer and fall of last year.
JM: The market understands now that Western Wind is executing well and will come online with these 130 MW this year. They’ve done it without issuing significant amounts of equity, and they have taken those investment tax credit (ITC) cash grants and arranged a bridge loan against those grants, avoiding having to issue equity.
TER: The big advantage for investors is that they haven’t been diluted.
JM: Right.
TER: You mentioned that Ram Power is a more speculative play for investors. Your implied return based on your target price is something like 50% or 60% from current levels.
JM: Right. All of them are around the 60% range.
TER: You spoke about its execution problems, but Ram has reported exceptional results on the rework of one of its wells, the SJ12-2 in Nicaragua. The well flow tested at 20 MW, and the lender’s agent was on hand to verify this. Why hasn’t the stock behaved a little bit better?
JM: The lender’s representative, GeothermEx, was on hand, but that doesn’t mean that it certified the megawatts. A certification by GeothermEx would be a strong Buy signal. Ram will have a large movement upon such an announcement. The idea is not to certify just a single well, but to run the whole well field at the same time and look at the total megawatts. This is needed to release up to $160M in construction debt financing because sometimes when you drill a geothermal well it can cannibalize another well. GeothermEx is running the whole field at the same time and measuring the results now.
TER: Ram also announced a revised power purchasing agreement (PPA) with Northern California Power Agency for the Geysers Geothermal Field Project. Better price?
JM: Yes. Ram got a slightly better price and a little bit better deal on some other terms there. The signed PPA is a positive achievement that will signal the lenders to begin their due diligence to determine what construction loans they might give against the project. I’m hoping for an agreement with nearby Calpine Corp. (NYSE: CPN) to take the steam from the existing four wells and pipe it over to Calpine’s plant. That way Ram would avoid building a plant altogether, save a lot of money and earn cash flow from that site two years sooner.
TER: Was there another geothermal that you like?
JM: I like U.S. Geothermal Inc. (TSX:GTH; NYSE:HTM). It has been pulled down unfairly with all the others. U.S. Geothermal hasn’t had any miscues. It’s been plodding, and it’s taken quite some time, but it is bringing a number of megawatts online this year. I expect it to be free cash flow neutral in 2012 and then positive in 2013. So it’s a case of the baby being thrown out with the bathwater. It’s been executing quite well.
TER: It’s down to a $55M market cap, and it’s really borderline with respect to the size of mutual fund that can buy the shares, isn’t it?
JM: Yes, $100M in market cap is a real cutoff in terms of what funds will participate in that size of company.
I have a $1.35 price target on Alterra Power Corp. (TSX:AXY), and the stock is in the $0.70 range. So you would think that would be enough for it to be a Buy. However, included in my forecast are three events that I need confirmed before I can move that one to a Buy. I need a resolution on their negotiations with Nordural in Iceland. This will allow the company to have a higher tariff on the 80 MW expansion of its plant in Iceland. I’d also like to see a joint venture partner announced and see what the terms of the deal are for the project in Chile. And, of lesser importance, I would like to see the company collect the ITC cash grant, probably $6-$7M, on the Soda Lake site in Nevada.
The only geothermal we haven’t mentioned is Nevada Geothermal Power Inc. (TSX.V:NGP; OTCBB:NGLPF). The company has had trouble with its flagship site, the Faulkner 1 Power Plant. It’s designed to operate at 45 MW net, but it can’t seem to get higher than 35 MW due to the injection program. You have to pump brine back into the ground as fast as you take it out and the company hasn’t been able to achieve enough injection capacity to match what it can produce. In effect, you have to lower the plant’s output, otherwise you’re just draining the system and suffering a high resource decline rate. I don’t think Nevada Geothermal is going to see any cash flow benefit out of that particular site. That means their fortune really is dependent on a joint venture with Ormat at Crump Geyser. Ormat is drilling there now.
TER: Ormat’s market cap is close to $1 billion. Do you see Nevada being a takeover target here?
JM: Historically, Ormat hasn’t bought a collection of assets and certainly not a public company. It is pretty site specific and very careful about what it does. Management probably prefers the joint venture route because they can go one at a time and firm up the resource in their own way before deciding whether to spend a lot of money on it.
TER: You mentioned run-of-river power. You follow one company?
JM: I have a Hold on Run of River Power Inc. (TSX.V:ROR). Its market cap is down around $10M now. It can’t really raise equity either. It does have a PPA for a 25 MW project, and it’s looking for a joint venture partner. It isn’t going to be able to put much cash into the project so it is going to end up with a minority interest, probably as low as 10%. It hasn’t won many PPAs. It has bid on much larger projects than the one it has, but has not gotten them across the finish line. I think its prospects right now are limited.
TER: And you follow one Swiss solar company, Etrion Corporation (TSX:ETX).
JM: It’s Swiss-headquartered, but its assets are all in Italy. It’s grown quite rapidly. It’s got 47 MW generating now, and it’ll be at almost 60 MW by the end of the year. It is strongly backed by the Lundin Family (The Lundin Group of Companies), which has provided €60M in bridge loans to construct all these solar plants. However, tariffs are falling in Italy now. Even so, incentives in Italy are still higher than in Germany—probably the highest in the world or near to it. But with the tariffs dropping, it means you have to get a lower price for construction costs.
TER: You’re following a biodiesel.
JM: Yes, BIOX Corp. (TSX:BX). The biofuels market right now is driven by the mandatory content requirements in the U.S., a billion gallon requirement in the market. This will escalate slowly, but right now biodiesel still costs more than regular diesel. In order to get rapid adoption, you need to get the price below that. I don’t think that is possible with the technologies I know of today, which is why we need the mandate. Right now the price of biodiesel is in the $5.60/gallon range. We need to see it at about $6.40/gallon for the industry to be profitable. That’s the key metric to watch.
TER: Do you think of your universe of coverage as a value sector right now?
JM: Looking at the group as a whole, most of them are near their 52-week lows and have been bouncing off that a little bit. So, from a chart perspective, it looks like many of them are beginning to form a value bottom. When that happens, a little bit of good news can go a long way in the price of the stock.
TER: John, this has been so interesting. Thank you.
JM: Thank you, too.
Jacob Securities Senior Vice President for Research John McIlveen has been with the firm five years and has a total of 26 years experience in special-situations research and merchant banking. In 2004, he became Canada’s first sell-side analyst to focus solely on renewable energy research and consistently has been ranked a top performer by Bloomberg on accuracy of estimates and returns. He is currently treasurer of the Canadian Geothermal Energy Association and a published academic with 15 papers, including his and coauthor Alan Rugman’s 1985 best Canadian book-nominated Megafirms: Strategies for Canada’s Multinationals.
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By Christopher Briem, on August 10th, 2011
No… I don’t do macro. More micro defaults:
The city of Vallejo California is exiting out of chapter 9 bankruptcy soon, all while Jefferson County, Alabama plays hardball with its bondholders in its bankruptcy.
As I pointed out in the past, by comparable metrics of debt per household, Pittsburgh is so far past where Vallejo was as it entered bankruptcy.. and that was before any of the latest developments were factored in.
By B.P.T., on August 10th, 2011
The Mortgage Bankers’ Association purchase index will be released at 7:00 AM EDT, providing an update on the quantity of new mortgages and refinancings closed in the last week.
At 10:00 AM EDT, the Wholesale Trade report will be released for June, showing inventory levels for wholesalers in the United States.
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 Treasury budget for July will be released, providing an account of the federal government’s budget surplus or deficit for that month.
By Trace Mayer, on August 9th, 2011
When the time for performance comes the time for preparation has passed.
Gold has powered higher at an incredible and, for many, unexpected rate going from FRN$1,658.75 in the 5 Aug PM London fix to FRN$1,761.50 at 6am 9 Aug London time. The DOW:GOLD ratio has plummeted to around 6.15. Hope you are strapped in because turbulence is ahead!
I recently finished two weeks in London which ended with the GATA Gold Rush 2011 conference. I was in the room during the taping of the Jim Sinclair interview. How right has he been all along!
Now I am in Athens headed to the islands for an enjoyable two weeks. With all the turmoil I often wonder: Do the riots follow me or do I follow the riots?
One common theme on RunToGold is to assess the probability and gravity risks, analyze potential solutions or plans and then take action with provident living principles which may lead to survivalism in the suburbs or some other form of life hedge.
UNITED STATES LOSES TRIPLE A RATING
In April Treasury Secretary Timothy Geithner was asked concerning the risk of the U.S. losing its triple-A credit rating: Secretary Geithner replied, “No risk of that.”
Then the politicians bickered about the debt ceiling and came to a faux resolution. On 5 August 2011 the Wall Street Journal reported:
S&P removed for the first time the triple-A rating the U.S. has held for 70 years, saying the budget deal recently brokered in Washington didn’t do enough to address the gloomy outlook for America’s finances. It downgraded long-term U.S. debt to AA+, a score that ranks below more than a dozen governments’
Boom, Boom, Pow!
THE GREAT CREDIT CONTRACTION INTENSIFIES
In 2009 Mr. Sinclair said of my liquidity pyramid: “A very good, simple and clear representation of the problem lacking a practical solution.” Before his interview at the GATA conference I wanted to thank him for his gracious compliment. Regarding the liquidity pyramid Mr. Sinclair remarked, “Perfect.”
PREPARATION, CONFIDENCE AND CALM
I have received a tremendous increase in comments and emails from readers and friends. They all seem to want expert advice from someone who knows what is going on. Why do you think I wrote hundreds of articles on Run To Gold? When the time for performance comes when the time for preparation has passed.
I really wish I could provide some advice for those ‘caught between a rock and a hard place’ who are watching their pensions and retirement accounts evaporate. But I am off swimming in the beautiful islands of the Mediterranean Sea and do not have ready access to the phone.
Those darn crazy gold bugs do not look so crazy now. How right was Mr. Sinclair when he called $1,650 gold a decade ago when it was around $265? Good thing his thin skin is gold-plated.
But I have already written about the evaporating Euro, how retirement accounts could boost Treasuries and as I wrote in 18 January 2009 why and how the Treasury bubble will burst:
As the yields on Treasury Bills approach 0% they have the return of cash but do not have the benefits of cash as they may be impregnated with counter-party risk or have decreased liquidity. In other words, Treasury Bills and cash have the same benefit profile but not the same safety and liquidity profile.
The Wall Street Journal reported 4 August 2011 that “Bank of New York Mellon Corp. on Thursday took the extraordinary step of telling large clients it will charge them [0.13%] to hold cash.”
Now the FRN$ moves one step closer to evaporating. Why pay 0.13% to hold FRN$ when you can pay a 0.18% storage fee to hold unencumbered allocated insured gold? Is it really wise or prudent to save five basis points to be in a potentially worthless fiat currency while being an unsecured creditor of an institution(s) that has needed trillions in bailouts? Treasuries are not looking so risk-free are they?
CONCLUSION
What is happening is no real surprise to those who understand monetary science and basic economic law. I laid out the case years ago in my book The Great Credit Contraction. Those persuaded have likely ensconced themselves within a financial forcefield of silver and gold.
As the storm rages and intensifies they feel no particular urgency or panic. They are prepared for Winter and can remain solvent much longer than the market can remain chaotic. After all, the melting point for gold is 1,947.52 °F which may be its FRN$ after this latest up leg.
For those who are new, I recommend Apmex for coins because of their A+ BBB rating and low premiums and GoldMoney if you want a third-party to store your metals.
DISCLOSURES: Long physical gold, silver and platinum with no interest in DOW, S&P 500, the problematic SLV ETF, gold ETF or the platinum ETFs.
By Ajay Shah, on August 9th, 2011
In February 2010, I had the opportunity to visit Pudhuaaru KGFS in Thanjavur. This is a remarkable project which helps us see the interface between households and the financial system in a wholly new light.
What a difference 17 months makes! On that visit, I had found a little tenuous Reliance CDMA cover at one place in Thanjavur city. On
this visit, I found 3g or Edge cover in many remote places. On that visit, the ride from the airport at Tiruchirapalli to Thanjavur took
two hours. This time, it got done in 30 minutes on the new NHAI road, with a peak velocity of 110 kph. While there are many reasons to be gloomy about the problems that India faces, some things are moving along merrily.
The KGFS approach to households and finance
KGFS emphasises the very important idea that for households to correctly engage with the financial system, this relationship must be
(a) rooted in high quality advice, (b) which is grounded in a state of strong information about the household. The first is achieved by
focusing on the incentives of the front line staff, by pushing them to think about household financial choice in its entirety instead of
thinking about one product at a time, and by having no sales commission.
The removal of asymmetric information matters in many ways. On one dimension, if credit is extended to the household, a state of high information helps ensure better credit decisions. But more generally, across an array of financial products, when the advisor knows a lot about the household, the advisor would be able to synthesise an appropriate mix of sophisticated financial products which add up to an improvement in household welfare. In time, the advisor will increasingly lean on an expert system to help him do this better: it’s a good approach today and it will get better in coming years.
I think there is enormous value in this approach. I believe that KGFS is doing a great job of building this kind of information about
households in their present rollout (which involves going into really small villages at three locations, in Thanjavur, in Uttarakhand and in Orissa).
The typical KGFS front-end is a three-man branch in a village, where the three employees live in that very village. Remote villages
in India are an environment of radical transparency. The households are relatively trusting. The three people in the outlet know an
incredible amount about the households that surround them. Households and dwellings in small villages are rather stable: there is relatively little action through migration / change in financial conditions, etc. If there was ever an environment where asymmetric information is being removed, it is this.
The line between household finance and small business finance cannot be drawn. An adaptation of the KGFS approach can be quite
effective with small business also: the KGFS branch would obtain a full picture of the firm, and deliver a portfolio of financial
services to it.
A nice feature of the places where KGFS branches are being rolled out is the lack of alternatives. At a time when Indian financial
regulation does not do much to check the behaviour of conventional financial distribution, a few high pressure sales agents can queer the pitch for the KGFS staff. By being in remote places that are being ignored by distributors, the KGFS staffpeople have the luxury of dealing with households without the households being tugged by various high pressure sales tactics of rival sales agents.
Urban households are being mistreated by finance
I also realised some limitations of this approach. Looking forward, India is urbanising. At first blush, it may appear that there is a big
problem with the utilisation of finance in rural India. But there are big problems with the utilisation of finance in urban India.
The urban middle class and upper class is deluged with sales pitches by a variety of sales agents of financial firms. But these
agents are almost always mis-selling, given their drive to push a product (through commissions) and given their lack of knowledge about the household’s overall financial problem. Almost all financial products that are pushed in India (i.e. sold and not bought) seem to be mis-sold. I also feel that when the conversation between a sales guy and the household is about a product and not the overall household financial choice, it is almost always leading to the wrong answers. It’s tantamount to a salesman who sells a drug without knowing anything about the patient.
What is out there, in urban finance, is a scandal, and I am embarrassed to be an accessory to the crime (in however peripheral
fashion). While in Thanjavur, I got the odd sense that at its best, a rural household that’s well connected to a local KGFS outlet is doing
better on utilising the power of finance, when compared with most urban households who are victims of the sales practices that are
mainstream in Indian finance.
In this sense, the real problem for India is not the tawdry state of financial inclusion of the very poor in remote places. The real
problem for India — one that influences the bulk of Indian GDP and the households that matter greatly for India’s growth — is the tawdry state of financial planning of the typical urban household.
The KGFS approach is valuable and important to the places where it’s being rolled out. But the burning challenge is that of fixing the
mainstream. The mode of India is not brutally poor and isolated; it is middle class urban. Improving the interface between middle class and urban households, and the financial system, matters on a GDP scale.
An unrelated rumination: How important is rural deprivation in thinking about India?
The discussion above is a recurring theme in Indian economics. A variety of incentives (development journals, first world aid agencies, government rhetoric) make it fashionable to emphasise rural deprivation. But India is changing and the sweet spot has shifted. The emphasis on poverty and rural is increasingly off-centre. To stay relevant, and do the most important things in today’s India, we have to keep our eye on the ball.
To fix intuition, it’s useful to look at the distribution of annual household income, over April 2010 to March 2011, from the CMIE
household survey of 143,000 households:
| Percentile |
Household income |
| 10 |
45,700 |
| 20 |
59,900 |
| 30 |
72,800 |
| 40 |
90,000 |
| 50 |
112,200 |
| 60 |
142,500 |
| 70 |
180,000 |
| 80 |
240,000 |
| 90 |
348,500 |
As an aside, I think it’s useful for anyone who thinks about India to memorise these nine numbers. Or at least memorise these three
numbers: the 25th percentile is Rs.66,000; the median is Rs.112,200 and the 75th percentile is Rs.208,500.
Middle India today has a household income from Rs.66,000 a year (at the 25th percentile) to Rs.208,500 a year (at the 75th
percentile). The old-style Indian story of rural deprivation is (roughly speaking) about the 20% of households who are below Rs.59,900 a year (and the size of that group is shrinking). The main story of India is about the remainder.
An emphasis upon exotic poverty is as misplaced, in thinking about today’s India, as an emphasis on designer clothes. Perhaps a bit
worse, looking forward, since the extremeties of deprivation are being extinguished by growth, while designer clothes are a superior
good.
Urban households are a much harder problem
So it’s natural to ask: How can the KGFS approach be applied to urban India? When dealing with the urban poor and middle class, it
seems that things are much harder.
Rural households tend to be more trusting, particularly in an environment of ethnic homogeneity and the repeated game that prevails in the village setting. But in urban India, households are more skeptical given the lack of ethnic ties and given the greater
experience with people who have finked in prisoner’s dilemmas.
Rural households tend to be a stable household in a stable dwelling place. Urban households tend to be physically mobile with greater fluctuations in the household composition.
Until deeper reforms on consumer protection take place in Indian financial regulation, urban households will be constantly tugged by unscrupulous sales agents of financial firms pushing products based on high pressure tactics Even if a KGFS tried to be patient and thorough, the very presence of such high pressure sales tactics would contaminate what a KGFS and its ilk can do.
It is relatively easy to construct information about the economic environment of a farming household (though seasonality and revenue volatility is a serious concern). I feel it may be relatively hard to even put together a picture of an urban household, particular when there is informality of labour supply coupled with entrepreneurship. This makes it difficult to do financial planning for such households.
On the other hand, in urban India, the revenue per household would be higher, and perhaps households could be persuaded to pay for advice qua advice. Or, the government could move on giving out advice vouchers to households, thus spurring the rise of an unconflicted advice industry.
Summary
I think KGFS is a great approach and it will be fascinating to watch them execute their agenda in the really remote places of
India. What they are doing is path-breaking and important. This should help us set our sights higher on the problems of urban India. I
have traditionally felt gloomy, in the knowledge that most households in India are being scammed by the agents selling financial
products. As I look at KGFS, I find myself thinking: Can’t we do something like this in mainstream India? I think this is an
important question to ask. At the same time, there are some visible hurdles which suggest that this will be hard.
Credits
I am grateful to Bindu Ananth, Ramesh Ramanathan, S. G. Anil Kumar, Kshama Fernandes and K. P. Krishnan for many conversations which helped in improving this post.
By Bron Suchecki, on August 9th, 2011
Late yesterday the bullion desk manager let me know that one of “my clients” had sold up. By “my clients” she meant clients I knew from when I worked on the desk, which was a long time ago.
This client bought $400,000 of gold about 15 years ago and sold it yesterday for $1.2 million. He and his wife are now in their seventies and are now drawing down on their nest egg.
Sometimes I’ve asked myself whether working at the Mint is of any benefit to society, whether it is a productive job – we don’t make anything useful like cars or food – we just melt and stamp and store metal.
It is days like yesterday however that give me a boost and make me feel like I am doing something useful.
By B.P.T., on August 9th, 2011
At 7:30 AM EDT, the NFIB Small Business Optimism Index for July will be released, providing information regarding the health and confidence of small businesses in the United States.
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 Productivity and Costs report for the second quarter of 2011 will be released. The consensus is that non-farm productivity decreased by 0.7% in the last quarter and labor unit costs increased 1.9%.
At 8:55 AM EDT, the weekly Redbook report will be released, giving us more information about consumer spending.
At 2:15 PM EDT, the FOMC Meeting Announcement will be made, which will provide insight into how long the Federal Reserve plans to keep their rates target at 0% to 0.25%. It is assumed that there will be no immediate change in the Fed funds target rate, but any hint that rates could rise in the future could have an impact on the bond market and stock market.
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By The Gold Report, on August 8th, 2011
 It seems to defy logic: even though gold prices are at historic highs, the stock in many junior gold companies has been languishing. Now is the time to give those shares a second look, says Vishy Karamadam, managing director of Ubika Research in Toronto, which runs the Ubika Gold 50 Index. In this exclusive interview with The Gold Report, Karamadam reveals which companies are poised to announce big news this fall.
The Gold Report: The United States narrowly averted defaulting on its debt obligations at the beginning of this week. What do you make of this high-stakes game of chicken that was played out on the global stage by American politicians?
Vishy Karamadam: It shows the difficult situation in the U.S., and to a similar extent, in Europe. Too many promises have been made to citizens without the resources to deliver on those promises. The debt ceiling is a symptom of the larger problem in all these countries as they deal with, “How do I cut down and where do I cut down?”
For the U.S., it is also indicative of a more fractured political system, which is preventing the debt ceiling from being raised, a fairly routine exercise under Ronald Reagan, George H.W. Bush and George W. Bush.
TGR: Basically, the GOP doesn’t want President Obama to have two terms. Politicians put people’s livelihoods at risk in order to achieve political goals. Even if this legislation gets the country past this hurdle, doesn’t it seem like this system is permanently flawed?
VK: The American system of divided government has served the country well for more than 200 years. The process of raising the debt ceiling, while it looks messy, is the case with pretty much all democratic processes. While there may be political agendas behind it, the U.S. is at a turning point.
TGR: Do you believe a deal will return the gold price to below $1,500/oz. (ounce) as it was before this crisis started to escalate?
VK: If the debt deal is to the liking of the market, there may be a short-term correction. However, larger themes are driving gold prices. One is the inability for many developed nations to manage their government debt. The other is the inflation scenario in emerging economies. Both of these have to play out over many years to come. While the debt ceiling may have an immediate impact, I don’t think it will change gold’s strong, long-term trajectory.
TGR: In late July, managed money funds increased their net long position in gold to 238,319 contracts, which is approaching the all-time high set in October 2009. Do you put much faith in those numbers when you make projections for gold?
VK: When we make projections, we tend to look at emerging markets. Overall demand for gold is roughly around 1,000 tons per quarter. Most of it is coming from the emerging markets. Gold had traditionally served to fight against inflation. That is a better indicator for gold prices.
We also watch the central banks because they tend to have a long-term view about macro-factors. In the first quarter, Mexico added around 100 tons of gold into its reserves. Emerging market central banks are trying to add more weightage to gold. In the previous cycles, central banks were net sellers of gold. Emerging market central banks have around 2% of their assets in gold. That shows that while the price of gold seems to suggest there is a bubble, the portfolios of central banks don’t hold a lot of gold yet.
TGR: Since your index, the Ubika Top 50 Gold Index, was launched on Feb. 1, 2010, the cumulative market cap of the 50 junior gold companies in the index has increased to $14.6 billion, or about 80%. That compares to a 36% increase during the same time for its benchmark, the TSX Venture Index. The gains are impressive, but the index is actually down so far this year due to share price declines for some notable juniors and mid-tier explorers.
VK: The index had a better run last year than so far this year. That is partly based on sectoral rotation away from junior gold stocks as some risk aversion has come into the marketplace. While the underlying commodity has been strong, the junior market’s drivers are not always correlated with the commodity. I would note that the TSX Venture Index is also down year-to-date. It’s not that there is not potential in these companies. It is a general market capital rotation away from junior companies.
TGR: Your index has moved steadily higher so far this month, however. You attribute this to investors turning their attention to relatively undervalued junior miners given the high price of gold. What are some companies that are riding that wave of renewed investor interest?
VK: One company showing signs of promise is Rye Patch Gold Corp. (TSX.V:RPM). It’s an excellent example of an undervalued gold junior with around 4 million ounces (Moz.) in Nevada, which probably is the safest jurisdiction for gold with so many acquisitions happening. It had some fantastic new drill results that could increase the resource estimate by more than 5 Moz. by the end of the year. Now that some of these companies have hit their lows, there is some interest in getting back into those quality juniors like Rye Patch.
Another example of a quality junior is Lexam VG Gold Inc. (TSX:LEX; OTCQX:LEXVF; Fkft:VN3A). It is a Timmins gold camp (in Northern Ontario, Canada) play that went through a correction when all the gold juniors were going down, but it is seeing some new interest. Quality gold juniors with strong resources located in safe jurisdictions with capital to expand those resources—particularly those that can advance and develop the projects—will start to see some interest in the fall.
TGR: What sort of news are you looking for after Lexam VG Gold’s summer exploration program?
VK: After the merger between Lexam and VG Gold, the company had a strong balance sheet with more than $15M. It has a $10M exploration program this year. Four rigs are turning and the company is trying to acquire a fifth rig. Between its Buffalo Ankerite, Paymaster and Fuller properties, there is a lot of resource to come. The company issued some good results recently, but the market did not fully appreciate it. It was a fairly significant development of high-grade gold in a new mineralized zone within the Buffalo Ankerite property. If it can continue those kinds of results, Lexam VG will have room to increase its resource estimate in the coming year.
TGR: Are there some other companies that offer value at their current price positions in the market?
VK: A number of companies we cover have taken a hit and come down in value. They are ripe for a re-rating of the stock and investor interest to return. La Quinta Resources Inc. (TSX.V:LAQ) is a Nevada gold junior company, which is exploring the Easter property. It has found some good mineralization extension of its current zones. The company has 110 thousand ounces (Koz.) in the indicated category right now, but it has promise of extending the mineralized zone. With the current drill program, the company could see some improvement in its resource estimations and that will start being reflected in the share price.
LaQuinta has a joint venture with an option to own from Pilot Gold Inc. (TSX:PLG), which was spun out of Fronteer Gold Inc. (TSX:FRG; NYSE.A:FRG) after its acquisition by Newmont Mining Corp. (NYSE:NEM). If the company can show some promise of a half-million to a million ounces, we think La Quinta will have a good chance of being taken out by Pilot or a company of that caliber.
TGR: La Quinta has had some trouble raising money. Have those issues been taken care of?
VK: It did have some challenges raising capital, but they have raised enough capital to continue with the current drill program. Interest in the stock should increase as results start coming in. It has already made some moves from its lows as the drill program has gotten underway.
TGR: What about Meadow Bay Gold Corp. (TSX.V:MAY)?
VK: Meadow Bay is another interesting Nevada play. It acquired the Atlanta Gold Mine project. The advantage of this project is that it is not a greenfield project, so the company is not starting from zero. It does have a lot of data from the past ownership. Kinross Gold Corp. (TSX:K; NYSE:KGC) had already estimated an internal resource of close to 0.5 Moz. within the Atlanta project. On top of it, Meadow Bay also acquired a lot of infrastructure. The company paid approximately $6M as part of this Atlanta Gold Mine project acquisition, when the replacement value of the current infrastructure on the site could be easily $20M to $25M.
TGR: You said in a research report on Meadow Bay that there would be medium-term cash flow. Will that come from Atlanta?
VK: The company’s goal is to commence small-scale production in the medium term. The company believes it can get a medium-term production scenario with an open-pit because it has infrastructure already there. The company is currently working toward making the resource compliant and expanding it to 1 Moz. We have a model price of $3.62 and it is currently trading at about $1.
TGR: NWM Mining Corp. (TSX.V:NWM; NYSE:NWMMF) has the Lluvia de Oro and La Jojoba projects in northern Mexico, very close to the border with Arizona. It just launched small-scale production in June of 303 oz. Can you tell us about that company?
VK: It’s an interesting story, which is on the cusp of moving from an exploration company to a production company. It’s aiming to produce around 12 Koz. this year and close to 40 Koz. in 2012. The Lluvia-Jojoba project is a fairly large land package of more than 5 kilohectors. The gold reserve is around 384 Koz. It is currently implementing all the project work to get going on a production scenario and that process is already well underway.
The company has a good management team. The chief operating officer, who ran the Mulatos Mine for Alamos Gold Inc. (TSX:AGI), is now managing NWM’s mining startup operations.
While the company is ramping up production, it also has simultaneously identified multiple areas of high-grade mineralized zone. That could help NWM to get to the 1 Moz. resource mark.
At that point, NWM could become an attractive target for other junior gold producers. The closest is Timmins Gold Corp. (TSX.V:TMM). Capital Gold, which was also in the neighborhood of NWM, was in a bidding war, and was taken out by AuRico Gold Inc. (TSX:AUQ; NYSE:AUQ)—Timmins Gold lost that battle. Timmins is waiting to find another junior gold miner to add to its production. NWM is in the same neighborhood. It would be an easy consolidation target. The only challenge is that it has a lot of shares outstanding at 400 million, making it a bit harder to move the price.
TGR: It produced 303 oz. of gold in May and expects to produce between 10 Koz. and 14.5 Koz. for all of 2011. Next year, the company forecasts it will produce between 35 Koz. and 42 Koz. Do you think that is realistic?
VK: It is realistic because it basically has two deposits. Right now, it is bringing one online. Over time, it will bring the next one online. With heap leach operations, companies have to get a lot of ore on the pads and the production kicks in down the road. It is quite possible as NWM is building all the leach pads to get the ore on there and then will have a fairly significant capital infrastructure already in place to get the leach going. I think it is a realistic scenario.
TGR: Chris Berlet, president and chief executive of NWM, comes from your side of the business: He was once an analyst. What do you think about the management team of NWM?
VK: The company has put a good team in place. The mine operation is headed by John Van De Beuken, the chief operating officer in charge of Mexico mines. John is a veteran of producing heap leach mines and is quite experienced in mine startup and production scenarios. The company has a good team in place locally to achieve the production scenario it is projecting, which is what gives us the comfort that they could hit those production numbers.
TGR: Atlanta Gold Inc. (TSX.V:ATG) is developing a gold-silver project in Atlanta, Idaho. The company has outlined more than 1 Moz. of gold in all categories and it is hoping to expand its resources with further drilling. What more do you know about the company?
VK: Atlanta was a past-producing property. Atlanta Gold has improved the resources significantly after its 2010 drill program. It now has around 1 Moz. of gold and gold equivalent. The interesting thing is 719 Koz. are in the higher indicated category. The average grade for the resource is fairly high as well at over 3.45 grams per ton (gpt). These are fairly impressive numbers for a junior gold exploration company.
The company delivered everything it set out to do in 2010, which gave us good confidence in the management of the company. The board and management have broad and deep experience, which you don’t normally see at junior gold companies.
The only downside is that it has close to 150 million shares outstanding, which could be acting as a drag on the stock price. The market hasn’t fully reflected what the company has delivered in its share price.
TGR: What is going to take Atlanta to the next level?
VK: Atlanta is continuing with a fairly aggressive drill program. The company will look to raise its resource estimate further. It’s also simultaneously working on getting into a production scenario in two to three years. Catalysts for investors in Atlanta Gold will happen as it develops projects and hits milestones. The company has strong exploration potential and an opportunity to expand and upgrade resources as it continues to drill at various targets.
TGR: Are there any other junior gold companies that have a good chance at publishing favorable drill results from their summer programs?
VK: HY Lake Gold Inc. (CNSX:HYL; Fkft:HYK) has assembled a fairly impressive property package in the Red Lake District, one of the premier gold districts in Canada. That district literally made Goldcorp Inc. (TSX:G; NYSE:GG) what it is today. Hy Lake’s flagship property is the Rowan Property, which is a joint venture with Goldcorp. This is one of the rare junior companies that has a fully earned joint venture with Goldcorp where Hy Lake owns 60%, while Goldcorp only owns 40%. It has been hitting some really good grades and found a number of vein systems that it is exploring further. The company will have a lot more drill results to come this year as it is implementing a fairly aggressive drill program both on Rowan and two other properties that it owns outright. Hy Lake is significantly undervalued compared to the better known Red Lake District junior gold companies.
TGR: If it’s undervalued, what has held the stock back?
VK: The drag on Hy Lake’s stock is likely because it’s listed on the Canadian National Stock Exchange, which is not as well known as the TSX Venture or the Toronto Stock Exchange. The company is currently working to move to a bigger exchange. That should substantially improve the profile of the company because the underlying property, the assets and the location are fantastic.
TGR: Do any other companies have promising drill results expected later this year?
VK: Eagle Hill Exploration Corp. (TSX.V:EAG) could deliver some good results and news flow in the latter part of this year. It is developing the Windfall Lake project in Val d’Or, Québec, which it acquired from Noront Resources Ltd. (TSX.V:NOT). Noront had already done a lot of work on the project, but Eagle Hill further developed it with a 10,000m drill program last year. It will do another 6,500m drill program soon. The company has identified more than seven mineralized zones, and found fairly high-grade gold near surface. More important, all of them seem to be open. The company engaged SRK Consulting to come out with a resource estimate. Looking at all of the results and our research, we believe that they could come out with a substantial resource deposit right away. Another very interesting thing about this potential deposit is that it could be relatively high grade as Eagle Hill has obtained some very impressive high grade results during the drilling undertaken over the last 18 months. That is a significant development for a junior company to come out with a big resource number right off the bat. Eagle Hill seems to have all the data points to get there. Investors should watch this company.
TGR: Give us one more company that you follow and we will leave it at that.
VK: Another interesting company that we follow is Focus Gold Corp. (OTCBB:FGLD). It is focused on acquiring and developing gold mining properties primarily in the Americas. The company’s flagship project is the Huicicila project in Mexico in the state of Nayarit (over 29,000 hectares), which is in the same region where upcoming junior gold producers such as Capital Gold (now owned by AuRico Gold Inc. (TSX:AUQ; NYSE:AUQ) ) are active. The company recently filed an updated NI 43-101 technical report on this project that suggests that this property could be hosting a buried porphyry copper-gold system. Porphyry deposits are generally very large in scale and potentially contain enormous amounts of gold and copper, providing economies of scale for large operations. As the company pursues a focused exploration program and finds more evidence of such a deposit, the valuation for the company can increase significantly. Focus Gold’s market value is currently at only $25M. This clearly does not reflect the potential ownership of a porphyry deposit system and can increase substantially if the company can successfully establish such a deposit.
TGR: Excellent. Do you have some parting thoughts for us?
VK: Junior gold companies haven’t been so good for investors this year, but investors should focus on finding high-quality junior companies developing projects with good management. Those types of companies are not a bad place to park some investment dollars because they will be rewarded eventually.
TGR: Thanks.
Vishy Karamadam, co-founder and director of Ubika Research, has over 15 years of management experience in corporate finance, management consulting, customer knowledge management and retail banking strategy. He has worked for blue chip organizations in Toronto, Canada and India. He is focused on investment research, content management and advanced analytics for Ubika Research. He holds a Bachelor in Technology degree in electronics and communication engineering, Masters in finance from University of Mumbai, India, and an MBA from McGill University, Montreal, Canada. Vishy was a recipient of McGill International Student Scholarship.
By Simon Grey, on August 8th, 2011
One can only hope that this is indicative of the future: For all the rancor, there were good intentions behind the recent deal to cut government spending and start reducing the national debt, which stands at about $14.3 trillion, nearly the size of the entire U.S. economy. The debt problem is a real issue, not a partisan one; if it keeps growing unchecked, America’s debt will become unsustainable, requiring far too much taxpayer money just to pay interest on all the money the government borrows. The Budget Control Act that President Obama signed on August 2 will begin to address the problem, with widespread spending cuts that will be modest over the next two years, then intensify.
The article then goes on to note six unintended consequences of the deficit deal passed by CONgress that include another round of inflation (aka “Quantitative Easing”), loss of confidence in political leaders, more pressure on the federal debt, and additional uncertainty. Really, it’s a miracle that any journalist in the MSM was able to pull their head out of their butt long enough to think rationally and abstractly about the long-term ramifications of the deficit deal. It’s a pity they waited until after it was passed, though; the time to think about consequences is before action is taken.
By Thomas Knapp, on August 8th, 2011
… that if you don’t check in with the government before wiping your bum, some idiot may blow $9,000 on extra toilet paper and blame you for it.
I’ve looked and looked and looked, and I can’t find anything in the Constitution about the airspace around POTUS being “restricted.” Nor are bullshit security theater antics covered in Article I, Section 8.
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