Opportunities abound across the spectrum of precious metal equities, which remain undervalued as bullion prices continue their upward trends. That’s the word according to Charles Oliver and Jamie Horvat, both senior portfolio managers at Sprott Asset Management. In this exclusive interview with The Gold Report, Oliver and Horvat express cautious optimism about the prospects for gold stocks in 2012.
The Gold Report: When we talked in the wake of the debt ceiling crisis last fall, Charles, you expected volatility to be good for gold and forecast a continuing long-term bull market for precious metals. These days, the scary stories pertain to the European Union (EU). Will negative headlines continue to play a role in the price of gold and silver?
Charles Oliver: Absolutely. The headlines about the European Central Bank (ECB) infusion of billions of euros into the banking system has been very good for the price of gold. Since the ECB announced it would be issuing €489 billion in December, gold has had a nice little rally off its lows. I expect in the next couple of weeks a further issuance of money will be quite supportive for gold.
Europe is still a mess. Greece seems to be heading to bankruptcy in slow motion. That problem has been going on for two years and we could find these issues still persisting a year from now. Ultimately, central banks around the world will continue to print and debase their currencies, which will be very good for the gold price.
TGR: Jamie, do you agree with that? Or might Greece strike a deal to pay off its debt, turning the price of gold down?
Jamie Horvat: I think the deal is based on the fact that the only tool governments have at their disposal is the continued monetization of debt and the continual printing of money, which is always good for gold. On the other hand, if Greece does not get the sought-after debt relief and restructuring or, if it is kicked out of the EU, it could result in the unwinding of the European banking system and could have larger implications globally. If that happens, we’ll see a short-term hiccup in the gold price as it is used as a source of liquidity and investors sell their future in an attempt to live and fight today. That may be the tail-risk event as we continue to see additional quantitative easing (QE) programs all over the world. From Japan to the UK, more than $1 trillion could be spent in the next few months to provide ongoing liquidity in Europe. That is why the longer term outlook for gold is still positive.
TGR: In a November television interview, Charles, you expressed concern about China’s growth. Has that changed? And what are the implications for precious metals?
CO: The China story affects the industrial metals more than the precious metals, but I’m still concerned that we see weakness in China. The volume of loans being done now and the contraction we’re seeing there both signal that weakness. A number of other economic statistics indicate that China is clearly slowing down; the only question is how big a slowdown it is. Ultimately I think it will impact the base and bulk metals more than gold and silver—copper, iron ore, steel, those types of things.
TGR: Your $644.5 million Sprott Gold and Precious Minerals Fund ended 2011 with a tough quarter, off 10.6% compared to an 8.7% loss on the benchmark S&P. Your quarterly report cited tax-loss selling as one of the reasons for thinly trading stocks performing poorly. Have you adjusted your portfolio since then?
CO: The portfolio is continuously being upgraded. We made a number of changes during the last quarter. We did some of our own tax-loss selling in the portfolio. When I sold some of those stocks, I tried to redeploy the proceeds into some of the other names that I wanted to own that were also experiencing tax-loss selling. A lot of companies in the junior space were down 70%. It wasn’t through any fault of their own; it was just because the market had no interest in small companies because it was risk averse last year.
TGR: Were the other names you were buying into mainly juniors?
CO: Yes, there were a fair number of juniors, but every segment of the gold stock market is very cheap today. I can find great valuations in small-, mid- and large-cap stocks. All of them are extremely cheap. That’s not always the case. You might think all segments would move together, but in reality one segment often does much better than the others during a particular year.
TGR: It appears as if about 30% of the fund is dedicated to the small-cap issuers, which have a little bit higher risk profile then the large caps. Do you see those small caps as the way to drive growth in the portfolio?
CO: If you look over the last decade, a lot of the alpha that’s being generated in the gold fund has been through small- and mid-cap names. That’s across the board. Whether in the gold space, the oil space or any other type of stock, generally speaking, small-cap stocks have better growth and long-term growth returns.
TGR: What are some of the juniors you picked up as you were redeploying at the end of the year?
CO: I can mention a few names from my most recent year-end report for investors. Canaco Resources Inc. (CAN:TSX.V) is a small cap with a project in Tanzania. It did a financing at around $5.40/share back in March 2011. It’s a good stock, but through tax-loss selling and an aversion to small-cap stocks, it has traded down to below $1.50/share. What a great opportunity.
I looked at Canaco several years ago. It was really interesting, but it was a little on the early-stage side and it got away from me. I’m not one who likes to chase stocks; I don’t run after them. And then last year, Canaco had a lot of cash on its balance sheet and suddenly came under severe selling pressure. I thought, “Great, I’m getting a second opportunity to buy something at a much better price.” Additionally, I expect its property in Tanzania will one day be a mine.
TGR: How many years away is that?
CO: Probably 5 to 10 years. The lifecycle in the mining industry is usually at least that long from a grassroots discovery through permitting, construction and ultimately getting into production. In the small-cap space, I’m always on the lookout for companies that I believe will have a mine at some point in the future. Canaco is a good example of that.
TGR: Any other examples of companies that could be big movers in 2012?
CO: Another company, Lake Shore Gold Corp. (LSG:TSX; LSG: NYSE) was down 70% in the last year. I actually owned it a couple of years ago, and thought it got expensive. It was trading north of $4.50/share not too long ago, and went down to almost $1/share. The company had a few hiccups in terms of its mine plan, but the stock has been overdone. I sold it up much higher and took this as an opportunity to get involved with it again.
TGR: How high could it go?
CO: There is no reason Lake Shore Gold can’t get back to the highs it made last year if it executes on its strategy. These things usually just take a bit of time.
TGR: Eric Sprott is probably one of the leading silver bulls in the world. In your view, what’s the ideal balance between gold and silver equities and bullion in an investors’ portfolio?
CO: I believe it makes a lot of sense to have a combination of both stocks and bullion. It really depends on the individuals in consultation with their financial advisors to get the appropriate allocation. Bullion is an asset that helps preserve capital. You’re not there to make a killing. You’re there to protect capital, especially in the context of the currency debasement that is going on. Gold stocks are more of an asset used to capture capital gains during the bull market we are in. Many studies have suggested that 5–10% on a long-term basis is a good allocation to precious metals. I’ve heard some numbers much higher at the Sprott organization, but again, I think it ultimately depends on an individual’s goals, propensity for risk and capital preservation requirements due to age and circumstances.
TGR: What are some of your favorite names among silver equities?
CO: I like the large caps. Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ), which is trading at about 9–10 times its price/earnings (PE) ratio, has potential to double production over the next five years as it builds its Navidad mine in Argentina. Pan American is fully funded to get that growth.
Coeur d’Alene Mines Corp. (CDM:TSX; CDE:NYSE) is another one trading at about 9–10 times its PE ratio. It has doubled production over the last four to five years. This company actually has done a great job; it’s one of the few over the last couple of years that have managed to do a pretty darn good job of keeping cash costs very low. If you look at almost all of the large-cap silver names, you’ll find most of them trading either at high single-digits to low double-digit PE ratios. They are extremely cheap.
TGR: What are some catalysts that could take Coeur d’Alene to the next level?
CO: I think it’s just a matter of time and execution. Ultimately these companies will make good earnings and cash flows at the current price. One of the things we’ve seen in the gold sector, and are certain to see a bit in the silver sector, is that a lot of these companies are starting to initiate dividends. Last year Hecla Mining Co. (HL:NYSE) announced a plan to pay a dividend linked to the silver price. In a recent presentation I attended, Coeur d’Alene suggested that it might start looking at paying a dividend sometime next year.
TGR: Could that have a big impact on the share price?
CO: We will have to wait and see, but I think investors look for good companies that pay nice yields.
TGR: What are some other promising silver names?
JH: On the development and exploration side, Tahoe Resources Inc. (THO:TSX) has great potential as it moves toward production on its flagship Escobal project in Guatemala. We like what we see in Tahoe’s exploration there—the whole development story. It may have a world-class asset with the resource and reserves it currently has on hand—plus significant exploration upside as well.
Scorpio Gold Corp. (SGN:TSX.V) is a junior that has come off the bottom. Scorpio has been viewed in the past primarily as a base metals company and a zinc producer, but most of its upside in terms of both exploration and production now comes from silver exposure. I continue to like Scorpio.
TGR: With so many companies in the small- and large-cap area beaten down, how do you determine which ones will deliver?
JH: As Charles mentioned, valuations are pretty depressed. Looking at the large caps broadly, you have to distinguish between those that are executing projects and those that aren’t. Among the companies reporting recently, Agnico-Eagle Mines Ltd. (AEM:TSX/NYSE) and Kinross Gold Corp. (K:TSX; KGC:NYSE) are two examples of companies that unfortunately lost some ground. Agnico enjoyed a premium thanks to its growth profile, but lost that premium because it didn’t execute on that growth profile. Kinross, too, has declined due to the lack of execution.
On the other hand, Barrick Gold Corp. (ABX:TSX; ABX:NYSE) was in line and Goldcorp Inc. (G:TSX; GG:NYSE) was above estimates. Both Barrick and Goldcorp have growth projected into 2016, but they’re trading at depressed multiples to the group. Goldcorp has 60% growth ahead of it.
Investors who have been going to the price participation of exchange-traded funds or gold bullion will slowly start coming back to the market if some of these companies continue to capture that cash-flow margin and continue to increase dividend payments. They will be attractive to investors if they show a willingness to return capital to shareholders. In terms of the market in general, investors seem to want to be paid to participate in the market, so they are looking for companies with yield.
TGR: What names fit the criteria you mentioned for companies that have upside ahead of them?
JH: Based on projects in development and assuming they continue to execute and move the projects forward, some of the names I like are Belo Sun Mining Corp. (BSX:TSX.V), Colossus Minerals Inc. (CSI:TSX), Continental Gold Ltd. (CNL:TSX), Premier Gold Mines Ltd. (PG:TSX) and Perseus Mining Ltd. (PRU:TSX; PRU:ASX). These are all things I continue to monitor and continue to like.
TGR: Belo Sun is sitting at about $1/share now. What do you like about it?
JH: Belo Sun’s 100% owned Volta Grande project in Brazil is located in an area with good infrastructure and the government is building the world’s third-largest hydro-damming facility just to the north. It’s a really good project with recent—and continuing—exploration success, in a good jurisdiction with good economics around the project. I believe that has the potential to be a mine one day.
Belo Sun also has added significantly to the resource and continues to move the project forward. I’ll continue to like those types of projects as long as they continue to execute. So far, though Belo Sun hasn’t been rewarded for its success. Small caps were down 38% on average in 2011.
TGR: Do you have favorite jurisdictions?
CO: When you look at the jurisdictions in our portfolio, about 80% of the companies are domiciled in Canada while 80% of the operations are international. We do have some big concerns about politics and country risk. A couple of years ago, when a lot was going on in Africa, we decided to cut back on some of our African names. Not eliminate them, but reduce the weighting and redeploy those funds into operations in North and South America. Now we are unfortunately experiencing some issues in South America, such as what is going on with the governments and some of the mining projects in Peru today. As with Africa earlier, last year we made an active decision to reduce exposure in Peru because of those concerns.
You can’t pick where the mines are—that’s geologically where the gold deposits are and it takes you to some challenging places. That is why we like to be in a lot of different countries, to diversify that risk. I have concerns about Peru but I’ve got a little bit of Peru. I don’t like Russia particularly, but I’ve got a little bit of Russia. Having a basket of these cases can minimize the risk. Having said that, I should be able to buy these companies in higher risk regions at cheaper valuations. Otherwise I certainly wouldn’t invest there.
TGR: Do you agree with that Jamie?
JH: Definitely. Taking a basket approach and diversifying the risk within the portfolio has been our practice for a long time. There have been a lot of discussions around people seeking more politically secure jurisdictions. But even in Canada, even in British Columbia, we have seen mines not get permitted based on native land rights issues, water usage issues and other local issues. So risk isn’t confined to places such as Africa or Peru. Using that basket approach definitely helps mitigate the jurisdictional risk.
TGR: You mentioned investors might start moving from bullion back into the stocks after a year when equities weren’t performing in line with the metals prices. The cliché is that investors are always wavering between greed and fear. What will give investors confidence to take a chance on some of these undervalued juniors?
JH: I think it all comes down to execution. Are you executing on that project? Are you moving it forward? Are you building per-share value by growing the resources and converting them into reserves? Are you advancing the project and doing the feasibility studies? Are you wrapping the economics around the feasibility of the project and the value and the leverage that you can obtain from putting that into production in the market? Companies that continue to execute and build their resources and reserves will get rewarded. Unfortunately, a lot of companies have made some missteps in the market.
TGR: Any other thoughts you would like to leave our readers with before we say goodbye?
CO: Gold equities didn’t do very well in 2011. It was a tough year. The last time we had equities perform so poorly was 2008. Then 2009 and 2010 were exceptionally good years for gold stocks. That pattern makes me cautiously optimistic that 2012 will be a very good year for gold stocks.
JH: I totally agree—2011 was a “lite” version of 2008. Small caps were down 78.5–79% in 2008, and last year they were down 38% on average. The U.S. banks and the mortgage-backed securities issue were at the heart of the 2008 liquidity crisis, and in 2011 the issues have rolled into a European bank and sovereign debt crisis—with the U.S. opening up the swap lines again, with unlimited U.S. dollar amounts to help with liquidity to European banks through to February 2013, I believe. Taking all of that into account, I’m cautiously optimistic. I’m hoping that as in the second half of 2009 into 2010, when we had a significant recovery in the precious metal space, we will see a similar type of recovery in 2012.
TGR: Thank you, gentlemen.
Bringing more than 21 years of experience in the investment industry, Charles Oliver joined Sprott Asset Management (SAM) in January 2008 as an investment strategist with focus on the Sprott Gold and Precious Minerals Fund (TSX:SPR300). Prior to joining SAM, he was at AGF Management Ltd., where he led the team that was awarded the Canadian Investment Awards Best Precious Metals Fund in 2004, 2006, 2007, and was a finalist for the best Canadian Small Cap Fund in 2007. At the 2007 Canadian Lipper Fund awards, the AGF Precious Metals Fund was awarded the best five-year return in the Precious Metals category, and the AGF Canadian Resources Fund was awarded the best 10-year return in the Natural Resources category. Oliver obtained his Honors Bachelor of Science degree in geology from the University of Western Ontario in 1987 and his Chartered Financial Analyst (CFA) designation in 1998.
Jamie Horvat joined SAM in January 2008. He is co-manager of the Sprott All Cap Fund, the Sprott Gold and Precious Minerals Fund, the Sprott Opportunities Hedge Fund LP and the Sprott Opportunities RSP Fund. He has more than 10 years of investment experience. Prior to joining SAM, Horvat was co-manager of the Canadian Small Cap, Global Resources, Canadian Resources and Precious Metals funds at AGF Management Ltd. He was also the associate portfolio manager of the AGF Canadian Growth Equity Fund, as well as an instrumental contributor to a number of structured products and institutional mandates while at AGF. He joined AGF in 2004 as a Canadian equity analyst with a special focus on Canadian and global resources, as well as Canadian small-cap companies. Horvat spent five years at another large Canadian mutual fund company as an investment analyst before joining AGF. He holds a diploma in mechanical engineering technology from Mohawk College and earned an Honors Bachelor’s of Commerce degree from McMaster University. He is a member of the International Research Association and a licensed international financial analyst. He is also a member of the Ontario Association of Certified Engineering Technicians & Technologists.
Wealthy kids are usually wealthy because their wealthy parents left them a lot of money. You might think that’s because parents are altruistic towards their kids. Indeed every dollar bequeathed is a dollar less of consumption for the parent. But think about this: if parents are so generous towards their kids why do they wait until they die to give them all that money? For a truly altruistic parent, the sooner the gift, the better. By definition, a parent never lives to see the warm glow of an inheritance.
A better theory of bequests is that they incentivize the children to call, visit, and take care of the parents in their old age. An inheritance is a carrot that awaits a child who is good to the parent until the very end. That’s the theory of strategic bequests in Bernheim, Shleiffer and Summers.
What seems to be left out of the discussion are two important factors: historical precedent and lack of perfect knowledge. Also, the theory seems to be predicated on the assumption that people are perfectly rational.
In the first place, historical precedent counts for a lot when it comes to human habits. Humans have a tendency to do things a certain way simply because that’s how things have always been done. Given that death could come at relatively young ages, in times past, and come rather unexpectedly at many cases, it made sense to defer giving one’s wealth to one’s children until one’s death, since there was no way to know in advance how much of one’s accumulated wealth one would need to live out one’s life. And, given that the vast majority of people that have ever existed were poor, it’s hard to give away a meaningful amount of your wealth when you’re not sure how much of it you’ll end up needing. Really, this period of massive personal wealth—relatively speaking—is an historical abnormality, so it should come as no surprise that humans have not developed new habits to replace a centuries-old custom.
In the second place, and in keeping with the first point, people do not know when they are going to die. Furthermore, they do not know the circumstances of their death, nor do they know what expenses they will incur between the present and their death. As such, it makes sense to keep a decent amount of money on hand to take care of one’s expenses, as well as handle whatever emergency medical expenses might come. Now, one might reasonably object that by keeping their money for themselves, parents are essentially saying they don’t trust their children to take care of them. This is certainly plausible, but one must also consider the issue of convenience. Even if one’s children were to be trusted perfectly, it still makes sense to keep money on hand anyway, since it usually easier to pay for things for yourself than to wait on someone to make your payments for you.
Finally, it makes no sense to assume that people approach the matter of inheritance with any degree of rationality. Since the transfer of wealth via the mechanism of inheritance is closely tied to death, it is understandable that many people do not spend a lot of time contemplating the matter. And since the current system of inheritance serves its purpose well, there isn’t that much to be gained from changing.
You may have already noticed that this one has been going the rounds. The piece is mainly driven by my colleague Jonathan Tepper’s work on the history of currency union breakups and how they work (or don’t).
It is a big piece in its entirety but the different sections can be read as standalone arguments. The summary is pasted below.
Many economists expect catastrophic consequences if any country exits the euro. However,during the past century sixty-nine countries have exited currency areas with little downward economic volatility. The mechanics of currency breakups are complicated but feasible, and historical examples provide a roadmap for exit. The real problem in Europe is that EU peripheral countries face severe, unsustainable imbalances in real effective exchange rates and external debt levels that are higher than most previous emerging market crises. Orderly defaults and debt rescheduling coupled with devaluations are inevitable and even desirable. Exiting from the euro and devaluation would accelerate insolvencies, but would provide a powerful policy tool via flexible exchange rates. The European periphery could then grow again quickly with deleveraged balance sheets and more competitive exchange rates, much like many emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, and Argentina 2002).
Whether it would be as easy as earlier episodes of currency breakups to dismantle the euro zone is a highly contentious issue. I am not sure that I believe it would be as easy is implied in the piece. But this is not the most important point. We are now in a situation where a breakup or a division of the euro zone into two is no longer a remote theoretical discussion. To this end I think the piece takes up (and describes the mechanics of) some very important processes and issues. Go read!
The Mortgage Bankers’ Association purchase index will be released at 7:00 AM Eastern time, providing an update on the quantity of new mortgages and refinancings closed in the last week.
At 8:30 AM Eastern time, the preliminary GDP report for the fourth quarter of 2011 will be announced. The consensus is an increase of 2.8% in real GDP and an increase of 0.4% in the GDP price index. The real GDP estimate is the same as the advance value for the fourth quarter of 2011, and the GDP price index is the same.
At 9:45 AM Eastern time, the Chicago PMI Index for February will be announced. The consensus index value is 61.0, which is 0.8 points higher than last month, and is still above the break-even level at 50.
At 9:30 AM Eastern time, Federal Reserve Chairman Ben Bernanke will give his semiannual report to the House Financial Services Committee.
At 10:30 AM Eastern time, 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 Eastern time, 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.
At 3:00 PM Eastern time, the Farm Prices report for February will be released, giving investors and economists an indication of the direction of food prices in the coming months.
CFRB compares the candidates’ plans to a “realistic” baseline that assumes the Bush tax cuts are made permanent and the automatic sequesters required by the Budget Control Act of 2011 are waived, among other things. Relative to that extremely pessimistic baseline, Santorum and Gingrich still want huge increases to the national debt; only Paul’s proposals would reduce it. Romney’s proposals would have little impact, but that was before his latest attempt to pander to the base: an across-the-board, 20 percent reduction in income tax rates. [Emphasis added.]
How is this possible, since all of them have promised to cut spending? Huge tax cuts, on top of the Bush tax cuts. Romney, as mentioned above, would reduce all rates by 20 percent, repeal the AMT, and repeal the estate tax. Santorum would cut taxes by $6 trillion over the next decade. Gingrich would cut taxes by $7 trillion. Paul, the responsible one, would only cut taxes by $5 trillion.
Of course, these projections need to be taken with a grain of salt since they are nothing more than an attempt to apply static analysis to a dynamic system.
Nonetheless, it should be quite telling that the two most nominally conservative candidates have the most fiscally irresponsible budgets.
(The penultimate paragraph of this post
deals briefly with this subject).
The moderate businessman has an essentially balanced budget, and the libertarian is the only one of the lot that actually attempts to decrease the national debt.
The reason why the “conservative” candidates’ budgets aren’t fiscally responsible is because they simply do not understand the simple reality that government spending is essentially the same as taxation. Every dollar that government spends must come from taxes. This can happen directly, indirectly (e.g. inflation), or it can be deferred (e.g. borrowing). However, at some point, government spending must come from tax revenue of some form. As such, it is downright irresponsible to cut taxes without also cutting an equal or greater amount of spending. Therefore, both Gingrich and Santorum are nothing more than political parlor magicians who are using sleight of lower taxes to distract from the insufficient budgetary cuts. Sadly, there are too many conservatives who will fall for this, and ignore the plain and simple fact that government dollars must first come from citizens’ pockets.
This is not to say that taxes should not be cut. To the contrary, the relatively high-rate of federal taxes are undoubtedly stifling the economy. Ultimately, though, these tax rates are nothing other than a reflection of the high rate of government spending. Thus, it is government spending that is stifling the economy, and therefore the federal budget must be cut if the United States are going to recover. At this point, it should be clear that there is only one candidate who grasps this underlying reality. We all know who he is.
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Sometimes it is worth looking back at old posts. Actually a reader reminded me recently that there still are ‘deals’ being shopped to consumers for locking in long term natural gas prices. Reminds me that a year and a half ago I posted this letter I received myself.
Was it a good deal? Even then Elwin pointed out the problems with interpretng the offer
. It seems the offer was just for the commodity price of the gas, not the total price consumers pay. If someone had taken this deal, they clearly would have lost out vs. the option of not taking it. But what about going forward?
There are current version of these deals being offered are you can check out the current version of the natural gas shopping guide
put out by the state. It seems to still be the case that for all the vaunted deregulation of natural gas supplies in Pennsylvania, some of us only have one alternative offer and even that comes at a price that is above
prices we get by default these days. That and I am pretty sure the current natgas price has not yet fully adjusted for the recent drops in natural gas prices.
The bottom line is that the only ‘offer’ I have is to pay a higher price than what I currently get with the added benefit that the higher price will be ’locked in’ for a year. You would think with all this gas literally erupting all around us there might be a few more suppliers willing to offer gas to consumers at more competitive rates? A curious system of ‘competition’ all around.
And on that state shopping guide page.. it seems that none of the archive links seem to be working??
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The biofuel sector, already an $80 billion a year industry, is still in its infancy. In this exclusive interview with The Energy Report, Biofuels Digest Publisher Jim Lane discusses the exponential growth slated for this once-obscure energy source, and how its market resembles the traditional oil and gas industry in many ways. While biofuels are not for the faint of heart, as Lane cautions, investors who do their homework can get in early on companies that offer incredible upside potential.
The Energy Report: Many investors have some level of familiarity with biofuels, but don’t have the depth of understanding required to enter that market with confidence. As the publisher of Biofuels Digest, which focuses exclusively on this sector, what do you think is the best way for investors to dip their toes into these equities?
Jim Lane: The biofuels sector has grown into an $80 billion (B) industry today, even though it’s only in its infancy. Why be interested in the sector? Because it’s big and it’s going to get bigger. There’s lots of money to be made and lots of good to be done.
TER: What exactly is a biofuel?
JL: Biofuels include any fuel molecule produced from a plant source using tools and microorganisms from synthetic biology. It could be a residue from agricultural waste, forest waste, municipal solid waste, animal waste, or something made using a biological process. There are about 100 different plants that can be used to produce biofuels, and many can be grown in areas that won’t support traditional food agriculture. The main plant sources are still corn, sugar cane and soy beans, but biofuels can also be made synthetically from carbon dioxide and water, or carbon monoxide and water. Biofuel processes can turn pollutant waste streams with little or negative value into value streams sometimes worth thousands of dollars per ton.
The main basis to date has been using traditional processes, such as yeast fermentation, to produce an alcohol fuel known as ethanol. We also have a process that takes plant or waste oils and turns that into what’s called biodiesel. Those are pretty built-out industries in many ways. They’ll grow, but they won’t grow quite as much in the future as what we call advanced biofuels, which use exotic processing techniques to extract value from unusual feed stocks.
TER: Are investors making money in this space at this time? What segments are doing best at this point and why would that be?
JL: Yes, investors can make money in this market. It depends on the stage of the company. It generally takes about 10 years to go from the original lab or research work to producing on a commercial or industrial scale. Depending on a company’s stage of development, investors may see early-stage cash burn, the beginnings of commercialization, or substantial profitability. The companies that are further along on their path are very profitable. For example, Valero Energy Corp. (VLO:NYSE) is a major U.S. oil refiner, and last quarter its most profitable division was ethanol production, based on about 1,100 million gallons in capacity. But the bigger opportunities for investors are in selectively picking the winners of tomorrow, because those will offer more upside.
TER: Is there a lot of research going on in different areas that aren’t anywhere close to commercialization at this point, or has commercial production been largely standardized?
JL: While there are well over 200 companies currently developing projects around the world using advanced biofuel techniques at various stages of development, there are three basic areas for investors to consider, much like the oil and gas market. We designate these areas as upstream, midstream and downstream.
The upstream segment includes companies that are developing advanced feed stocks with higher yields that grow under more exotic conditions. They’re working on genetics and seed development.
Midstream companies utilize processing technologies that extract fuel from plants or waste material, similar to an oil refinery, whereas upstream is comparative to traditional oil and gas exploration. Consider the feed stocks an above-ground oil fuel, if you will.
Downstream companies are the ones that get the fuel to market, such as the pipelines or the gas stations that are delivering those fuels to consumers.
TER: What would you say to those critics who suggest that biofuels are just another passing fad? What are the growth prospects for this industry?
JL: Any business that’s gotten to $80B in sales is real, and in the United States and Brazil it’s now an unsubsidized business. Ethanol, in Brazil, is unsubsidized and actually outsells gasoline. The International Energy Agency projects that 30% of all transportation fuels could be biofuels by 2050. We use 1.2 trillion gallons of traditional fossil fuels worldwide, so the demand potential is in the hundreds of billions of gallons and the sales will be in the trillions of dollars. It’s definitely not a passing fad; the potential is just being unlocked now.
TER: What are the job creation possibilities in this industry?
JL: It’s a very robust job outlook, according to a recent report by Bloomberg called Moving Towards the Next-Generation Ethanol Economy. Looking just at U.S. ethanol, which is a small piece of the pie, they expect that by 2030, 2.4 million man years of employment would be created. A lot of that is in construction—680-odd thousand man years between now and 2030. This includes engineering talent, operators, laborers, people who collect and transport the biomass and the fuel and also the administration and management. These are very similar to jobs in traditional oil and gas facilities, with a few more biologists.
TER: What factors and investment criteria should investors consider if they want to get involved in this industry space?
JL: Investors should look at three main factors. First is the extent to which the processing technology is proven or demonstrated at scale. Has it been done at pilot? The earlier you take that on, the more risk you have that the technology may fail along the line. A later-stage technology gives you more confidence. But, the returns are going to be commensurately smaller. So, the more research you do on the processing technologies, the earlier you can invest with confidence; which should give you a bigger return. I think that goes for every kind of high technology.
Next is feedstock. To what extent does the processing technology have a guaranteed price at which that feedstock can be acquired? A company that has a 20-year contract for municipal solid waste at a fixed price is on solid ground. If it is buying a commodity crop with fluctuating prices, investors need to understand how the company has hedged that, because you don’t want to be buying $8 feedstock to make $3 fuel.
On the downstream, you want to make sure there is an offtake contract with a credit-worthy buyer. You certainly don’t want to have a long-term contract with a company that may go bankrupt. Investors should look for companies that have done a really good job of locking in feedstock costs as well as a reliable offtake contract.
The more certainty investors have on those three fronts, the less risk they will shoulder. On the other hand, less risk usually means less potential reward.
TER: What are some of the leading companies in the industry at this point, and what are they up to?
JL: We’ve had seven companies with successful IPOs in the last 18 months, with 10 in the IPO queue right now. Of the entire cleantech sector, 75% of the companies in the IPO queue are biofuel companies. That tells you a little bit about where Wall Street is putting its emphasis and which of these sectors is going to succeed in the short term. The biggest success stories include companies like KiOR, Inc. (KIOR:NASDAQ), which went public last year. It’s a company that uses a technique called Biomass Fluid Catalytic Cracking. KiOR creates diesel, jet fuel and gasoline from wood chips very cost effectively. The company already has over $1B valuation. It’s now building its first commercial facility in Mississippi with very strong support from former Governor Haley Barbour to build a total of six plants in the area.
Renewable Energy Group Inc. (REGI:NASDAQ) is another company that just did its IPO. That company is the number-one biodiesel producer in the United States, at about 300 million gallons a year, and had strong revenue growth last year.
TER: What other companies look interesting?
JL: Solazyme, Inc. (SZYM:NAS) is a company that makes renewable oils from algae using advanced synthetic fermentation. It also makes skin creams, which are selling on the Home Shopping Channel very successfully. Solazyme is making fuel and also has a joint venture with Roquette Group. It is also making algae cookies and has all kinds of products it can make from renewable oils. We expect them to be very successful not only in food and skin care but also in making jet fuel for the Navy and in all kinds of applications across the spectrum.
Gevo Inc. (GEVO:NASDAQ), went public last year and makes isobutanol, which is an alcohol-based fuel. Isobutanol also a very important component in the chemical industry. Gevo is just building its first commercial facility, which will be open in the first half of this year. That’s a very exciting company to watch.
Amyris, Inc. (AMRS:NASDAQ) is based out of Silicon Valley. Its technology uses sugar cane syrup and is being commercialized now in Brazil. Amyris makes an exotic collection of fuels and chemicals and lubricants and all kinds of great products from sugar cane, as well as a renewable jet fuel and diesel being commercializing in Brazil.
Another Silicon Valley company, Codexis Inc. (CDXS:NASDAQ), is an enzyme, fuels and chemicals developer. Its major investor is Shell, and it is producing enzymes and other components of fuel creation in its work. The company recently bought its chemical rights back from its original parent, Maxygen, Inc.(MAXY:NASDAQ). Codexis is now deploying a wide variety of solutions to make low-cost sugars for the chemical industry. That’s important because you need sugar in order to turn something into a chemical. This company is going to be the “Intel-inside” of the industry.
Then there’s Rentech, Inc. (RTK:NYSE.A), which has a very advanced process making diesel and jet fuel through what’s called gasification. It’s based in Los Angeles and commercializing its technology in Ontario, Mississippi and Colorado. These companies are examples that are at, or are going to commercial scale right now, in which investors can take a position today.
TER: Are these companies making money, breaking even, or are they still in the “trying to get there” stage?
JL: Most of them came out quite early. Biotech stocks often come out either pre-revenue or early stage. Renewable Energy Group came out a little bit later in its evolution. The other ones are still in the cash-burn phase. I think Amyris is deploying its second commercial plant and the others are in the process of building their first commercial facility. Amyris will need to get three or four up to be solidly profitable and cover the overall administration and R&D costs. You would expect to see most of those in the black around 2014 or early 2015. The most important thing for an investor is not current profitability, but where they are on their path to profitability. Waiting until they are totally in the black and everything is already established is less risky, but you’re going to be sacrificing some of the upside.
TER: What sort of capital costs are involved in putting a commercial plant into production?
JL: The first commercial plant is usually the most expensive due to the R&D involved, and can cost anywhere from $250-400M. Larger projects can be up to a billion dollars apiece. As the industry develops standard designs, costs could drop to somewhere in the range of about $200-300M per project. So this is not for the faint of heart. Certainly these companies will be accessing project financing for the debt component. This is a very capital-intensive industry similar to the traditional oil and gas industry.
TER: You also publish the Biofuels Digest Index composed of 30 component stocks that seem to cover a pretty broad range of companies. How do you determine who you cover?
JL: We look at the 30 companies that have the largest capacity and also include some pure plays. So, we have companies like BP Plc. (BP:NYSE; BP:LSE) and Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE). BP’s biofuels unit alone has 4,000 employees. It’s a very heavy investor in biofuels. Shell also just did an $8B acquisition or joint venture and merger last year. We also have Archer Daniels Midland Co. (ADM:NYSE). From large-caps we go down to some of the smaller ones I’ve mentioned like Solazyme, KiOR, Gevo, Amyris, Rentech, Codexis and Renewable Energy Group. The key there is that all of them are fully focused on biofuels and chemicals, or it’s a significant part of their operations and profit flow. We change them around a little bit, of course, as we’ve had a lot of recent IPO activity. It has been a pretty good sector to invest in over the last 18-24 months.
TER: Do you have any other points you’d like to discuss and closing thoughts you’d like to leave with our readers?
JL: Investors usually ask me what the best way is to pick winners and avoid losers. The answer to that is to read a lot and study up on the technology. Never buy anything that you’re not sure of, or you don’t know. These are exotic technologies. A lot of them are early stage. It’s very important for investors in early-stage, high-technology companies to be fluent in understanding a company’s upstream feedstock strategy, if its processing technology is proven, and who’s the offtaker. And is that represented in hope or is that represented in hard contracts and real dollars? If you’ve done your homework, you can find a lot of value, which plenty of investors have. It’s all based on being a knowledge worker before you are an investor.
TER: We greatly appreciate your time and input today on a sector that certainly provides another growth area for investors to consider. We’ll look forward to talking with you again to see how these companies progress.
JL: Much appreciated.
Jim Lane is the editor and publisher of Biofuels Digest, the most widely read biofuels daily newsletter. The Digest covers producer news, research, policy, policymakers, conferences, fleets and financial news. It is home to the Biofuels Digest Index™, The 30 Most Transformative Technologies, and the “50 Hottest Companies in Bioenergy” annual rankings.
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At 7:45 AM Eastern time, 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 Eastern time, the Durable Goods Orders report for January will be released. The consensus is that there was a decrease of 0.7% from the previous month.
At 8:55 AM Eastern time, the weekly Redbook report will be released, giving us more information about consumer spending.
At 9:00 AM Eastern time, the monthly S&P/Case-Shiller home price index report will be released. Given that most economists don’t expect the overall U.S. economy to improve until housing prices end their decline, the market will be watching this number closely.
At 10:00 AM Eastern time, the monthly report on Consumer Confidence for February will be released. The consensus index level is 64, which would be a 2.9 point increase from last month’s number.
Also at 10:00 AM Eastern time, the State Street Investor Confidence Index will be released, which looks at changes in the amount of equities held in the portfolios of institutional investors.
Also at 10:00 AM Eastern time, the Richmond Fed Manufacturing Index for February will be released. The consensus is that the index will be at 13, which would be an increase of 1 point from the previous month.
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Watching Europe sink into recession – and Greece plunge into the abyss – I found myself wondering what it would take to convince the chattering classes that austerity in the face of an already depressed economy is a terrible idea.
After all, all it took was the predictable and predicted failure of an inadequate stimulus plan to convince our political elite that stimulus never works, and that we should pivot immediately to austerity, never mind three generations’ worth of economic research telling us that this was exactly the wrong thing to do. Why isn’t the overwhelming, and much more decisive, failure of austerity in Europe producing a similar reaction?
Here’s the simple answer: austerity is not about promoting growth, it’s about getting one’s fiscal house in order, which is to say that austerity is all about reducing government spending and government debt. More to the point, there are a couple of flaws worth pointing out here.
First, there is the obvious flaw of growth measurements. Growth measurements include government spending so, by definition, whenever government spending contracts, growth will decline. Complaining about the lack of growth in light of government budget cuts is like complaining about the definition of wet.
Second, the main problem right now is debt.
Namely, that it has to be paid.
When you borrow from the future, you will eventually hit a point when the money you borrowed is due, with interest.
And that point is here.
People have to pay their debts, which is one reason why austerity is necessary.
Third, and along the lines of the second point, the current situation does not fit in any way with three generations of economic research. If one were to actually read Keynes’ policy prescription, one would find that it has very little bearing to reality. Keynes’ fundamental prescription for smoothing out economic turbulence was to raise taxes and save money when the economy was experiencing growth and lower taxes and spend money when the economy was cooling down. (Incidentally, this very thing has worked at least once in history.) The problem is that the experts in Washington only did one of those four things.
See, the only part of the policy that Washington followed was increasing spending at the start of the downturn. Washington lowered taxes during the boom, exacerbating the boom, and then failed to save money for the inevitable decline. And now that the decline is in full force, Washington is considering raising taxes. So even if the economic research is correct, it is certainly not being followed in any meaningful way. As such, appealing to this research is simply ludicrous, as it doesn’t apply anyway.
After a tough 2011, Mark Raguz and his colleagues at Pinetree Capital are looking at the junior resource sector with renewed optimism. In this exclusive Gold Report interview, he names some of the plays that are fueling that sentiment, from gold names in Northern Ontario to silver names in Mexico.
The Gold Report: Mark, what do you think will determine Pinetree Capital Ltd.’s (PNP:TSX) success in 2012, especially regarding the junior resource sector?
Mark Raguz: What we need to see is the embracing of less risk aversion and the desire of investors to move further along the liquidity curve toward the junior resource space. There are signs this is starting to happen. In the meantime, we believe we can add value by drawing on our expertise in the resource sector and filtering out the best names, whose value might be realized over time.
TGR: How do you determine the best names?
MR: We see things very early and we look at a lot of different names. Finding the gems becomes a lot easier as we have a lot of experience in this area and a lot of comparables to use because of the amount of companies we look at. My goal is to draw out the best management teams with the best assets, given our exposure to most of the names in the space.
TGR: Based on your experience in previous cycles, when does capital tend to return to the mine commodities sector after a dip?
MR: These cycles tend to work in 18-month spurts. You get a good 12-month run, but at some point fantasy gets ahead of reality and the juniors tend to take a breather. Of course, when the exuberance goes away, so does the liquidity. This leaves a lot of investors trapped near the top, holding a lot of paper. The subsequent liquidation takes up to a year and a half. There are a lot of indicators suggesting that we have gone through this phase and that interest in juniors is reviving again, as gold in particular appears to be ready for another leg.
TGR: What makes you think gold is ready to advance another leg?
MR: Late last year a lot of liquidity dried up. People got off their positions and this was exacerbated by tax-loss selling. A lot of our names got beaten up. In January, we started to see many of those names return to levels that we feel are more in tune with a renewed positive cycle.
TGR: Are there certain events, perhaps a debt deal in Europe, which might bolster the gold price?
MR: I think the debt deal will be helpful, but maybe not for the reasons you might think. The risk of a successful deal comes with a question: If Greece does not have to pay, why do I? The Irish are asking it; the Portuguese and the Spanish will soon be asking the same thing.
The possible, immediate consequence is a sharp spike in gold, silver and other commodities, along with a flight from currency, falling equities and debt valuations or even maybe a banking crisis. While it probably would not last long, it could be long enough to shake things up.
While this might play a role in investor behavior, generally speaking, confidence will continue to return to the market. It has definitely started to in the last couple of months. So, solving each political event will definitely help, but I do not think it is critical.
TGR: Why should investors return to the junior resource sector now?
MR: Geopolitical issues notwithstanding, the fundamentals driving supply-and-demand imbalances have not changed. Consider Fukushima. That took a bite out of the invested capital in the uranium space but Japan is continuing with nuclear power, as is China. For the first time in a very long while, the U.S. just approved a nuclear plant. All of that bodes well for the fundamentals, which I believe are why investors should return.
TGR: What themes might retail investors be able to target in the space this year?
MR: Stick with the fundamentals. Certain commodities will face different supply-and-demand imbalances over the next decade, the uranium story being among the most acute. We see no evidence of demand for precious metals subsiding. In the last few weeks, we have seen some buoyancy in the iron ore names in our portfolio. Those are some things I like going into 2012.
TGR: You have many positions in small-cap companies seeking gold in Northern Ontario. Which ones does Pinetree believe are well positioned to perform in 2012?
MR: I really feel that this jurisdiction is one that is occasionally mistakenly overlooked; I really like Northern Ontario as an exploration jurisdiction. Prodigy Gold Inc. (PDG:TSX.V) delivered consistently, with a 40,000 meter (m) infill drill program in 2011. It both reduced its strip ratio and added ounces. This equated to a very robust preliminary economic assessment (PEA) in December 2011. It has outlined another ambitious 60,000m drill program for 2012. It will be a mix of drilling for resource delineation and resource expansion. This provides Prodigy Gold the potential to increase ounces heading into a Q412 feasibility study. A recent financing left it well capitalized; it has four rigs turning now and is trying to source three more. I think it’s a great story.
Gold Canyon Resources Inc. (GCU:TSX.V) also stands out. Relative to other Canadian bulk tonnage stories, we expect the grade at its Springpole deposit to exceed that of its comparables. An imminent resource update will leave it well positioned to meet analysts’ upside expectations when it releases its PEA this fall. I would not be surprised by a PEA of 6 million ounces (Moz) with a high-grade starter pit and stout economics, given the success to date.
Queenston Mining Inc. (QMI:TSX) continues to deliver drill results. Its positive drill results near surface at Upper Beaver are beginning to show unexpected potential for open-pittable ounces. The drilling here continues to extend the Upper Beaver laterally and to a depth of 1,200m. This is likely to be Queenston’s maiden producing asset. We just saw an initial PEA here in the last few days that was robust and left the bulk of 2011 drilling to be added in the future, potentially sweetening the economics.
The company also has applications for underground drilling on the Upper Beaver. Concurrently, it is targeting an extension of Kirkland Lake Gold Inc.’s (KGI:TSX) high-grade South Mine complex through both a joint venture with Kirkland and in deep drilling below the AK deposit.
Your readers are no doubt aware of the acquisition potential of Queenston. I think it is well capitalized and if it delivers on key catalysts through 2012, it should perform well regardless of mergers and acquisitions.
TGR: Why is Northern Ontario experiencing such a renaissance now?
MR: Money tends to flow to the more glamorous jurisdictions, whether it be South America or Eastern Europe. Ontario has been kind of picked over. But given the volume of dollars going into exploration in Ontario, there is no doubt in my mind that a lot remains to be found. I would rather be here than anywhere else.
TGR: Moving south, Pinetree is heavily invested in silver plays in Mexico. Recently, Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) took out Minefinders Corp. (MFL:TSX; MFN:NYSE) to gain a foothold there. Which silver names are positioned to create shareholder value?
MR: The Cream Minerals Ltd. (CMA:TSX.V; CRMXF:OTCBB; DFL:FSE) story is one we are very proud of. This is an example of how a sleepy story with a great asset can unlock value through drilling. The company is targeting a resource update on its flagship Nuevo Milenio project in Nayarit State this quarter. The combination of steady extension drilling and a strong silver price could put the upside potential well north of 100 Moz silver in all resource categories. I would expect the upcoming resource update to be in the ballpark of 75–90 Moz silver equivalent in all categories. This resource is one of the first to be completed on an independent basis and will shake out a lot of the negativity previously associated with this name.
We also follow Argentum Silver Corp. (ASL:TSX.V), which is drilling on its flagship Coyote property. Assay results from the first holes of a 19-hole program are expected shortly targeting five veins delineated from historical mining down to the water table. Chip and channel samples taken last year indicated the veins carried silver, so we are looking forward to the results in the next few weeks. The company is well financed to complete its current drill program and follow up on the test results. We are watching this one closely.
TGR: Is there an iron ore name you can talk about?
MR: We are long-time investors in Canadian Orebodies Inc. (CO:TSX.V). It recently released its initial resource of 230 million tonnes (MMt) at 35.15% Fe Indicated and 289 MMt at 35.47% Fe Inferred. The company could potentially process the ore on the Quebec side, where there is abundant hydropower. I believe the quality of the asset warrants the costs associated with re-handling. One could expect good things as it continues to drill adjacent targets.
TGR: Can you give us some plays that target niche commodities?
MR: Matamec Explorations Inc. (MAT:TSX.V; MRHEF:OTCQX) is a rare earth element (REE) company exploring the Kipawa deposit in southwestern Quebec, another great jurisdiction. The majority of the deposit’s value is carried by the heavy rare earths. The company recently released a PEA with a before-tax net present value of $606 million (M) and a $316M market cap. It signed a memo of understanding with Toyota Motor Corp. (TM:NYSE) that allows Toyota to earn 49% of the project for approximately $17.5M. Although we think the project is worth more than what Toyota will potentially pay, the appeal is the addition of significant metal expertise and the potential for full-debt financing and an offtake partner. We are waiting for this deal to be finalized in the coming months. The appeal of this story is not really the size of the deposit, but its potential to be the first North American heavy rare earth deposit to be brought online. Catalysts in the next 12 months are a finalized deal, drill results that will potentially add significant tonnage and a feasibility study.
TGR: Are you bullish on the REE space in general or just selective names?
MR: Last year we saw a little exuberance in the run-up of REEs, but I think there are fundamentals driving demand for REEs. As long as we’re positioned in the best-of-breed names, I think we will do well.
TGR: Is that an overarching philosophy with Pinetree? I ask because you hold positions in a number of companies that would not be considered best of breed.
MR: We are a long-term investor. It may seem that some of our names are not in that category, but we feel that as long as we look for quality assets, time will eventually be on our side moving into a positive cycle.
TGR: What is the timeframe for that?
MR: As I mentioned before, with these 18-month spurts, I think we are coming out of a period of reduced liquidity that tax loss selling exacerbated, which leaves us well positioned moving forward.
TGR: When you and your fellow analysts at Pinetree got together at the beginning of the year to map out strategies, what was the general feeling at that meeting?
MR: My biggest takeaway was the renewed optimism. Last year was a tough one for Pinetree, as you mentioned. Going into 2012, a lot of our core positions caught that bounce that we have been expecting for a long time. We are moving along with our core strategies.
TGR: Mark, thank you for your time and insights.
Mark Raguz is an analyst with Pinetree Capital Ltd. He was previously in research at GMP Securities and was the president of New Texmont Explorations Ltd., a private company involved in mineral exploration. He has served as a director of various TSX Venture listed companies. Raguz is a graduate of the Lassonde Mineral Engineering Program at the University of Toronto.