Even in an environment ripe for takeovers, finding and sticking with quality precious metals assets is the strategy that speaks loudest to James West, publisher of the Midas Letter. Read about his philosophical and practical switch from “trader” to “investor” and about which companies lead his list of favorites in this exclusive Gold Report interview.
The Gold Report: James, do we have to rely on a successful Greek bailout to push gold above $2,000/ounce (oz) in 2012, or will that happen regardless of events in Europe?
James West: I think the latter. The deterioration in European sovereign debt integrity is only one factor pushing gold up. Numerous other forces could push gold down. Foremost is the success U.S. dollar-backed interests in the banking sector are having in pressuring the government to induce positive pricing in commodities and in the markets in general.
The federal government, the Federal Reserve and the U.S. Treasury understand that investor sentiment is influenced by the metrics issued at the close and during the trading day. Influencing those metrics causes equities to be bought or sold; it creates or perpetuates up and down days.
In an election year, President Obama and his advisers are doing all they can to create the impression of a robust, recovering economy, jobs growth and S&P Index growth. The Republican element is more interested in portraying the president as an economic bumbler who has done nothing to spur recovery, is responsible for the continued economic malaise and is an enemy of economic recovery and growth. Those forces obviously are interested in negative economic metrics.
Markets seize up when broad global investor sentiment is negative. Everybody sits on the sidelines, financing and credit grind to a halt, as do hiring and business. Then layoffs start and the cycle becomes actively negative instead of just passively negative. The government understands that and is no longer willing to let markets be unfettered. That’s because, if left to a free market, the government’s massive debt problem would be interpreted as terminally negative.
TGR: Which would be more positive for gold, a Democratic administration or a Republican one?
JW: I do not think it matters. We measure gold in currencies or we measure currencies by their value in gold. The most direct metric comes down to the quantity of a currency vs. the quantity of gold. Global output of gold is stagnant or in decline, and the availability of dollars, euros, pound sterling and renminbi is in an ongoing, exponential growth cycle. As a result, the price of gold can only rise as measured by that metric.
TGR: The recent merger of Xstrata Plc (XTA:LSE) and Glencore International Plc (GLEN:LSE; 0805:SEHK) will create the world’s fourth-largest mining company with a market cap of about $92 billion. Will this precipitate more takeovers?
JW: Absolutely. BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) and Rio Tinto (RIO:NYSE; RIO:ASX) are constantly threatening to take each other over. Barrick Gold Corp. (ABX:TSX; ABX:NYSE) has an insatiable appetite. It would love to absorb Newmont Mining Corp. (NEM:NYSE) or Goldcorp Inc. (G:TSX; GG:NYSE). The problem is that those transactions would be just massive, especially in the face of the rising gold price.
TGR: Given Xstrata’s history of acquisitions—I am thinking of Alcan and Falconbridge—and Glencore’s cash reserves, will this merger create a predator on the hunt for takeouts?
JW: Absolutely. Consolidation is a function of market growth and evolution. The majors tend to go after smaller companies when prices drop. And prices are strong right now, so I think. . .
TGR: You think prices are strong?
JW: Certainly. Copper is heading to over $4/pound, gold is over $1,700/oz.
TGR: Commodity prices are strong, but share prices are not.
JW: That is true, share prices have not recovered fully from the Q411 slump, but they are starting to recover.
We have seen all the consolidation we will see from the Q411 slump. The question now is whether the companies that are acquisition targets can evolve or grow their assets enough to warrant higher valuations in the eyes of an acquirer.
I look at companies like Newstrike Capital Inc. (NES:TSX.V), my favorite gold company. It is well capitalized and has been drilling like crazy. It keeps coming up with great results. This would be a good acquisition target, except for one thing—it has not published an NI 43-101. There is no way to quantify the value of its resource, except through press releases, drill maps and back-of-napkin calculations.
A lot of companies intentionally avoid resource calculation because they know it will trigger the interest of predatory majors. For example, Ari Sussman, the chairman of both Continental Gold Ltd. (CNL:TSX) and Colossus Minerals Inc. (CSI:TSX), will not let the majors visit the properties because he does not want to be taken over. He wants to maximize shareholder value before he invites that kind of attention.
TGR: But majors often get around that by buying a significant amount of shares and using their voting clout to get a seat on the board, where they find out what is going on.
JW: That is true. However, in general they are disinclined to buy shares out of the market. For example, Newstrike Capital has $17 million (M) in the bank and a share price in the $3 range. It would be expensive to build a position warranting a board seat. Continental and Colossus are financed repeatedly by a group of associates close to those companies. It will be virtually impossible for a major to muscle into position there without having to buy in the market.
These three companies raise money intentionally, not from a position of weakness. They finance with people whose interest is cashing in on the future value of the asset, not flipping the stock for whatever they can squeeze out of it. I try to align myself with deals that have serious shareholders, real investors, not just paper flippers.
TGR: Are takeovers resulting from across-the-board lows in share prices a near-term thesis for buying equities?
JW: I focus on the asset. If it is a great asset and I can get a position cheaply enough, I don’t care if it is a takeout target. I don’t care whether it goes to production or enters a joint venture. I follow the asset over time. It does not matter who owns it, as long as some major does not come in and opportunistically buy it at a price lower than my average cost.
Quality assets will always be developed. Stick with the asset, and ignore the short-term economic noise.
TGR: What other investment themes will play out in 2012?
JW: The key themes for 2012 are the elections and G8 governments printing money with abandon. More capital fabrication always means higher asset prices, a bull market.
TGR: But the elections are 10 months off and a lot could happen.
JW: As an investor, Q1 is the time to acquire positions in quality assets, when prices are coming off their lows. Then, you have to be prepared for post-electoral volatility. That is when they will seriously try to tackle the debt ceiling and will stop printing money. But that will not matter until 2013. This year, 2012, is all about the illusion of prosperity.
TGR: That sounds ominous.
JW: Our leadership has chosen delusion over hard reality. Down here on the street, we have no choice but to go along with it, capitalize on the opportunities and avoid the risks as much as possible.
TGR: In a recent interview, you said that the collapse of the junior mining sector in late 2011 made you “10 times more picky” about the equities you were buying. Are you doing anything differently now?
JW: I like to buy or participate in early-stage, pre-public opportunities based on management. If the stock is cheap, I will take positions in a wide variety of projects without necessarily knowing a lot about them, because it is a numbers game. If you take positions in 20 companies, one asset will emerge as a contender. Then, you lighten up on the other positions and add to the asset that seems to have real mine potential.
I used to be more of a trader, looking for the quick double. Now, I am more of an investor. I invest in the asset, sit back, let it grow, evolve, go through changes in management, whatever it has to do to get to production. That is what I am doing differently.
TGR: Let’s get into some of your favorite positions operating in Canada.
JW: One of my favorites is Prodigy Gold Inc. (PDG:TSX.V). The company is developing the Magino deposit in Ontario. Its Feb. 3 updated preliminary economic assessment (PEA) increased its resources and projected profitability.
TGR: It just did a financing, too.
JW: It just announced another 60,000 meters (m) of drilling and will issue a full feasibility study late this year updating the gold resource based on that drill program. It just keeps getting bigger and better. There is no longer much doubt that this will become a mine.
At this point, it has Indicated gold resources of more than 2.1 million ounces (Moz) at 1 gram per ton (g/t) and 1.7 Moz Inferred. At the end of the day, if it puts those Inferred ounces into an Indicated category, you are looking at a deposit of more than 4 Moz, going into production with a 250,000 ounce (Koz)/year production rate over 11 years.
TGR: What about some other names?
JW: Confederation Minerals Ltd. (CFM:TSX.V) now owns 70% of the Newman Todd project, and I believe it will eventually own 100%. Right now, it shares that with Redstar Gold Corp. (RGC:TSX.V). Every time Confederation drills a hole, it comes up with great news. On Jan. 23, it announced 27m of 5.95 g/t, including 1m of 139 g/t.
TGR: And it has only 45M shares outstanding.
JW: That’s right. It just raised almost $5M on the exercise of warrants from its last financing. In November, it announced 11m of 5.75 g/t. The sale of its potash division netted it 40M shares of American Potash LLC. In October, it announced 20 g/t over 2m and 22m of 5 g/t. It has consistent bands of high-grade mineralization over a 20m width.
Confederation is well priced, it has good structure, lots of room to grow, cash in the bank, drilling underway and the potential to own 100% of the resource; it definitely is a takeover candidate.
TGR: Maybe one more in Canada before we move on to another jurisdiction.
JW: Gold Canyon Resources Inc. (GCU:TSX.V) keeps coming up with great results. It has 50,000m of infill drilling underway and looks to me like it will be a 5–8 Moz resource at some point.
TGR: How about Prophecy Platinum Corp. (NKL:TSX.V; PNIKD:OTCPK; P94P:FSE)?
JW: Newstrike and Prophecy share equal billing at the top in terms of current and future value.
Prophecy just started a 20,000m drill program at its Wellgreen deposit in the Yukon, where it can drill through the winter on 4 kilometers (km) of historic underground drifts from when Hudbay had the mine in production back in the 1970s.
It has an 11 Moz resource of combined platinum, gold, copper and nickel on a portion of the strike that would constitute less than 10% of the whole geophysical signature. This has a very high potential to produce many millions of ounces of combined gold and platinum group metals (PGMs). Obviously, 20,000m of drilling starting underground will mean a lot of infill drilling, which will simply add to the quality of the resource.
The real excitement will begin when it starts step-out drilling after the snow melt. That will be at least 1km from the existing resource. If Prophecy hits the same mineralization to depth in 2012, it will be massive.
TGR: Deposits of PGMs plus nickel and copper are unusual. Are we looking only at drill results, or are there other catalysts?
JW: The catalyst is continued drilling. The company will do a resource calculation and issue a PEA this year. That will catalyze a major share price increase. There are metallurgical studies underway. With complex, combined metal output, those studies are a key ingredient. The company plans to ship a concentrate.
TGR: That keeps the capital expense lower, too. Will this be an underground mine?
JW: No, the concept is open pit. The mineralization is so widely disseminated, with high-grade lenses and massive sulphides, open pit is the right way to look at it.
TGR: Let’s head to the southwest U.S. Which companies do you see as potentials for takeover?
JW: I am waiting, almost minute by minute, for a takeout offer on Redhawk Resources (RDK:TSX; QF7:FSE; RHWKF:OTCQX). The company has 3.4 billion pounds copper in a resource, but it has been on a 30,000m drill program that will produce a new resource calculation in April. I think that will almost double the resource, triggering the interest of majors looking for high-value, safe-jurisdiction copper deposits with good production infrastructure.
There are all kinds of mines in this part of Arizona. Within a 25–50km radius of Redhawk, Rio Tinto (RIO:NYSE; RIO:ASX) is developing a copper mine and BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) has a producing copper mine.
TGR: ASARCO LLC (AR:NYSE) also has a smelter nearby.
JW: ASARCO butts up against Redhawk. ASARCO would be a good candidate to take over Redhawk, but the fact that it has not acted leads me to think it will not. I think a Chinese firm is a more likely takeover. They are a bit more aggressive in acquiring high-value copper deposits right now.
TGR: What do you know about Redhawk’s management?
JW: The company is sufficiently controlled by management to prevent an opportunistic major from taking it out at a discount. Redhawk’s largest shareholders are unanimously adamant that they will not take less than $2/share if they have to sit on it for a century. That is probably why you see a bit of weakness in the share price.
If the updated resource is doubled, the share price will reflect that in very short order. A rising share price will trigger the interest of a major who wants to get in before the price goes up too high. I think that will happen for Redhawk in 2012.
TGR: Are there some other names you’d like to tell us about before we let you go?
JW: Corazon Gold Corp. (CGW:TSX.V) is a great opportunity when you look at what is happening in Nicaragua. Calibre Mining Corp. (CXB:TSX.V) just made some porphyry discoveries there and B2Gold Corp. (BTO:TSX; BGLPF:OTCQX) has had success with its Jabali vein. Corazon is drilling madly on vein structures. It has great potential to do very well in the near term.
TGR: Is Nicaragua a safe jurisdiction?
JW: Absolutely. There has never been any indication of government interference or political problems. Everything gets permitted. There are no problems with the investor split to the government.
TGR: And one more company?
JW: Inter-Citic Minerals Inc. (ICI:TSX) is very interesting to me. Last year, the company turned down an unsolicited bid from a major Chinese company that management viewed as excessively opportunistic. Since then, it has announced great results from its drilling at Dachang and has increased the value of its deposit.
Inter-Citic is a great entry-level stock now. It is lower than before the takeout offer, and we know that the company that wanted to take it out is still watching it. I think we will see an improved offer from the same or another Chinese company.
TGR: Is it an advantage that Inter-Citic has a large gold deposit in China?
JW: Absolutely. For five years, China as a sovereign entity has been the largest acquirer of gold in the market and the Chinese people are among the world’s most aggressive consumers of gold for investment purposes. Inter-Citic’s proximity to that market is a direct advantage.
TGR: Why has Inter-Citic’s share price lagged?
JW: The fact that it’s in China. There is a perception that only a Chinese major or a Chinese mining company could put it into production successfully.
Some investors saw the failure of the last takeover bid as a lost opportunity. But if you look at the deposit, I think management did the right thing. Drilling aggressively while improving the deposit is the right move.
I think the share price is directly a result of the failed takeover bid. I think the share price will rise dramatically as the value of the deposit is improved and the inquiring company will return with a better offer.
TGR: Any parting thoughts for us, James?
JW: I would emphasize that volatility in the market on a day-to-day and week-to-week basis is the new norm. To consider yourself a real investor who does well, you must ignore the economic noise. That is to say the volatility caused by mainstream media coverage of issues like sovereign wealth and sovereign debt. Investing in a quality asset and a quality management team is all that counts.
TGR: James, thank you for your time and your insights.
Midas Letter is the Journal of Investment Strategy of the Midas Letter Opportunity Fund, a Luxembourg-based Special Investment Fund that specializes in Canadian-listed emerging companies in the resource sector with a focus on precious metals explorers and miners. James West is the portfolio and investment adviser to the fund. West’s Midas Letter Premium Edition deconstructs the economic and political events of the past and upcoming week and identifies risks and opportunities to investors seeking to profit while the majority of investors are losing money.