By The Energy Report, on December 16th, 2011
As developing countries increase their energy consumption, the oil and gas sector will continue to grow, powered by Canadian companies feeding global demand. In this exclusive interview with The Energy Report, President and Portfolio Manager Bill Bonner of Brickburn Asset Management in Alberta reveals several energy companies with maximum production and growth potential.
The Energy Report: Bill, your bottom-up firm makes its investment decisions based on individual company fundamentals, but do you have a sector bias?
Bill Bonner: Our focus is entirely Canadian energy, with one exception: We also manage private client assets and traditional portfolios. I have two partners who look after non-energy holdings in those portfolios, but our background has been as energy investors for 30 years, so that’s what we focus on. People allocate capital to us because of our energy expertise.
TER: Are you bullish on oil and gas as commodities?
BB: Over the near term, it’s hard to be bullish about the price of natural gas. Even if there were some abnormal weather events this winter, it’s unlikely we’re going to get a big bump in the price of natural gas. Over the medium to longer term, we can be quite bullish. The outlook for gas over the long term is spectacular, given it’s an environmentally friendly commodity. If you had a choice to burn coal or natural gas in your power plant, you probably should pick natural gas. That transition is happening.
There is one caveat. Natural gas liquids are a component of natural gas. Producers today are likely not looking for dry sweet gas—they’re looking for gas that has some liquids component. The heating value is higher, and companies can extract the liquids if the price is positive. So, while operators acknowledge the gloomy near-term outlook for gas, there are companies that want to focus on liquids-rich natural gas.
Oil is an entirely different scenario. Given the volatility of oil, prices are up. We are consuming more energy than ever, and that trend’s not going to decline. Yes, there will be some bumps along the road, the Eurozone issues for example, but the energy demand in Europe and North America is not the most important variable today. Emerging markets in developing countries are driving the demand higher, and that’s not going to change. The outlook for oil demand will continue to be positive in the short, medium and long terms.
TER: What is your oil forecast? Are you using current oil prices or higher oil prices in your models?
BB: The baseline we use is $80/barrel (bbl) for light sweet crude oil (West Texas Intermediate, WTI). There are many other lighter crude qualities that are more important than WTI, but it’s a benchmark that’s commonly used. Our near-term projected range is $80–100/bbl, and we’re at the upper end of that now. In the past six months, we’ve had two tests, and in the worst—Europe’s contagion—$80/bbl was the bottom, so we think that has established a bottom price. Not only that, the Organization of Petroleum Exporting Countries’ range last year in its World Oil Outlook was $75–85/bbl. This year’s report defines the trading range as $85–95/bbl, so we say $80/bbl is a pretty comfortable bottom level.
We’ll look at a business and ask, what happens if the oil price is $80/bbl? What happens to the cash flow and the capital spending program? If we’re comfortable that the company can still plow ahead even at that level, then we want to take a position. It’s possible to be seduced by the higher price at $100/bbl, but you have to recognize that in the short term, that is a windfall. However, one to two years out, the baseline might be $100/bbl. That’s the direction we’re going.
TER: So is the recent WTI of $102/bbl a bit overbought?
BB: I wouldn’t necessarily say that. Does $2 make a difference if your top level is $100/bbl? I don’t think so, but at that level the market is pricing in a degree of optimism that we are comfortable with. If we saw $110/bbl, I wouldn’t feel as comfortable.
The feedback we get from producers is that they are hedging as soon as they see prices in excess of $100/bbl. That indicates industry is thinking cautiously, so perhaps we should be thinking the same way.
TER: Gasoline prices at the pump are down about $0.10/gallon (gal) over the past two weeks, but crude has been in a trading range over H211. If it remained in this range, would that be an extremely bullish scenario for oil producers?
BB: Yes, I think so. If the new baseline could become $100/bbl as opposed to $80/bbl as we believe it sits today, then we have to adjust our thinking. In the U.S., $4/gal seems to be a magical number. Above that, you get lots of chatter in the press about how horrible that is; below that, people seem to be accepting.
TER: As of June 30 in your Dominion Equity Growth Resource Fund, you were invested in oil and gas production 2:1 versus exploration, 62% versus 31%. Why are you weighted the way you are with a growth fund?
BB: The production stories are cheap, yet they have organic growth built into them. There are three names I really like; two are large, and one is small: Whitecap Resources Inc. (TSX.V:WCP) and Surge Energy (SGY:TSX.V) being the large ones and DeeThree Exploration Ltd. (DTX:TSX.V) being the small one.
If we want exploration exposure, we tend to focus on international stories as opposed to domestic stories. It’s more and more difficult to find a good exploration story in the Western Canadian Sedimentary Basin. Pre-production or small-production stories in places like Argentina and North Africa are quite exciting. Our investment view and portfolio weight is driven by the fact that we see the production stories are inexpensive.
TER: Surge is one of the larger of these that you like, with $602M market cap. What’s your story there?
BB: Surge is becoming quite oily. You can’t get away from natural gas with most of the producers in the basin here in western Canada, so if you want to play an oil story, you’re probably going to end up owning some gas too. Surge is about two-thirds oil and one-third natural gas.
The management is what really attracts us to the company, as we’ve been invested with the management team a couple of times prior to Surge.
Three of the company’s plays really jump out at us, all light oil plays. The opportunity on those, based on about a 10% recovery factor, is about 30 million barrels (MMbbl) of recoverable crude. When you apply secondary production technology (i.e., water flood), that number almost doubles. It’s not a matter of finding the hydrocarbons; they are there. It’s a matter of exploiting what you already have. And Surge has good operators who can take a challenging situation and figure out a way to improve recovery factors. Surge is also sitting on some big oil-in-place opportunities with just under 500 drilling locations. It expanded its capital expenditure budget from $120M to $160M to take advantage of its inventory of opportunity. The company has had no dry holes in 2011 so far—not a bad batting average.
TER: About a month ago, Surge revised its 2011 production rate up 73% over its exit production of 2010. The market is looking at that as history though. Does that have any bearing on 2012?
BB: Surge is going to continue to organically grow production, however it acquired an asset at Valhalla at the Peace River Arch area in Alberta, Canada, which is partly why production jumped.
As for internal organic growth, Surge has its top three plays well positioned. It’s just a matter of completing exploitation of these plays. We expect the company will exit this year at 7,000 barrels of oil equivalent (boe) and has the potential to double production in 18 to 24 months. That’s pretty good growth.
TER: What’s your investment thesis with Whitecap?
BB: We’ve also had some past experience with management at Whitecap, and it has built previous companies through an active acquisition strategy.
Whitecap has made three or four acquisitions that have all been accretive to shareholders, and now the company is roughly the same size as Surge. Interestingly, Whitecap is in some of the same areas that Surge is in, up in the Peace River Arch area. Whitecap and Surge have similar profiles in terms of production mix—two-thirds oil, one-third gas. That’s the production base; when you look at the revenue however, it’s more like 90% oil and 10% gas; that’s a reflection on how tough the gas business has become.
Whitecap is an aggressive hedger. It will hedge up to two-thirds of its production. We don’t have a problem with that because we just want to make sure the company executes on its budget.
Smaller producers used to be criticized for hedging, and the argument was that they were taking away upside from investors. That has changed. Now, financial analysts say hedging is fine if it achieves the objective, which is to meet the capital spending. We want to see production growth. Whitecap has been a good example of a company that does that. Its hedging experience has added 10–15% to its netbacks.
TER: Is that because there is a very high relative strength that’s up 28% over the past 12 weeks?
BB: Yes, the Whitecap story is partly management and partly execution, which is a reflection of management. The company is positioned to again double the production, and when you start to run through the metrics of the inventory, making some assumptions about how much it will take to finance the process, you can see an added $10–11/share. I look at the stock at $8.50/share, and I think it could potentially double from this point. This production story has growth.
TER: So Whitecap is going from a small-cap to a mid-cap producer.
BB: Yes. It’s a larger small-cap company at the moment, with 7–8 thousand barrels a day (Mbblpd). In Canadian terms, we would probably call this a mid cap at the current $750M enterprise value. Things are a little smaller in Canada in terms of definitions.
TER: It opens up the possibilities of being owned by larger mutual funds too.
BB: It certainly helps.
TER: DeeThree has had a bumpy ride over the past 12 weeks. It’s down 40%.
BB: This is more of an exploration story than a production story, although the company certainly has production. The leverage here, compared to either Surge or Whitecap, which have the potential to double, is that DeeThree has potential to quadruple.
TER: It’s a value play.
BB: It’s a matter of execution too. Again, this is a situation where we’ve been familiar with management and have made money with them in the past. When DeeThree first set out, it made a significant acquisition in southern Alberta that included all kinds of infrastructure, gathering systems, plants, etc. What the company didn’t realize at the time was underlying its lands is a play that is now emerging and catching everybody’s attention. It’s the Alberta Bakken. DeeThree has been able to farm out part of its massive land spread. There are 250–300 prospective sections on trend (a section is 640 acres). Recent land sales on trend have gone from $500/acre to $1,000/acre. That equates to a large “conceptual” value for DeeThree and it got us interested in the name.
Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE), Crescent Point Energy Corp. (CPG:TSX), Murphy Oil Corp. (MUR:NYSE), Nexen Inc. (NXY:TSX; NXY:NYSE), an independent called Legacy Oil & Gas Inc. (LEG:TSX) are all playing this trend in southern Alberta. If it works out, DeeThree’s farmout on 30% of its lands will have essentially confirmed the trend is present on its lands, which in our opinion sets it up to be an acquisition target.
In addition to the Alberta Bakken lands, DeeThree made an acquisition we thought was absolutely spectacular. It’s a light oil play in the Brazeau area of northwest Alberta. The Belly River formation is the producing horizon. The company acquired 42 sections of land that prospectively may have oil in place of 50 MMbbl per section. That represents an incredibly large resource number. However, because the oil formation is very tight, well completion success will be determined by successful multistage fracks. It is in its early stages, but DeeThree is getting results.
I think DeeThree can triple its production on Brazeau, in addition to its growth potential with its Alberta Bakken play. The company would emerge from roughly 3,000 boe to something closer to 10,000 boe and have that Alberta Bakken inventory still sitting there. There’s great leverage in the name, especially at $2.20/share.
TER: Why has DeeThree been so weak recently?
BB: It’s partly market cap, but there have also been confusing signals coming out of the Alberta Bakken play. There was some suspicion that Legacy, partnered with Bowood Energy Inc. (BWD:TSX), was going to abandon it. Crescent Point also suggested there might be some challenge with the play itself. That’s not surprising, but some of those negative comments affected DeeThree’s stock.
I’m looking back to when DeeThree bought the Brazeau property in Q111. That was a $125M acquisition, and the company issued a bunch of equity. The market hasn’t focused too much on what’s happening at Brazeau, though, and has just focused on Alberta Bakken.
TER: You’re clearly not averse to owning private equity in this fund. ET Energy Ltd. is your largest holding, representing nearly 22% of your Dominion Equity Resource Growth Fund net asset value as of June 30. Is that percentage holding?
BB: It’s increased slightly because the fund has shrunk in size, but it wasn’t our plan to have that large a weighting.
TER: How do you value a private equity in your portfolio?
BB: There’s the fantasy valuation, and then there’s the valuation that our auditors will accept. Under the new International Financial Reporting Standards rules, we have to value it based on what we really believe the value is, but we need reference points like third-party pricing events. We look at whether the company issues equity to outsiders or there’s trading activity in the stock, and even then we have to make a judgment call. For example, if a company has 66M shares outstanding and 100K shares trade at $3/share, is that really the value of the company? I would argue it’s not. In terms of our analysis, we’ll look at a variety of things, including third-party pricing events, but we’ll also pay attention to what the company is publishing and what the independent engineering data suggests. Then it’s a judgment call.
We have to be careful in that our fee revenue is based on the value of these portfolio components. We tend to err on the conservative side in terms of valuation because we never want to be accused of raising prices to get more fees.
With ET Energy, we’ve held our position for almost six years. We bought it at $1/share and have written the position up to $7/share over that time period. We had evidence that the stock traded well over our carrying value, but over that time, we also had the meltdown in 2008 and further trouble in 2010, hence we are comfortable with our current carrying value. We know the company is in the midst of a pre–initial public offering (IPO) financing round, and we’ll have to see how that looks and adjust the value accordingly. Our reference points make us very optimistic about the real value. The company’s execution of its business plan will be the convincing factor.
TER: Will that pre-IPO financing round be equity?
BB: Yes. The most recent financing round was a three-year note with warrants attached to it. Share purchase warrants were valued at $10/share. There’s some anti-dilution provision in that warrant, but there’s a reference point.
TER: Why do you love this company?
BB: We like the oil sands to start with, but also ET’s production technology is environmentally friendly. There’s no water used, and it’s very energy efficient. The capital costs to put it in place are a fraction of the alternatives. We also know the resource is well defined on the company’s land. It’s just a question of executing and unlocking the value. What’s given us real confidence is the fact that Total (TOT:NYSE), the French company, is now partnering with ET in its commercial development. Having a big brother like that by your side adds credibility to ET’s execution of its business plan.
TER: What is your exit strategy?
BB: The exit strategy is to wait and see how the public markets react. We believe ET will be public sometime in the next 12 months. That comes from management, but it’s subject to the markets, of course.
As far as other companies go, our ambition in the portfolio is to hold roughly 20 names. We like the exploration stories that are unfolding in Argentina. Madalena Ventures Inc. (MVN:TSX.V) and ArPetrol Ltd. (RPT:TSX.V) are companies that have land positions, production and growing opportunity in Argentina. Argentina looks like Alberta did 25 years ago. There’s been some political risk over the last 10 years, but a lot of that has been put aside. Argentina knows it has an energy deficit and the solution is to develop its many reserves.
TER: Thank you for your time and insights.
Bill Bonner is co-founder and president of Brickburn Asset Management, a Calgary-based investment counseling firm largely focused on the Canadian energy sector. He is directly responsible for managing energy investments in public market portfolios, private client portfolios and private equity pools. With over 30 years of energy capital markets experience, Bonner brings a perspective to Brickburn Asset Management that has been built on a solid foundation and in-depth knowledge of Canada’s energy sector. Prior to founding Brickburn Asset Management, he was a founding director of Network Capital, the predecessor to Brickburn. His career also included 14 years with Peters & Co. Limited, where he was a significant shareholder, member of the Executive Committee, and managing director of Institutional Sales and Trading.
By The Energy Report, on October 5th, 2011
 With well over 100 attractive companies to choose from in the mid-tier Canadian oil and gas industry, investors have many interesting opportunities to profit from continuing demand growth. In this exclusive interview with The Energy Report, former Mackie Research Senior Energy Analyst Robert Cooper zeros in on three of his favorite stocks and elaborates on his investment criteria.
The Energy Report: What’s your big-picture view of Canadian junior oil and gas companies?
Robert Cooper: The business plans for junior and midsize companies have changed dramatically in the past five years, largely due to three game-changing events. The first was the elimination of the royalty trust structure. Number two was royalty changes in Alberta. The third was the advent of horizontal drilling.
Through the mid-2000s, the trusts were essentially industry Pac-Men scooping up smaller companies. With a couple of thousand barrels of production per day, companies had an obvious exit plan via sale to the Trusts. Once the trust structure was eliminated in October 2006, so was the appetite for mergers and acquisitions (M&A) from the trusts as they had to retool their own asset bases. Many of the midsize trusts were acquired themselves and morphed into larger companies.
Secondly, the ill-conceived royalty changes in the fall of 2008, which have since been rectified, were extremely punitive to conventional producers and explorers. As a result, juniors had to adapt to lower geological risk models in order to stay in business. Finally, the development of unconventional plays through technological changes, principally horizontal drilling and multi-stage completions, caused the business model to change again, this time to a better-capitalized and longer-term business plan.
Today’s smaller producers tend to have a signature property that is a resource play. The companies are usually better capitalized and generally larger than they were five years ago. While M&A still occurs, it’s for strategic assets, unlike the previous market environment, where companies could put together some assets and find a buyer after three years. Now juniors need to have a scalable business plan and properties with enough scope such that if they seek to be acquired, their properties are sizeable enough to be a signature growth property for the much-larger acquirers.
TER: What are you looking for in the coming months for the oil and gas markets?
RC: Overall we’d expect continued volatility in the equity markets. The macro situation is clearly in a massive state of flux on a number of fronts. Sovereign debt concerns clearly represent the largest near-to-medium-term threat in our view. No one knows exactly what the ramifications will be if Greece or another peripheral European country defaults. But in investors’ minds, that will inhibit risk taking, and that’s negative for small-cap stocks and commodities, including crude oil. That said, we’re much more constructive on crude than natural gas, despite the apparent downside risks in crude. Even with consistent prints in the $80s, most western Canadian sedimentary basin producers would still have pretty robust economic returns. Crude oil is ultimately a secular growth story with rising supply costs and rising demand.
With natural gas, I’d say we are neither bearish nor bullish. There might be periodic trading opportunities that are largely related to seasonality, but the big move down has taken place. The supply curve has changed, and that’s severely impacted the price. On the other hand, we don’t yet see a reason to become bullish.
I’d say we need to see a structural move higher in the demand curve for natural gas, and that could manifest itself through the elimination of coal-fired power plants or the implementation of natural gas-fueled vehicles for long-haul trucking, for instance. In Canada, it could be the development of export markets to Asia that could fundamentally alter the equation for Canadian producers. North America is clearly awash in natural gas for the foreseeable future. It’s still bewildering to me why the U.S. doesn’t incorporate natural gas into the energy mix in a much greater fashion. It would do wonders for reducing U.S. reliance on foreign sources of energy.
TER: Getting to specific companies that you cover, what are the selection criteria that you use in determining which companies you want to cover?
RC: We’re normally bottom-up value investors but incorporate a macro overlay. We assemble a list of candidates and then do our due diligence on the companies that meet our criteria. First, we look at product split—gas or oil or liquids-rich gas. All of them can be very profitable at certain times in the cycle. I’d be more biased toward oil and liquids-rich gas right now. Two, we’re looking at the plays and properties—conventional or unconventional. Our focus tends to be on unconventional resource plays. The third item would be management. Are they trustworthy? Have they had success previously and are they significantly, personally invested in their companies? The fourth thing would be operations. Do they have a high working interest in their properties? Do they own or control their infrastructure? Do their properties consist of repeatable play types, repeatable drilling inventory with multi-zone potential? Do they have scale and scope? The fifth thing is capital structure or valuation. Is the level of capitalization congruent with the type of opportunity the company is pursuing?
We’re value investors, so we tend to look for situations where there’s a mispricing of assets or a market misunderstanding combined with a pending catalyst that will propel that stock. If we’re correct, this provides the opportunity to earn outsized returns.
TER: Just for a little further background—about how many companies are there in the oil and gas business in Canada of a viable size that would be of interest for you to cover?
RC: It’s gotten smaller lately. Off the top of my head I’d probably say there are over 100 public companies on our radar, about 60% of which are small-to-medium-cap companies.
TER: Can you tell us about some of the companies you particularly like and give us a little detail and reason why people ought to be interested?
RC: We’ve been focused lately on Yoho Resources Inc. (YO:TSX.V), Crocotta Energy Inc. (CTA:TSX) and Open Range Energy Corp. (ONR:TSX). Yoho and Crocotta have the scale and scope in their properties that we think will ultimately lead them to be acquired. Open Range is a hybrid. It’s a top-decile gas producer with an excellent gas-weighted property in the Deep Basin of Alberta. It has another division called Poseidon Concepts, which is a fluid handling business. Open Range announced in early September that it’s spinning both these businesses out to shareholders. Its gas property still has the scale and scope that we like and think it will be acquired. The fluid handling business is going to be a whole new entity that has material growth and cash-flow generation capacity. But all of these companies fit our criteria. They’ve got enough scale, scope and potential that someone might decide to buy them, take over the property and apply some capex to it to really accelerate growth.
TER: Was that the philosophy behind Open Range Energy’s spinoff?
RC: It was starting to look like it was suffering on a small scale from what we call the “conglomerate discount.” Some investors wanted to participate directly in the tank business while others wanted to participate on the E&P (exploration and production) side. It made sense to separate the two and let investors choose a pure play in which they can participate.
TER: About a year ago, ONR was trading around $1.60 and now it’s moved up to the $9.00 range. What are the prospects here after the split up? Is there still some upside at this entry point?
RC: The tank business is where the big growth is. It is scheduled to pay a $0.09 per month dividend, so, it’s going to be a hybrid growth-plus-yield entity. Open Range basically created this unit from thin air. An engineer in the field figured out how to construct fluid handling tanks in a manner that allowed them to be easily assembled in the field in a matter of hours. The tanks have obvious advantages in that they are easy to use and assemble, reliable and eliminate logistical problems because they are easily transportable and its use results in a substantially smaller environmental footprint. ONR management patented the concept and managed to create a business from scratch in early 2010 into a projected $130M EBITDA (earnings before interest, taxes, depreciation and amortization) in 2012. It’s had a phenomenal growth trajectory and we think that there’s still room to grow, particularly in the U.S.
When the company is spun out, it will be able to operate on its own and it’ll attract a different investor base, mainly yield investors. In terms of market share, we think there’s still probably room to double before potentially significant competition enters the space. It’s running at 80% operating margins now and that’s inevitably going to attract competitors. But because they’re the only player in the space at this time, they’ve got the early-mover advantage. The faster they maximize their market share, the more able they will be to deal with competition from a position of strength. But in the near-term, once it’s spun out at the end of October (assuming investors approve), investors will be collecting what looks to be a ~15% yield out of the gate. It’s very difficult to find this level of yield in today’s market.
TER: They used to pay something like that in the old days, didn’t they?
RC: Yes; and the upside is that if it trades down to a 10% yield investors could see potentially a ~50% capital appreciation, plus a healthy dividend. The main risk is competition. As we mentioned, the margins are stellar and that is ultimately going to result in new entrants in the market. The large service companies such as Baker Hughes (BHI:NYSE), Schlumberger (SLB:NYSE) or Halliburton (HAL:NYSE) would be formidable competition down the road.
TER: That’s still a pretty phenomenal growth story in a short period of time.
RC: It truly is.
TER: What about Yoho and Crocotta?
RC: They’re both pure E&Ps. We like Yoho for a bunch of reasons. Yoho’s CEO is one of the most impressive exploration geologists we have followed. He’s consistently early on high-potential plays and he’s done that again within Yoho. He’s run three or four different companies and had success in each. Yoho has the largest, or very close to the largest, exposure to gas in place of any junior we know of in western Canada at over three trillion cubic feet (Tcf.). Now, “resource” is not the same as reserves, but it’s a pretty good indicator that reserves can be captured with some prudent development. There are three material plays within the company right now that are not, in our view, recognized by the market. One of the two main plays is called the Duvernay Formation in West Central Alberta. The second one’s called the Montney Formation in Northeast B.C. The Duvernay has been the subject of a lot of chatter in Calgary as industry has spent close to $1.6 billion (B) on land in the last year and a half on the trend.
Majors such as ConocoPhillips Company (COP:NYSE), Encana Corporation (ECA:TSX; ECA:NYSE), Talisman Energy Inc. (TLM:TSX) and others all have announced major positions on trend that is thought to contain very high amounts of gas and liquids in place per section. Yoho is by far the smallest player in the Duvernay and, as such, has the most leverage to drilling success. The Montney, on the other hand, is a very well known formation. It’s also thought to have significant gas in place.
Yoho’s partnered with a large and successful company on this play and they’re actively drilling over the next fiscal year (YO has a September 30 year-end) on both plays in an effort to further quantify the potential. Both plays produce liquids-rich natural gas. If they’re successful, we see the potential for material leverage to reserve and production growth. The plays are certainly large enough that Yoho will ultimately be attractive to larger companies. The key risk here is financial. Wells are expensive and Yoho is a smaller company.
TER: How about Crocotta?
RC: Crocotta is another very well-run company. Similar to Yoho, the CEO’s been successful in past E&P companies he’s led. This is his fifth company on that front. The company has an excellent balance sheet and the capacity to expand and accelerate its drilling program over the coming months. Two main plays are in Alberta’s Deep Basin and in the Montney, Northeast B.C. In the Deep Basin, Crocotta has a multiyear inventory of low-risk, high-return, liquids-rich natural gas wells. The company has recently expanded this inventory through a farm-in with an industry major. Over the next couple of months we’d anticipate continued production growth coming from the Deep Basin property. Secondarily, we’d expect some incremental drilling in the Montney, which holds significant gas in place. Competitors all around Crocotta have had very good results from the Montney. If Crocotta has similar success, we think it could add significant reserves. Finally, Crocotta’s CEO has done a great job creating value, as he’s had to transition the asset base to adapt to the factors we mentioned previously. He has a great sense of the market and he’s a significant shareholder himself. We’re pretty confident that he’s going to do the right thing on behalf of shareholders.
TER: So, what are your expectations as to where the stock is headed?
RC: We think $4.00 is achievable and, with luck, it could be higher than that. “With luck” means with a more constructive macro environment in which E&Ps are acquisitive. We view the properties as top tier and they have scope and scale—key criteria in our view when looking at potential acquisition targets. The main risks are commodity prices and drilling/completion risk.
TER: What do you think energy investors should be aware of at this point, focusing on the next six to 12 months, to maximize profits and minimize risks?
RC: Energy prices are dependent on the economy; that really drives investor sentiment with respect to taking or reducing risk. Proper stock picking is very important: Companies with good fundamentals offer a buffer against those macro issues. If we’re looking at a disintegration of the euro, for instance, small-cap stocks are not going to be in vogue, and that’s a big risk and headwind. However, if you take a longer-term time horizon, the junior energy sector in Canada certainly has potential to offer some excellent returns.
TER: What is the downside risk for oil if the economy takes an abrupt turn for the worse?
RC: Good question. You certainly could see $60 or $70 oil. We’ve already seen prints in the $70s for crude oil a few weeks ago. We would be quite concerned if emerging economies catch the flu from developed economies and those regions really slow down. That’s where you’ll see the most deleterious impact on crude oil prices. But if they don’t, then beyond periodic hiccups in the economy and the cyclical moves, supply costs are rising and demand is on a step change higher every year. So on a longer-term basis, we advise investors to have exposure to crude oil. In the short term, investors will need to watch the health of the economy because European issues will weigh heavily on the market.
TER: In the meantime, you’ve given us three interesting stocks to consider. We appreciate your time and input and look forward to talking with you again and seeing where things have gone at that point.
RC: Thanks; I hope I’m right.
Robert Cooper, CFA is an energy analyst based in Calgary with a focus on Canadian oil and gas exploration and production companies. Robert has more than 10 years experience in the investment industry and has been covering the Canadian oil and gas sector since 2006. Robert is a Calgary CFA Society board member and recently served as president of the Calgary CFA Society.
By The Energy Report, on August 12th, 2011
 The Williston Basin is a hot area of exploration and production that oil and gas analyst Jason Wangler follows from his SunTrust Robinson Humphrey office in Houston. In this exclusive interview with The Energy Report, he shares his thoughts on the near-term prospects for oil and gas demand and prices, and tells us about several attractively priced names with good upside potential from current levels.
The Energy Report: Thanks for joining us today, Mr. Wangler. You and your associate, Neal Dingmann of SunTrust Robinson Humphrey, follow quite a number of energy stocks as well as the oil and gas markets in general. Oil prices have been relatively stable over the last few months with oil in the $90-$100/barrel (bbl.) range, and gas in the $4.20-$4.80/thousand cubic feet (Mcf) range. What are your expectations for the oil and gas markets in the next 6 to 12 months?
Jason Wangler: I think we’re really going to see a lot more of the same trading ranges. In the last couple of years, the economy, especially in the United States, has been building back from the terrible situation of late 2008 and early 2009. In 2009 and 2010, we were growing slowly and getting back to a level that was making more sense. But now that we’ve gotten a little more than halfway through 2011, there are still a lot of issues here in the United States. The debt ceiling and budget crisis and the general concerns with the economy not growing as fast as people expected have all had their effects.
We see the Brent crude prices $15 to $20 ahead of where the West Texas intermediate (WTI) oil prices are here in the States because there is excess supply in the U.S. right now and not as much expected demand for that oil. If you look at gas, it’s very much the same way, not only in the U.S. but worldwide. The other countries around the world would love to have the amount of natural gas that we have. The U.S. is blessed with the riches of natural gas from its shale plays. So you’re probably going to see gas stay in the $4-$5/Mcf range and, I think, probably below $4.50/Mcf for the most part, until we have either a demand or supply change that’s very dramatic. That would probably have to come from the demand side either in exporting natural gas or additional uses, whether it be for vehicles or heating more homes or something of that nature.
TER: It’s interesting how the whole gas situation has turned around because there was all this talk a few years ago about building ports to import liquefied natural gas (LNG) and now we’re talking about exporting LNG.
JW: It is amazing. The “shale revolution” has really changed the dynamic for a fuel that was very hard to come by but can’t be easily transported. You have to build these very large, expensive ship-loading facilities. Some people looked at the market in the U.S at the time and wanted to build import facilities because we would need them and we’ve leaned on Canada and Mexico for quite a few years to supply us with natural gas. Now we have so much at $4/Mcf, we wish those countries would need some of ours. Exporting LNG could start to balance out how much oil we have to import.
TER: Looking at your coverage list, some of the stocks are under $0.50 with market caps under $20 million (M), and others are big institutional favorites that trade above $100 with market caps over $50 billion (B). How do you decide which companies you want to follow?
JW: My colleague Neal Dingmann and I look for names and stories that interest us. We look at the management teams as well as where the assets are located and actually break our coverage down based on specific basins. I cover the Williston Basin in North Dakota and everything west. He covers Eagle Ford in Texas and everything east. And then we try to cover a group of names in each basin in different life cycles of each play. It could be one that’s just a very early entrant, which may have a $100M market cap, such as a Voyager Oil & Gas Inc. (NYSE.A:VOG) in the Williston, up to somebody who’s in the $10B+ range, such as a Continental Resources Inc. (NYSE:CLR) or a Whiting Petroleum Corporation (NYSE:WLL).
TER: You seem to be quite hot on the Williston Basin. Tell us why you like it so much.
JW: It’s one of the most economic and best resources that we have, not only in the U.S., but, really, in the world. There’s lots of running room and we’re very early into the play with lots of acreage still to be drilled. We could be up there for 50 or more years drilling very, very strong wells and putting lots of oil into U.S. tanks. The Eagle Ford and the Utica in Ohio have interesting and up-and-coming plays, but the Williston really has been shown to be as economic as any other, if not the best. It’s always nice to be in an asset that has the best type of results.
TER: A lot of these Williston stocks that you’ve recommended in the last few months have had some respectable moves. Is there still some good upside available there?
JW: I think there still is. The winter was colder than usual in North Dakota and Montana. After the winter season they had floods, which caused a lot of problems throughout the Midwest in general, starting up in North Dakota and Montana.
So, there were a lot of problems with shut-ins. They couldn’t work at the same pace they typically had been able to so production numbers were not as high as expected. Wells were not coming in on the expected timeframe. So, some of these stocks took a significant hit. The weather has been good since the beginning of June. Now we’re really starting to see some very impressive rates. Going through the second quarter earnings season, when we start hearing these names report, I think people are going to understand why they’re going to be a little bit lower than we originally expected entering the year.
Today, a month or two since the weather improved, we are able to say that this is a resource that makes sense. And as long as the weather works, we can really start churning out some very impressive numbers. So, I look for the Williston names to really have some impressive growth rates, not only for the full year, but, mostly based on just the second half of this year, because the weather has finally started to cooperate.
TER: Can you tell us about some small-cap names you particularly like at this point?
JW: One of them is a very early stage play in the Williston called Kodiak Oil & Gas Corp. (NYSE.A:KOG). The company has about 100,000 net acres at this point and is really starting to turn on a lot of wells. It should actually be able to start talking more and more about some very impressive production growth rates, not only for this year but next year. In the next couple of quarters, Kodiak could double production in only one quarter because it is able to bring on three, four or five wells. It currently has a couple of rigs running and will be moving to five rigs by the end of this year. Next year, 2012, we should see explosive growth much as we saw from Brigham Exploration Company (NASDAQ:BEXP) a few years ago. So, I look at Kodiak as an earlier stage play in the Williston with a very nice acreage position and cash on the books. When the additional rigs start running, it’s just a matter of focusing on operations and getting the oil out of the ground.
One other one is GeoResources Inc. (NASDAQ:GEOI). It’s a very interesting small company with a strong management team and a great balance sheet. The company has been around for quite some time and has been able to put together nice positions in both the Williston and the Eagle Ford. It’s just starting to drill now on those positions as the operator. It has a couple of wells in the Bakken that weren’t as great as maybe some other results. But, I think you will see some better results coming out of there as the company comes to understand the resource. Then down in the Eagle Ford, GeoResources just reported some very impressive results a few weeks ago coming out of the Gonzalez County area, a little bit further north than most people thought the Eagle Ford to be. It has some good partners and I think you’ll continue to see it be able to add rigs and really start moving that production level much higher.
TER: What else do you like?
JW: Another one that makes a lot of sense to me is Gulfport Energy Corp. (NASDAQ:GPOR). The company is in the Utica Shale as well as a lot of other places. Utica has become a play that everyone’s really curious about and Chesapeake Energy Corporation (NYSE:CHK) is really the only other one that’s talked about Utica very frequently. According to Chesapeake, Utica has the potential to be better than the Eagle Ford. It will be very interesting to see as we start getting some results out of that Ohio area. Gulfport is also drilling wells in south Louisiana and in the Permian Basin of Texas, and in the Niobrara in the Rockies. It also has some oil sands in Canada. Gulfport has a lot of different very strong assets predominantly focused on oil. And it’s been able to keep the production moving forward. So, I think that the good asset base will continue to turn into better and better cash flows moving forward.
TER: Any other low-priced ones you like?
JW: One other one I like is Abraxas Petroleum Corp. (NASDAQ:AXAS). It’s a smaller name with a position in almost every interesting play that’s not only already being produced in the U.S, but also a few others that are emerging as well. The company is in the Bakken area, the Eagle Ford and the Niobrara. It’s also in a couple of other plays including a small one called the Alberta Basin in Montana that’s becoming more and more exciting as Newfield Exploration Company (NYSE:NFX) and Rosetta Resources Inc. (NASDAQ:ROSE) start to do a little more work there. Abraxas is really a very good company getting out there early and picking up some acreage. Now it’s focusing on drilling that acreage, getting the production to the market and then growing its cash flows. But it’s one that I think is very interesting from an asset standpoint. With a stock price under $5, this is one you could really look at as a nice entry point into quite a few different interesting plays.
TER: You also cover Venoco Inc. (NYSE:VQ). Do you have any thoughts on it?
JW: Venoco is an interesting story but the company has had a tough year so far. It’s in the Monterey Shale in California. It and Occidental Petroleum Corp. (NYSE:OXY), are really the only two companies that are in that play in size, at least that we hear about on a regular basis. It’s taken the company a little bit longer than I think it would have hoped for. Tim Marquez is a smart guy and he’s been the CEO for quite some time. But the play has just really not come along quite as quickly as it had expected. Venoco has got some solid assets and solid production but the stock’s really gotten hit pretty hard over the past six months or so.
A lot of people are banking on this Monterey Shale becoming a very interesting and substantial shale play, and it just hasn’t done that yet. I think ultimately it will work, whether it’s Venoco or somebody else out there. I think Venoco has a great position. But, like a lot of other things, it just takes a little bit more time than we or even the company would like to see and so we’ve seen the stock come down. But it’s starting to get a lot more interesting down here in the sub-$12 range. I think it’ll start looking a little better as production ramps up and Venoco gets a little further up the learning curve on the Monterey Shale.
TER: So, generally, what are your expectations for the coming months that people ought to be aware of, concerned about or hopeful for, as far as investing in oil and gas stocks?
JW: The last few quarters really have all been very strong for the entire industry. Oil prices have been very healthy but gas prices not necessarily as much. The biggest questions have really been the macro situation. Is the economy going to grow? Is there going to be a situation like we had a few years ago where oil just absolutely fell off of a cliff? If it can stay in a range bound area, it will be much easier to make smart decisions on a company-to-company basis regarding who you really like and why you like them, as opposed to the whole industry having to come down.
I think that the industry right now is still severely undervalued, probably closer to the $70–$75/bbl. range for these stock prices versus oil trading in the $80-95/bbl. range. That’s because there’s a fear that the economy is going to pull down the market and oil and the stocks are just going to have to come down because higher oil prices have taken a toll on potential growth.
But the $90/bbl.+ range is a fair range. I think it makes sense as far as the world economy and I think that there’s still enough room for the country to grow, in terms of GDP and everything else, to keep these stocks moving and to keep oil prices where they should be. So, I think there’s a lot of room for these stocks to move. I would just continue to watch what the economy and oil prices do because those are going to be your two big drivers as, right now, these companies are making a lot of money at this $90-$95/bbl. range.
TER: So, to sum up, as far as you’re concerned, there’s more upside at this point than there is downside.
JW: Yes, I think so. For the companies, there’s a lot of upside and not as much downside. The assets they should be able to find with these shale plays are very repeatable. They are capital intensive but as long as the companies can maintain a good balance sheet, you’re safe there. At this point you’re in a price area where you really need to pick one or two that you want to get into and get comfortable with their management teams. The biggest overriding factor at this point is going to be what oil prices do. And what drives that is what the economies, not only here but across the world, are going to do. That’s the thing I think is going to be the most important factor.
And, like you said about the upside, I think one other thing that’s interesting and that could be one of those big upside drivers is that there’s going to be a lot more consolidation. Many of these smaller names will get picked up by larger names that have a lot of cash and want to find a way to grow their production and cash flows further. They need to go out to these new emerging plays in order to do that. So, I think you’re going to see continued consolidation in the market, which I think again, would be very positive for investors who go into these smaller to mid-cap names that may be taken out by the larger names at a nice premium.
TER: That sounds like a pretty optimistic picture for people who are willing to take a shot at some of these promising deals.
JW: Absolutely.
TER: We appreciate your taking the time to talk to us this afternoon and all the good information you’ve given us, Jason.
JW: Thank you.
Jason Wangler has over five years of equity research experience focused on the exploration and production (E&P) and oilfield services (OFS) sectors of the energy space. Jason previously worked at Wunderlich Securities Inc. and Dahlman Rose & Company before moving to SunTrust Robinson Humphrey. He also previously worked at Netherland, Sewell & Associates, Inc. as a Petroleum Analyst. He received his master’s in business administration from the University of Houston, where he was also named the 2007 Finance Student of the Year. He received his bachelor of science degree in business administration with a focus on finance from the University of Nevada, where he was named the 2003 Silver Scholar award winner for the College of Business Administration. In 2010, he was highlighted as a “Best on the Street” analyst by the Wall Street Journal and has been a guest on CNBC.
By The Gold Report, on August 4th, 2011
 Move into gold and silver was the advice James West, founder of the Midas Letter Opportunity Fund, gave Midas Letter subscribers in June. He recommended moving from the junior stock market to 100% gold, silver and precious metals funds backed by bullion. For a while it looked like a bad call. But as markets tanked, gold and silver soared, and it turned out to be a smart strategy. Now might be a good time to sell the metals and get back into the juniors, he says.
The Gold Report: James, in June you advised selling off all stocks and investing directly in precious metals. What prompted you to dump juniors and go to gold and silver?
James West: It was evident to me that the risk to equities in our space, the junior miners, was going to increase as the debt issues in Europe and the United States continued to fester. Back in June, the likelihood of the U.S. not raising the debt ceiling in time for the August 2 deadline was considered very remote. But the last minute deal was nothing more than a Band-Aid on an open artery. The partisan politicking could result in rating agencies downgrading the U.S. triple A rating with or without a default. You can hardly rate the world’s largest sovereign debt load as triple A after this most recent fiasco. And when you consider that the only solution is to raise the debt limit, issue more debt, print more money and further debase the currency of the world’s largest economy—well, to me, it’s just plain dangerous to be holding equities in anything under those circumstances. That environment only bodes well for gold and silver prices.
TGR: So now that there is a deal, will equities rise and gold and silver fall?
JW: Temporarily, yes. That’s exactly what I think will occur. Given the gnat-like attention span of investors and the deluge of information flow we are all immersed in, it is what’s happening right now that dictates market movements. With these temporary deals done, for the next few weeks, it will seem like the problems have been solved, disaster averted and the party will be back on.
TGR: So we should sell gold and silver and buy equities?
JW: You bet. Sell the precious metals at the high, buy the juniors who have been beaten up in recent months and wait for the next batch of horrible news to make precious metals turn around and head north. It’s a volatile market, but junior precious metals explorers and near-term producers are finally going to get some of the attention that has been absent for the last few months.
TGR: We saw you on BNN last week in Canada, and you mentioned that you were looking at copper juniors as well. Is copper going to benefit from the same influences as gold and silver?
JW: Well, copper has been holding on close to all-time highs despite softening growth in China. That’s because speculative groups, like hedge funds and ETFs, are actually buying physical copper and storing it in warehouses. So not only do we have a growing portion of diminishing global production being taken off-line and stored for investment reasons, but copper consumption for industry, while it may weaken as China growth slows up a bit, is still strong in India and Brazil as those economies continue to expand rapidly.
TGR: We hear you have also launched a fund to invest in emerging miners. What’s that all about?
JW: The Midas Letter Opportunity Fund is a Luxembourg-registered Special Investment Vehicle, which is a sub-fund of the Commodity Capital AG fund. Tobias Tretter, the former top fund manager for Deutsche Bank’s gold fund, and I came up with this idea to capture all of the early-stage, pre-IPO opportunities that come my way as publisher of the Midas Letter. Up until now, I just haven’t had the bandwidth or the manpower to take advantage of these ideas. So we put together this fund, which is capitalized by members of the Canadian A-List of mining entrepreneurs on one hand, and the A-List of high net-worth, private family offices in Luxembourg and Switzerland, to provide a place where the two groups can access each other’s value propositions. The fund does well because it’s got access to pre-public deal flow, and the European investors do well because they have a window into these pre-public opportunities through the fund, where they get the chance to participate in secondary and tertiary post-IPO rounds.
For Midas Letter subscribers, it’s a win as well, because now the newsletter becomes the journal of the fund’s investing activity. While subscribers can’t generally participate in the fund, they can participate in what the fund is buying, and hear about pre-IPO opportunities that other newsletters generally don’t bother to cover because there is no way for the investing public to access these deals.
TGR: So, the Midas Letter now only covers what the fund is doing?
JW: No, no. Of course, I still have my personal investing activity that will make up a lot of the content of the newsletter, too. But most likely, my personal activity will reflect the opportunities that the fund has uncovered. This will also free us up to shoot more Midas Letter Mine Tour videos, where we visit developing projects around the world, and in a National Geographic- or Discovery Channel-level of production video, answer the questions that all investors, institutional and private, would want to know about these projects.
TGR: Wow. So, you are busy, to say the least. What companies do you see yourself investing in going forward?
JW: Well, as far as gold companies are concerned, we follow closely what’s going on at Baron Group in Vancouver, headed by David Eaton. He has a process where he gets companies to list inexpensively on the CNQ before moving over to the TSX Venture. Baron has an absolutely stellar collection of strong companies coming together.
TGR: For example?
JW: Well, where to begin? I guess we’ll start with the older ones, Evolving Gold Corp. (TSX.V:EVG; OTCQX:EVOGF; Fkft:EV7), which is one of Quinton Hennigh’s first big wins. Quinton is an epicenter of geological discoveries unto himself, and he figures prominently in a lot of the stories we like right now. As most people know, Evolving Gold has a joint venture with Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) on its Rattlesnake Hills project in Wyoming, and is owned at least 15% by Goldcorp Inc. (TSX:G; NYSE:GG). Despite that, the company trades at a great discount to enterprise value considering the advanced stage of the deposits.
United Silver Corp. (TSX:USC) is another excellent example of the Baron Group. It started life on the CNQ and raised $10M (million) there before moving over to the TSX senior board. Things were going well until Charles Pitcher was hired to lead the company. He blew the treasury and let the company stagnate before leaving it in shambles. Fortunately for USC shareholders, a deal with Stan Bharti’s Forbes & Manhattan merchant bank will see new leadership, another round of capitalization, and the advance of the company’s project at the Crescent Mine. If you don’t think it is cheap now, compare that to the $250M IPO planned for the Sunshine Silver Mines Corp. (NYSE:AGS) with participation from Morgan Stanley, UBS Investment Bank and RBC Capital Markets. The Sunshine Mine produced an astonishing 360 million ounces (Moz.) of silver since 1880, but the Crescent Mine, which has produced only 25 Moz. in its history, did so at a grade of 27 oz./ton—the highest in the district. Keep in mind that Sunshine has 17 other exploration projects and a second very advanced project in Mexico, so comparing USC to Sunshine is not exactly apples to apples. My point is that silver mining in the Coeur d’Alene belt in Idaho is attracting some weighty players.
Current offerings from the Baron Group include Golden Fame Resources Corp. (TSX.V:GFA), whose mission is to “acquire and put into production historically productive gold, silver and copper properties that have become economic due to the robust upward movement in metals prices.” The company has $7M in the kitty, and started work in July on the Algun Dia copper-gold-silver project located near the city of Guanajuato, Mexico, into which it is earning a 70% interest. Algun Dia is an advanced-stage exploration project with demonstrated past economic production of gold, silver and copper from a major vein-hosting structure with mineralized true widths exceeding 10m (meters). Historical reports indicate that 2002 through 2007, the property produced approximately 15,000 tons of ore during periods of test mining. That resulted in approximately 750 tons of gold, silver and copper concentrate processed at the Peñoles Mining mill.
Another one I’m looking forward to with great expectations is Novo Resources Corp. (CNQ:NVO), which has management in common with Gold Canyon Resources Inc. (TSX.V:GCU), a Midas Letter favorite for the last year. In particular, Quinton Hennigh, the geologic force behind many of the Baron Group’s deals, is said to be particularly excited about Novo’s prospects, and is the company’s president. Novo has the exclusive right to earn a 70% interest (as to gold and minerals associated with and normally mined with gold) in the tenements comprising certain mining leases covering the Beatons Creek conglomerates located in Western Australia.
I can’t stress enough the value in Confederation Minerals Ltd.’s (TSX.V:CFM) Newman Todd project, a joint venture with Redstar Gold Corp. (TSX:RGC). That project in the Red Lake district in Ontario is starting to shape up into what is looking more and more like 5 Moz. of gold. The source of that geological opinion has requested anonymity, but, safe to say, it’s not me pulling a number out of the air. In my opinion, the current share price level will prove to be a steal when the market realizes what’s going on underground here.
TGR: Now what about copper? You’ve recently been quoted as being quite bullish on copper.
JW: To be clear, I think copper is in a long-term bubble formation in the classic sense. The price is rising despite weakening demand fundamentals out of China, and Brazil and India are absolutely not the sustainable demand powerhouses painted by the mainstream media. J.P. Morgan is taking delivery of physical copper into warehouses in support of its copper ETF, which is putting an insanely artificial demand pressure on the metal. That means when the copper bubble pops, so will this and other ETFs based on copper, which will exacerbate the downward momentum copper will face when China pops. And increasingly, there are signs that the China bubble may be starting to deflate a little.
That all being said, the China growth machine will still gobble up a lot of copper, so for the time being, world consumption, diminishing supply and growing demand for the physical metal for investment and hoarding purposes will continue to maintain the price near or beyond all-time highs, which makes copper exploration plays are of supreme interest to us.
In particular, I’m a huge fan of CuOro Resources (TSX.V:CUA) and its Santa Elena property near Medellin, Colombia, where two shallow holes were drilled to depths of 3.55m and 7.61m, respectively, at a down dipping angle of 20 degrees (widths represent down hole core lengths and the true width is unknown at this stage). At 1m intervals, 1.5 in.-dia. cores were assayed from these shallow holes. The highest individual result was from hole C4-4; it returned a 1m interval grading 9.51% copper, while the two holes averaged 5.63% copper over 7.61m and 4.53% copper over 3.55m. Those are some stellar grades. Now there’s at least one drill going on the project with two more on the way. The company will drill an initial 25 km. to be immediately followed by an additional 15 km. With over $20M on hand to cover exploration for the next two years, it’s as “de-risked” a copper exploration play as you can get, which is why you’re seeing the premium valuation.
TGR: I understand you’re in the Yukon right now. What are you doing up there?
JW: We’re here to make some videos with a professional TV crew in support of our new product, Midas Letter Site Visit Reports. We are visiting exploration projects in the Yukon that will be the subject of videos seeking to answer all of the questions that determine a mining project’s economic viability. We do that through interviews with technical talent on the ground, as well as interviews with regional stakeholders to make sure we are not just getting the sweetened version from the companies. Then we distribute the videos first to Midas Letter subscribers and unit-holders of the Midas Letter Opportunity Fund, and then to the general public.
TGR: So who are you going to see while you are there?
JW: Well, the primary one at this point is the Wellgreen Deposit held by Prophecy Platinum Corp. (TSX.V:NKL; OTCPink:PNIKD; Fkft:P94P), John Lee’s spin-out from Prophecy Coal Corp. (TSX.V: PCY) that just announced a 10 Moz. combined platinum group metals and gold inferred resource, with 0.4% nickel and 0.4% copper to go along with it. Some pretty good rare earth grades are in there that are not part of the equation yet. All of this is just from 2.3 km. of a 17 km. strike length. We are going to find out just how good the potential is for a major extension to the existing resource as drills are turning and a lot of analysts head up there to kick the tires.
A list of other companies we’d like to shoot is a little premature to discuss, but suffice to say we are looking at the cream of the Yukon crop.
Publisher of Midas Letter, James West has devoted 20 years to helping small companies in the resource sector—helping them raise money, further their projects, build their identities and get their stories in front of investors on the lookout for quality investments with excellent returns. The Midas Letter Opportunity Fund, is an institutional and high net-worth-only open-ended fund based in Luxembourg that specializes in early stage investments in Canadian-listed precious metals explorers.
By The Energy Report, on July 29th, 2011
 Oil and gas prices may go up or down, but that doesn’t bother Josh Young, portfolio manager and founder of Young Capital Management. In this exclusive interview with The Energy Report, he tells us why his key to finding potential winners in the oil and gas (O&G) business is based on finding stocks with attractive assets trading at a large discount to their intrinsic values rather than particular commodity prices. This is something Fisher Investments has been great at spotting, time after time.
The Energy Report: Since you last spoke with The Energy Report in April, the O&G markets have been pretty much sideways. What do you think is going to happen in those markets over the next 6 to 12 months?
Josh Young: My investments generally aren’t contingent on specific commodity prices. I do expect that oil will continue to trade in a range and I think that natural gas prices are below the marginal cost of production and should trend up over time. The types of things I’m looking for are really mispriced situations where it doesn’t matter quite as much whether oil is $80 or $120/barrel (bbl.). It only matters that a company is undervalued.
TER: So, basically you’re looking for bargains that are undiscovered or unrecognized by other people. Is that correct?
JY: Yes, I try to find situations where a stock is cheap enough at lower commodity prices that it would still be a good investment and where an identifiable event is likely to unlock substantial value in the near future.
TER: We see all these references to various areas and geological formations such as the Marcellus, Barnett, Bakken and Eagle Ford shales. For those readers who aren’t familiar with these areas and names, maybe you could give us a quick tutorial that could help to make references to them a little clearer?
JY: Sure. I’ll give them in the context of specific investments I’ve made, which run the gamut across some of the better known and more economic shale plays.
The Marcellus Shale is widely known as the most economic natural gas shale play and one of the most economic natural gas formations in the U.S. It ranges from West Virginia all the way up through Pennsylvania into New York. Typically, wells there are economic even at natural gas prices below $4/thousand cubic feet, making them very favorable compared to other gas shale plays.
I have exposure to the Marcellus Shale through an investment in Gastar Exploration Ltd. (NYSE:GST). Gastar is the cheapest way to play the Marcellus on a per-acre basis and has over 15,000 acres in the core of the liquids-rich portion of the play with over 83,000 total net acres in the play. The company has some well results coming out soon from the liquids-rich portion of the play that should highlight their value.
Switching over to oil shale, two of the most favored oil shale plays are the Bakken oil shale up in North Dakota, which ranges across northwestern North Dakota and eastern Montana and the Eagle Ford Shale play, which ranges across much of southern Texas.
I have exposure to the Bakken through an investment in U.S. Energy Corp. (NYSE:USEG). In the early development of the Bakken a couple of years ago, USEG financed Brigham Exploration Co. (NASDAQ:BEXP), which is now one of the largest pure Bakken play companies in the world. U.S. Energy has a fantastic position in, and is trading at a large discount to its peers in the Bakken Shale. Wells there, at current oil prices, earn anywhere from a 35% to 100% internal rate of return, depending on the specifics of the well. Wells come on with very high initial oil production that declines fairly rapidly, but the company gets paid back fairly quickly.
Similar to Gastar in the Marcellus, U.S. Energy is one of the cheapest ways to get exposure to the Bakken and they already have meaningful production and reserves. Eventually the market will discover them and the stock will trade up in line with or potentially in excess of its peers.
The Eagle Ford Shale ranges from dry gas in the south up to a wet gas play with a combination of natural gas and oil or natural gas liquids. Further north, you get pure oil production and very little gas or natural gas liquids. I have exposure to the Eagle Ford from a couple of investments. It is one of the most economic shales to drill. U.S. Energy recently announced it is drilling a few thousand net acres in partnership with Crimson Exploration Inc. (NASDAQ:CXPO). The market gives them zero value for that acreage. The company has completed one well, but hasn’t announced the results yet. It’s in a really good area right next to a Chesapeake Energy Corp. (NYSE:CHK) well that did extremely well. I expect that U.S. Energy may have some good exposure.
Some companies, like U.S. Energy, trade at a large discount to their peers. Other companies trade at an extremely rich valuation compared to their peers. One company that is comparable to a company like U.S. Energy is Aurora Oil and Gas Ltd. (TSX:AEF; ASX:AUT). Aurora has a small amount of acreage in the Eagle Ford, not much more than U.S. Energy, and less than U.S. Energy has in the Bakken and Eagle Ford combined. But Aurora trades for almost a $1.5 billion valuation. So, compare a U.S. Energy, which is getting almost no credit for its Eagle Ford and has a $120M (million) valuation, to a company like Aurora, which is getting a tremendous, almost $90,000/acre credit for its Eagle Ford acreage. It definitely gets you excited about U.S. Energy’s prospects.
Finally, any discussion of shale fields would be incomplete without mentioning the Barnett Shale. The Barnett is one of the original natural gas shale plays where the technique of drilling horizontally and using multiple-stage hydraulic fracturing was developed. I don’t currently have any investments with meaningful exposure to the Barnett. But, the Barnett is a really good example of what to expect from other plays where a lot of small companies were involved and as the play matured, were bought out or consolidated or traded up to a fairly rich valuation. Companies like Gastar and U.S. Energy could trade up to rich valuations too or potentially be taken out as their respective plays get developed.
TER: You talked in April about Equal Energy Ltd. (TSX:EQU; NYSE:EQU), which is an interesting Canadian company. Can you bring us up to date on what has developed with them since April?
JY: I still think Equal is trading at a very large discount to its peers. It hasn’t announced well results recently and there hasn’t been a lot of news flow beyond an acquisition and subsequent equity offering, so the stock has languished. There will be well results over time but there is nothing in particular coming up in the near future, at least from an operational perspective.
There is some possibility the company could spin off one or more of its assets into a royalty trust, which Chesapeake is actually in the process of doing and SandRidge Energy Inc. (NYSE:SD) successfully did with the SandRidge Royalty Trust. If Equal Energy went this route, it could potentially achieve a much higher market valuation than it currently has. In the interim, Equal could be a bit quiet for the next few months.
TER: How about some where you think there is going to be some action coming up that people can get excited about?
JY: I’ve made interesting investments recently that I’m quite excited about. The first one is a company called Gasco Energy Inc. (NYSE:GSX). The company recently completed an equity offering in which I participated. It is a natural gas company with a field in Utah’s Uinta Basin, which is more of a conventional gas field play. Despite having a small production base, the company needed money to survive for the next 18 to 24 months while it develops the new oil plays it thinks it found. I’m inclined to agree that there is oil in place and that it will be recoverable. The company currently has around a $30M market cap and $120M in debt. If Gasco discovers oil and it is of the order of magnitude that it expects, this could be a tremendous home run.
In California, Gasco developed a number of prospects and sold them to a large, undisclosed, publicly traded company that is active in California. This undisclosed partner is funding 100% of the well cost on five different exploratory wells in order to earn an 80% interest in the wells. Gasco gets to keep 20% without having to pay for the drilling. That is very exciting for a small company to be able to get exposure to some potentially 20 Mbbl. or greater prospects and not have to pay anything for it. The company expects to drill the first well in the third quarter of 2011, the second in the fourth quarter and the remaining ones in 2012. That adds a lot of upside potential from there.
Gasco’s main gas field is actually in the Uinta Basin, situated between Newfield Exploration Co.’s (NYSE:NFX) Monument Butte Field, which has been really successful as a conventional oil play, and Questar Corp. (NYSE:STR). Questar drilled an oil well in the Green River block on the trend that the Monument Butte Field produces from, immediately on the other side of Gasco’s acreage. Questar will be drilling more wells on their acreage. So, it looks like there’s an area that has been delineated by that well.
Gasco also has some old wells on that same Green River trend, drilled in the 1980s, which had been producers for a long time. Some of them are still producing a few bbl/d. It is very likely that when Gasco drills a couple of wells on the Green River trend, it will hit oil and those wells will be highly economic. The impact of having an economic oil play could produce a multiple times valuation uplift. The most I can lose is the money I invested, but I could make five or ten times my investment.
TER: That is a nice multiple for anybody. So, what else do you like?
JY: I seldom buy debt, but there is a natural gas company in which I actually own preferred stock. This preferred is convertible and it’s currently yielding 12.5% and trading around par. The common is trading only 15% away from the conversion price. It is a very undervalued natural gas stock that is out of favor called GeoMet, Inc. (NAS:GMET).
The preferred stock provides a margin of safety and pays me to wait. If the company went insolvent or if there were some sort of prolonged downturn, the preferred offers more protection than the common. Plus, it pays 12.5% annually. If natural gas prices recover, GeoMet could be worth two or three times what it is trading for now.
I have done a lot of work on GeoMet and on the field it is developing. The company had a problem in one of its fields where its wells were not producing as expected. It changed its fracking technique and it looks like it fixed the problem and could potentially be looking at substantial additional reserves, which are definitely not priced into the stock. There is a lot of operational upside in addition to potential from natural gas prices.
This has been a very illiquid situation and it was hard to build my position. But, people really want yields and this is a nice way to get this combination of yield as well as a chance for a substantial equity return.
TER: Well, it sure beats 2% to 3% in Treasuries.
JY: It does, and GeoMet has meaningful natural gas production, cash flows and reserves that backstop the value of the investment and provide some potential inflation protection and exposure to an improvement in natural gas prices. GMET is far and away my favorite debt security at the moment.
TER: Anything you like in Canada?
JY: There are a couple of other companies that I own stock in that are worth mentioning. Petro-Reef Resources Ltd. (TSX.V:PER) is one of the more promising junior oil and gas companies in Canada that U.S. investors may not have heard of. It has a conventional natural gas field where there appears to be highly prospective oil zones above and below the gas zones from which it is already producing. The July production rates are about 300 bbl. of oil plus about 700 bbl. of oil equivalent (boe) natural gas per day. Their current enterprise value is about $30M.
Using a $100,000 per flowing bbl. of oil metric, you get the natural gas production for free. Using a natural gas metric, you get their oil for very cheap. In addition to being cheap on current production, it looks like Petro-Reef is on the path to meaningful rampup by drilling additional oil wells. It has around a 20,000-acre position in an unconventional play in Canada called the Swan Hills, where it has completed a well. The company is still looking at the data and might actually lease a little more acreage before announcing results. I invested on the assumption that the Swan Hills play won’t work. But, there has been a lot of activity and positive well results in the area; it sounds like the company likes what it sees. If the play actually works, it will be a huge home run.
TER: Do you have some other ones that you would like to talk about?
JY: There is one more company that I have been involved with off and on for years and built up a position in again, relatively recently. It’s called Sonde Resources Corp. (NYSE:SOQ). It has $50M in cash, no debt and a market cap of around $200M. It is trading for around the value of its existing production. It has a lot of unconventional acreage in Canada from residual natural gas production that it is in the process of developing, with a lot of un-booked upside.
Sonde recently sold one of its assets and repatriated the cash to develop its unconventional oil acreage. It also owns a portion of a recent large oil discovery on the border of Libya and Tunisia. Prior to the problems in the Middle East, it looked like this discovery could be worth hundreds of millions of dollars to Sonde. The company said it was in active discussions with potential joint venture partners to farm out some of its interest to get carried in the development, or possibly to sell it. The possible upside is in excess of its market cap and total enterprise value right now. Development of the find is on hold but the company has continued to study and delineate it. It sounds like it is sitting on over 100 Mbbl. of oil in this one discovery. And it has a tremendous amount of additional acreage, where it will be able to explore for other prospects with similar potential. So, this could be a real game changer that isn’t reflected in the stock price. Neither is the company’s unconventional acreage. Only existing production appears to be priced in.
There is potential upside whenever the situations in Libya and Tunisia get resolved. Meanwhile, you get a great, undervalued natural gas and oil company in Canada. Sonde also has well results expected shortly from an area called the Drumheller, which could be a meaningful driver. I have a lot of respect for the Sonde’s CEO, Jack Schanck. For a number of years, he was the co-CEO of Samson Oil, a private company out of Tulsa and helped the company get into North Dakota and a number of other areas. He grew it from a smaller company to a larger, more successful company before leaving to go off on his own. He has assembled a team, some from Samson and elsewhere. I am very excited about Sonde because it has quality management and you get to actually invest at a substantial discount to net asset value.
TER: Any final thoughts on what investors should be looking at or concerned about in the coming months regarding the energy market and what could be a catalyst to make it go up or down drastically?
JY: A number of things could go wrong or could go right. From my perspective, the important thing is whether you are in a good company that is value priced like a U.S. Energy or an Equal, a Gastar or a Gasco. If the company hits oil or sells an asset, the stock is going way up and if not, the stock isn’t. A lot of really talented people out there are analyzing the macro-picture and trading oil commodities. I focus on these small, under-followed public oil and gas companies with attractive risk/reward odds.
TER: Those all sound like pretty interesting and undervalued opportunities. Thank you for taking the time to tell us about them.
JY: I appreciate it. Thank you very much.
Josh Young is an honors graduate of the University of Chicago, where he majored in economics. Before founding his own investment management partnership, he worked with Mercer Management in Chicago, after which he joined a private equity firm in Los Angeles. He also worked as a buy-side analyst and money manager in a single-family investment office with more than $1 billion under management.
By The Gold Report, on July 26th, 2011
 Laurentian Securities Analyst Eric Lemieux was headed out into the field a few days after this interview to check out the latest progress on some of his favorite exploration plays in the James Bay area of eastern Canada. In this exclusive interview with The Gold Report, he shared his latest insights on the gold market, and his current thinking on some of his favorite plays in the vast untapped areas of Quebec and Ontario now being opened up to expanded exploration efforts by both juniors and majors.
The Gold Report: When you last spoke with The Gold Report in May of 2010, you gave Laurentian Securities’ price forecasts for gold that turned out to be pretty conservative pretty quickly. What are you predicting for gold prices now?
Eric Lemieux: I was quite conservative, and obviously, I underestimated gold’s momentum. I think right now the price of $1,600/oz. is set to go even higher in light of the increasing global economic turmoil. The U.S. debt ceiling and credit rating will fuel gold’s price rise to even greater heights. Add in the European bankruptcy threats and you have the catalysts to justify gold’s further appreciation. Demand is largely based upon the view that gold is effectively a monetary instrument and a “valeur refuge” (store of value). Together, I think they explain the gold price action in the last year, which has been quite remarkable, but based on good fundamentals.
TGR: So, you must have higher target prices for gold now?
EL: Yes, those have been revised and our range is now between $1,650 and $1,750/oz. until 2015. I set a very long-term price of $1,000/oz., which I think is still conservative, but I think it’s justifiable since this is probably the marginal cost for producers. Gold still has some great upside, but I may not be the one who says it’s going to go up to $5,000/oz. I see price stability, less downside risk and I think the $1,500/oz. range is probably something that we can envision in the long term.
TGR: Is gold in a bubble?
EL: I think not at all. Right now, if you look at the fundamentals, there are reasons for the precious metals’ strength. On the supply side, there are still some challenges. Mine production has pretty much stayed constant, and the best deposits have been mined. We’re now going to lower grade deposits. There are more jurisdiction and social challenges to mine gold. So, from the supply side, these are elements that provide some support to the price of gold.
TGR: Laurentian is based in Quebec and your focus is mainly on opportunities in Eastern Canada, from where most of the gold produced in Canada has come. As far as the recent changes in Quebec’s tax regulations, what effect do you envision that might have on exploration and the mining industry in general, especially for the junior companies that rely on certain tax benefits?
EL: Obviously, I think there has been an impact. The government has made some questionable changes to mine legislation in line with the “resource nationalism” going on in the world. Governments have been pressed to increase royalties and tariffs on mining operations. The legislation in Quebec has tried to address this and an increase is probably acceptable to a certain measure.
However, one thing that is really frightening in Quebec now is that some municipalities can have a say on claims and project status. That explains in part why Quebec has gone down in the Fraser Institute ranking because of the uncertainty that has been created in some aspects of the mining legislation.
The fact that they’re increasing the royalties is perhaps fair in light of the strong commodity prices. There’s a bit of give and take and the industry eventually has to give a little. At the same time, I think the government has perhaps been very aggressive about raking in even more profits and caving into special interest groups. What is really dangerous right now in Quebec is this trend of wanting to control the claims and what can be done in terms of development and even exploration.
TGR: Do you think there might be any re-thought or reversal here if they end up seeing opposition from the mining industry?
EL: I think so. The metaphor we use is “Balkanization” of the mining resources, which is very dangerous. Once people are aware of the adverse impact that is having on the economy, I think they will realize that perhaps the government has gone too far, resulting in a readjustment. The pendulum swings from one side to the other, and now that we’re really going to one end, hopefully we’ll be able to eventually find a balance.
TGR: Historically, most mining in Eastern Canada has been underground mining when gold prices were relatively low and you had to have fairly high grades to justify the costs of doing so. With $1,500/oz. gold, we seem to be seeing a lot more talk about companies doing open-pit mining in much lower grade areas with much larger tonnages. Is this something that is going to be happening more in the future?
EL: This is definitely the wave of the future. Improvements in mining methods and economies of scale allow for bigger open-pit operations. The other thing that I think we will probably see also is bigger underground bulk mining scenarios such as Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) Goldex mine near Val d’Or. So, I think that will be another wave of the future where you will have these bulk mining operations. In the Abitibi Greenstone Belt, open-pit operations are fully justifiable. I think the fact that you saw Osisko Mining Corporation’s (TSX:OSK) Canadian Malartic project go ahead and perhaps be a success story is a catalyst for more of these operations.
We will see these done in a sustainable manner in the sense that they will have to get community and First Nations acceptance with minimal impact on the environment. When you say an open pit, people think of an eyesore, but once they see the benefits that can be reaped for the local population in general, I think people will be more open to this sort of operation. In the long term, these big open pits can actually be transformed into lakes and it’s not necessarily a big eyesore after operations end.
TGR: When you talked with us last year, you discussed a number of companies you liked, and Premier Gold Mines Ltd. (TSX:PG) was one of them. They just announced this deal to acquire Goldstone Resources Inc. Can you update us on what’s going on with Premier?
EL: Premier has been very active on several fronts. The company has four key sector area plays located in safe jurisdictions and offering excellent infrastructures. In Nevada, the company acquired the Saddle gold project in 2010. In the Beardmore-Geraldton area, it is owns the Hardrock project and has reported a new, growing 3.6 million ounce (Moz.) global gold resource. Premier also has two projects in the Red Lake District, and the PQ North project in the Musselwhite District of Ontario. Premier just acquired Goldstone Resources and expanded its land package considerably in the Beardmore-Geraldton area. It now controls a strike of about 50 km., consolidating a mining camp district—which could be interesting for any major that wants to position itself there. So Premier has set itself up for discovery and it is ready to do some very good project development.
TGR: Another one you talked about was PC Gold Inc. (TSX:PKL) and it is still quite active up there. What’s going on with that situation?
EL: I have to say I don’t follow PC Gold closely; it’s not a company that I have actually covered, but I think the company just provided an update to its mineral resource, which now stands at 1.26 Moz. This, again, is a recipe of revisiting old mining camps with a new set of eyes and advanced geological concepts. It’s one that is interesting because it has an open-pit scenario with an underground component that, with time, may allow the company to play with different mining methods.
TGR: The James Bay region has turned into a hotbed of exploration and a lot of companies are looking at things up there. One that you talked about in the past was Eastmain Resources Inc. (TSX:ER). What’s going on with that situation?
EL: The James Bay region is a hot area that is vast and underexplored. It will become even hotter as Goldcorp Inc.’s (TSX:G; NYSE:GG) Eleonore Project gets its permits for full blast construction toward the end of this summer.
What I find interesting for the James Bay area and Northern Quebec is the fact that the Quebec Government has just announced the Quebec Plan-Nord that will provide even better road, power and communication infrastructure to the area. Although there is some amazing infrastructure right now in the James Bay area, potential expansion, on a sustainable development basis, should provide a competitive advantage.
The Cree Nation, Inuit and Innu people are participating more and more, which opens up to sustainable development in that area and bodes well for social acceptability.
Eastmain has three very good positions—the Eastmain Mine, Clearwater and Eleonore South projects. The last one is a joint venture with Azimut Exploration Inc. (TSX.V:AZM) and Goldcorp. Eastmain released a new global resource estimate of 1.6 Moz. in April on the Eau Claire deposit. There was a substantial increase in the measured component of the mineral resource estimate. The project includes both an open pit and an underground target. The open-pit component has about 4.1 million tons grading 4.7 grams/ton, which is at the higher end of grade for open-pit mined gold deposits. So that is a positive.
Eastmain is currently drilling toward the west of the 450 West Zone in a new zone called the 850 West Zone that wasn’t part of the mineral resource estimate in April. There is a lot of upside to increase that mineral resource, both for the underground potential and the open pit scenarios. I expect that for the Eau Claire Project some news will emerge in the course of the year. I think some interesting things will come from the Eau Claire as the company has the advantage of good infrastructure and accessibility.
Eastmain also has the Eastmain Mine Project, which was quite remote. It’s going toward Stornoway Diamond Corp.’s project where the Quebec government will soon extend Route 167, the Otish Mountain Route. Eventually, it will be accessible via a hard surface road rather than an old winter road. The Eastmain Mine Project has now started to drill and has about 15,000m planned. Again, this is a gold project with a known mineral resource that is open for expansion.
The Eleonore South Project is a joint venture with Goldcorp and Azimut Exploration located to the southeast of the Eleonore deposit. Goldcorp is working very aggressively on the Eleonore project, and building a world-class mine there, but I know it is also active on the exploration front in areas further from the mine site. I believe the Eleonore South project will eventually be re-worked by the partners and could become an interesting development project in the long term.
TGR: Another one up there is Virginia Mines Inc. (TSX:VGQ), which is also active. What’s been going on with that company since the last time we talked about them?
EL: They’re very active. Virginia will have about a $17M exploration budget for 2011, of which $9M will be partner funded. New, high-quality partnerships include IAMGold Corporation (TSX:IMG; NYSE:IAG), Quadra FNX Mining Ltd. (TSX:QUX) and Anglo-American PLC (LSE:AAL).
The key for Virginia is its strategic acreage in James Bay and northern Quebec, where the company has been able to develop expertise that continues to be recognized. Virginia has a lot of projects going on right now. It is very aggressive. It is manned by explorationists who are able to generate and advance projects. I think it is just a matter of time before the company makes more discoveries. With a $17M budget, we can expect a lot of important news from Virginia.
Remember that Virginia discovered and holds a 2.2-3.5% NSR royalty on the Eleonore deposit, now going into production for Goldcorp by 2015. As the Eleonore project continues to grow, the project is being de-risked with the on-going exploration shaft and ramp sinking.
TGR: That sounds pretty positive. How about Midland Exploration Inc. (TSX.V:MD)? You also talked about them last time and that company has some interesting things going on.
EL: Yes, I always like to say that Midland is like a smaller version of Virginia in that it has the same sort of quality management and the same sort of explorationist business model. Midland also eventually farms out projects to quality partners.
The company is active on several fronts. In the course of 2010-2011, it acquired new projects by staking. I always appreciate the fact that a company is able to acquire projects by itself through staking rather than acquiring a property with a partner or from someone for shares and money. I believe it is good when you can do a thorough geological assessment of an area, pinpoint areas that haven’t been staked, then go and get them for cheap. Here in Quebec, it’s not very expensive to acquire claims through map staking. I think it’s very positive that Midland can generate and acquire projects relatively inexpensively.
Midland is active on several fronts—gold, base metals, rare earths. It is exploring for gold with Osisko Mining Corp. (TSX:OSK), Aurizon Mines Ltd. (TSX:ARZ; NYSE.A:AZK), North American Palladium Ltd. (TSX:PDL; NYSE:PAL) and Agnico-Eagle Mines Ltd. So, we can expect lots of news as projects are drilled. Midland just announced a gold and nickel discovery on the Laflamme property, which is a partnership with North American Palladium. Midland also has a project called Casault, which is east of Detour Lake on the Quebec side. It’s an area that I think will become a hot spot because of the size of the Detour deposit and the focus on possible satellite deposits. The Quebec side it hasn’t been explored much because it’s very swampy land, but a few companies are very well positioned in that area, including Balmoral Resources Ltd. (TSX.V:BAR) and Adventure Gold Inc. (TXS.V:AGE). Certainly the Detour/Sunday Lake Deformation Zone will be the most interesting revived gold belt to watch evolve and is well worth continuing to explore. So Balmoral, Midland, and Adventure Gold are well-positioned. The key words for Midland are diversification, partnerships and exploration.
TGR: Another interesting one is Detour Gold Corp. (TSX:DGC), which is building the largest gold mine in Canada. You talked about this company last time. What is the update there?
EL: I would summarize by saying: On track, on schedule and room to grow. I think it’s a 14.9 Moz. reserve with more room to grow and perform. The company is building a world-class mine with a strong operating team north of Cochrane in Northeast Ontario. The pieces are coming together and that’s very positive. The project is being de-risked in a very good and sustainable gold price environment. I think this project should be on a lot of people’s radar screens.
TGR: Are there any other thoughts that you would like to leave us with at this point?
EL: The Quebec Plan-Nord should put a spotlight on northern Quebec. The Ungava Peninsula, even higher up than the James Bay area, is perhaps the next frontier for Quebec exploration. Toward the east, near Labrador, the iron ore is a hot spot. There is even talk about expanding the railways in that area.
Up in northern Quebec, a number of companies are working toward discovery and advancing some huge deposits in rare earth elements (REE), uranium, gold and copper. These are very early stage, but I think there are some good elements for long-term development. Global warming might even result in year-round shipping lanes. Virginia is probably the beacon. I wouldn’t be surprised if someday world-class deposits are developed up there.
TGR: So we’ll have to stay tuned. Thanks for taking the time to bringing us up to date on these opportunities.
EL: Thank you.
Éric Lemieux is a mining analyst who joined Laurentian Bank Securities in 2008. He worked for nine years as a consultant responsible for applying Regulation NI 43-101. He has worked at the Montreal Exchange, and prior to that managed exploration projects for Cambior, Noranda and Soquem. He holds two master’s degrees, in mineral economics (Colorado School of Mines) and in metamorphic-structural geology (Laval University).
By The Gold Report, on June 2nd, 2011
 Yukon explorers are just getting started, says Jim Mustard, vice president of investment banking, mining, at Vancouver-based PI Financial. In this exclusive interview with The Gold Report, he shares several of the Yukon companies he believes have the potential to produce significant returns for investors.
The Gold Report: A feature titled “Gold Mania in the Yukon” was published recently in The New York Times Magazine. Is this a sign that the recent Yukon gold rush is over-hyped?
Jim Mustard: I don’t believe that article was hyping the Yukon as it was really a human interest story about Shawn Ryan, who came to the Yukon as a mushroom picker. Mushroom pickers can make an awful lot of money over short periods of time and for most of the year they are idle. He was bitten by the mining bug and ended up, through perseverance and being mentored, developing a particular skill in taking and interpreting early-stage soil geochemical data. He has now capitalized on this several times over and is a significant shareholder in Ryan Gold Corp. (TSX.V:RYG). The article talked about his life, his living conditions, his family and his success. While his success and his very specific exploration ideas have spawned market interest in what is going on in the Yukon, the area is not over-hyped, in my opinion.
TGR: We’ve all heard about the Yukon being the first area play in Canada since the Lac de Gras diamond rush in the Northwest Territories during the early-to-mid ’90s. You’ve been in this business longer than most people in your position. Do you believe the Yukon is a true area play?
JM: The Yukon is, literally, a very large area play, but not necessarily focused on one type of commodity or geologic setting the way it was at Lac de Gras. During the Lac de Gras rush, we were all looking for kimberlites and only one commodity, or, if we went to Labrador, nickel was the primary focus within a somewhat narrowly-defined district. In those cases, we were looking for a fairly specific type of geologic setting that hosted only one key commodity. In the Yukon, we have a vast array of geologic domains that are permissive for a range of deposit types and commodities: from large copper-gold porphyry systems to high-grade veins. There are also copper deposits that are very unique, such as the Minto deposits, which is not porphyry copper, but are more structurally controlled in south-central Yukon.
At the other end of the spectrum, we have a brand-new and exciting exploration model. Carlin-style gold replacement occurrences have been discovered that, until last year, were previously unrecognized in the Yukon. Also present, and sometimes forgotten, are world-class SEDEX (Pb/Zn) deposits and high-grade meso-thermal silver-rich veins. The Yukon also hosts significant intrusion-related gold deposits in the Dublin Gulch-Mayo area (and perhaps in the Dawson range south of the White Gold area). Nickel and PGM deposits are present as well as a past-producing gold heap leach mine. Yukon has the hallmarks of a very large area of interest that’s woefully underexplored. The activity underway by a multitude of companies is sustainable for several years to come—likely much longer than Lac de Gras.
TGR: Before we started the interview, you mentioned that if you were still an analyst, you’d be all over the Yukon. Why would you be so excited?
JM: We’ve had technical success with discovery. We’ve had corporate success in terms of one company being bought out by a major company at a very early stage. We’ve also had a tremendous number of companies and individuals moving into the territory, acquiring ground, doing basic prospecting. These developments have led to rapid advancement. I believe there will be additional exploration success and additional M&A activity—this all equates to multiple opportunities, given that combined exploration budgets this year are likely to be close to $200M compared to an estimated $160M spent on exploration in 2010.
An analyst has an opportunity to follow and recommend companies based on strong technical data or the presence of “nearest neighbors” within one common jurisdiction with similar geological settings.
TGR: What is going to take us to the next level? Is it another major discovery?
JM: At the moment, we have two key areas in the Yukon: The White Gold Area (where Underworld Resources was focused) about halfway between Dawson and Whitehorse, and a carbonate inlier of the Selwyn Basin, where ATAC Resources Ltd. (TSX.V:ATC) has made a couple of Carlin-style discoveries on the Rackla Project, NE of Keno City.
Market sustainability is going to come from continuing success for companies such as ATAC or Kaminak Gold Corp. (TSX.V:KAM), which probably have the two most advanced exploration stage projects because of their success last year.
Along the way, if we have another discovery by another company that is not on people’s radar screens, it will further add to the interest.
TGR: You mentioned that these are very risky plays at the moment. What are some investing strategies you could offer our readers?
JM: One of the best strategies here is to look at a map. Out of some 100 companies operating in the area, find out which ones are at the mapping or prospecting or soil sampling stage and which ones are going to have a drill program this year. That’s one way to play the game. Invest in companies that will have a drill bit turning in the next several months because otherwise you might have to wait a full year before you see any progress given the seasonality in most of these areas.
You can also pick one or two companies that have a fairly large position in any one of the areas—companies that may be just starting out, but have successful neighbors. The market will generally add value because of the area play concept since there is still a fair amount of mystery about the geological setting—this is a key factor that will not last, but is likely to stay in place for at least two to three years.
The other way to choose a company is to review the technical data and talk to management. It’s always a challenge to pick out one soil anomaly from another soil anomaly. A basket approach can help mitigate the risk.
TGR: Are some Yukon companies employing management that has made significant discoveries in the past? Do some companies have more experience and, therefore, a bit less risk?
JM: Management that has made discoveries in the past and capitalized on those discoveries by either putting them into production, joint venturing them out or selling the company outright, bring an advantage because they have been through it before. In a technical sense, however, it’s always the luck of the draw.
TGR: Any specific names of companies with experienced teams?
JM: The one that comes to mind immediately is the ATAC/ Strategic Metals Ltd. (TSX.V:SMD) (the Strategic Exploration Group) because their history in the Yukon flows out of the consulting group Archer Cathro & Associates, which still exists. Archer Cathro has operated a consulting practice in the Yukon since the late ’60s. He has a legacy file of information on many early-stage projects that he managed on behalf of others over the years. That access to historic information allowed the company to acquire a tremendous number of properties.
Another one would be the technical group that came out of Underworld that made the discovery on the Golden Saddle area, which was taken over by Kinross Gold Corp. (TSX:K; NYSE:KGC). That management group is now behind Smash Minerals Corp. (TSX.V:SSH). Kaminak Gold, which I mentioned before, is strongly managed by Rob Carpenter.
Golden Predator Corp. (TSX:GPD) is another one that has a similar advantage because they recently hired a geologist away from the Yukon Geologic Survey. This individual, for probably 15 or 20 years, liaised with industry and visited many projects throughout the territory. He knows the Yukon geology better than most. That provides a lot of intelligence in managing that company and acquiring new properties or exploring existing properties.
TGR: And that individual would be Mike Burke.
JM: Mike Burke, yes.
TGR: You’re based in Vancouver. What projects in the White Gold district interest you?
JM: The one property that is probably the most advanced in the White Gold area is Kaminak’s Coffee Project, which has had a lot of drilling success. They anticipate operating four drills very shortly and a possible fifth one sometime later this summer. The company did a lot of soil sampling, prospecting and drilling last year. It is following up this year. So that’s one property that is going to see a lot of drilling and is probably going to lead the pack in that area.
Another company that is not that far away is Pacific Ridge Exploration Ltd. (TSX.V:PEX). John Brock is a seasoned Yukon veteran. The company did some trenching and a lot of soil sampling last year on its Mariposa Project. It recently flew an airborne mag survey and is now back in the field, preparing to drill an area where they had a trench show about 30m of 1.25 g/t Au. This trench is within a soil geochemical anomaly (1100 x 600 meters) called Skookum Jim. Historically in the Yukon, anomaly recognition followed by some trenching has led to some early-stage drill bit discoveries. I would say Pacific Ridge is embarking on that pathway.
Early-stage companies in that area that are a bit more at the project generator or target generation stage include Ethos Capital Corp. (TSX.V:ECC; OTCQX:ETHOF), which has a fair amount of ground distributed in that same area, and Smash Minerals Corp. Smash Minerals has a very large land package on which they plan a program of grid soil sampling. The company has identified six high-priority areas to detail sample. Management intends to have a small drill program out of the gate later this summer or early fall.
TGR: Do any of these companies have projects directly related to Shawn Ryan’s work?
JM: A lot of these companies are taking more consistent soil samples at a deeper level and at a consistent horizon because of the success of his methods and his proven methodology. Because this part of the Yukon was not glaciated, we can correlate soil results as being in place—directly over bedrock sources. You don’t have to be concerned about a dispersal train that would occur in a glaciated area.
TGR: What are some companies you expect to see some influential drill results from this summer?
JM: Taku Gold Corp. (TSX.V:TAK; OTCBB:TAKUF) has a number of projects, some of which will see some drilling. I believe Silver Quest Resources Ltd. (TSX.V:SQI) will have one or two drill programs in that area as well. Wolverine Minerals Corp. (TSX.V:WLV) will be drilling a number of targets in the Dawson Range, south of the White Gold area.
TGR: When was the last time you saw something like this? Was it Lac de Gras?
JM: I think the Yukon play overshadows some of these other area plays because this is not just about one target or one commodity. There have been two successes in the near term: We’ve had Underworld taken over by Kinross, and then we had ATAC come out of the gate with a brand new geologic model that’s clearly captured the market’s attention.
The other reason this is sustainable is that there’s a lot of technical success here—many of these companies are very well managed technically, and they have gone to great lengths to educate investors. I could allude to Strategic and ATAC because of the newness and the time they have spent profiling their discoveries.
So, two discoveries and one takeover already. What’s going to sustain the area is more discoveries, or an expansion of those areas that have already seen a drill bit. We will, I believe, see more discoveries because the sustainability takes money, and the market has shown a lot of interest in the Yukon. With upwards of CAD$200M of expenditures this year on exploration alone, good things should happen. Come the fall, hopefully, we can table another discovery or two. A lot of fresh ideas and capital have come into the marketplace—this will sustain the interest—there’s no question in my mind.
TGR: As vice president of investment banking, are institutions coming to you saying that they want a stake in some of these plays in the Yukon?
JM: Yes, there continues to be a very healthy appetite for financing these companies. They’re in Canada, so there’s a lot of geopolitical security. Land claims have largely been settled. The government is supportive of mining. The area has a high degree of visibility and has had a lot of success in the past with several operating mines. There is a real opportunity and a real comfort for institutions.
TGR: What about new companies? Are people getting some properties, sending them into a shell company or doing an RTO, and then coming to you and saying “We need some cash?”
JM: The rate of company creation has been high over the last six months, as a lot of staking took place in the fall and winter. That has now translated to new companies. I think that will increase as we have additional discoveries, and as long as the capital market is there to finance these companies—new company creation will continue.
TGR: If there were a red flag anywhere in all of this, what would that be?
JM: The capital markets and the ability to raise money is one. But that does not impact the fundamentals near term as most companies are financed for their 2011 programs. Perhaps something out of the blue could impact markets—an environmental concern, a permitting concern or maybe, in some cases, exploration resources get overwhelmed.
TGR: If you were a betting man, Mr. Mustard, who would you give the best odds in terms of the first one to develop a mine?
JM: I tend to go to the companies that have led out of the pack, and I’ve mentioned Kaminak being one of them. In the White Gold area, they are the go-to company at the moment because they’ve got the largest budget and the most well-developed targets.
Beyond that, moving further northeast, you have ATAC Resources, which will have the largest exploration activity in the Yukon, a tremendous amount of drilling, a lot of heightened expectation, a lot of resources and a lot of expertise. So I would certainly rank them very high, however, they are a ways off from mine building. Alexco Resource Corp. (TSX:AXR; NYSE.A:AXU) has already built a mine at Keno Hill and, given some exploration success, could expand their operation.
Strategic Metals is another one because of the nature of that company; it has been an incubator of a number of other companies and has a large shareholding in several others. They also have significant properties that they’ll be drilling on, particularly a silver-lead-zinc property that is just northwest of Faro, where there’s very good infrastructure. That’s a fairly new discovery, and that project will see a tremendous amount of drilling.
Pacific Ridge is perhaps is a bit of a high-risk company because the property has not been drilled before, whereas ATAC, Kaminak and Strategic all have had a fair amount of drilling last summer. Golden Predator is another one because they’ve got Brewery Creek, where we saw some phenomenal drill intercepts already this year. They’ve got that project and they’ve got Clear Creek and Grew Creek as well, which is another asset that has had some recent successful drilling.
As far as the first new mine to be developed, it could be Victoria Gold Corp.’s (TSX.V:VIT) Eagle Gold Project where feasibility work is underway and they are targeting a production start-up during 2013.
TGR: What does the geology look like in the Yukon?
JM: We’re still at an early stage and haven’t identified all of the environments. Clearly there’s a lot of exploration left to do over the next few decades. But the Yukon is part of a regional geologic setting where world-class discoveries have been made. Exploration has been cyclical and it will likely continue that way to a certain degree. Now it has a lot of money being thrown at it on a sustained basis. That’s really, I suppose, what separates where we are now from where we were in the past. In the White Gold area, we have what I would call intrusive-related or breccia-related gold targets. We also have evidence of large bulk tonnage copper systems nearby. Casino is a billion-plus ton deposit with copper and gold that has been through a number of phases of exploration. Its challenge has been the fact that it’s a large bulk tonnage system and it needs good infrastructure. Infrastructure is one thing that is not that well developed in the Yukon. That’s why gold deposits have more attraction—because you can fly the gold bricks out—whereas copper concentrates require a bulk tonnage system.
There is a brand-new area being prospected for Nevada-style Carlin replacement gold deposits. A whole range of deposit types are clearly on the horizon for exploration and potential discovery.
The take away—our metallogenic (ore deposit formation) understanding of the Yukon is still very much in evolution.
TGR: Thank you so much for speaking with us.
Jim Mustard joined PI in October 2009 and brings an extensive range of capital-market and industry experience that spans multiple commodities in a global context of exploration, development and operations. Immediately prior to joining PI, Jim was at Canada Zinc Metals Corporation for two years and prior to that was a vice president and senior mining analyst at Haywood Securities for 11 years. Previous work periods also include several years in Latin America, two years with the Canadian federal government and five years of exploration in Yukon. Jim’s core strengths are his ability to recognize early to advanced-stage opportunities in a broad-based context of geological and economic factors and his extensive professional and financial network. “I believe the resource industry will continue its recent momentum over an even wider range of commodities than before, as global growth regains its former pace of expansion,” he says. Jim has a bachelor of applied science in geological engineering from Queens University, Kingston. He is a registered professional engineer with the Association of Professional Engineers and Geoscientists of BC.
By The Gold Report, on February 21st, 2011
Michael Fowler is a senior mining analyst with Loewen, Ondaatje, McCutcheon in Toronto and he was more than willing to speculate on potential takeovers in this exclusive interview with The Gold Report. “All of these gold producers are going to be active in the mergers and acquisitions (M&A) market. They are going to acquire because there’s a huge amount of cash on their balance sheets,” he says. Michael also talks about some undervalued names in his coverage universe, including one junior he thinks could climb 210% before year-end.
The Gold Report: Michael, please tell us a little bit about Loewen, Ondaatje, McCutcheon (LOM).
Michael Fowler: LOM Ltd. is the oldest independent research boutique on Bay Street. It’s been around for 40 years or so. What we are today is an institutional broker that focuses on small- to mid-cap mining issues. We also do high tech and biotech.
TGR: There is certainly a lot of room for growth in those sectors. Today, we’re focusing on potential takeovers and mergers among Canadian junior gold companies. Last week, Goldcorp Inc. (TSX:G; NYSE:GG) sold its 10% stake in Osisko Mining Corp. (TSX:OSK) for $530 million. What did you make of that deal?
MF: I think it was telegraphed by Goldcorp to some degree, but what interests me is the timing of that transaction. I suspect that Goldcorp probably didn’t want to wait until Osisko’s Canadian Malartic mine in Quebec went into production. Mines that go into production have huge amounts of risk. Also, I would speculate that Goldcorp is certainly in the market for other assets. It’s an interesting transaction.
TGR: Well, it’s not like Goldcorp is cash-poor. Have you heard anything on Bay Street about potential targets?
MF: Goldcorp is reviewing targets all the time. I wouldn’t be surprised to see the company pop its head up and look at Ventana Gold Corp. (TSX:VEN), for example, even at this late stage. There are other targets that it also might go after, which might suit its portfolio. I haven’t heard of anything specific.
TGR: One common tack of majors like Goldcorp or mid-tier producers like Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) is to take a stake in a junior, get a look at the drill core and the deposit models and get a seat on the board. Do you know if Goldcorp has any seats on junior boards?
MF: I’m not aware of any particular boards on which the company sits. I wouldn’t be surprised if it had stakes under the 5% threshold, which it doesn’t have to report. The company took an equity interest in Gold Eagle Mines, which it took over a couple of years ago. I wouldn’t be surprised if it had equity stakes all around the industry actually.
TGR: Despite about a 30% upswing in the gold price over last year, Goldcorp shares traded between $37 and $49. Over the same period, it’s a similar story with Barrick Gold Corporation (TSX:ABX; NYSE:ABX) with its shares roughly trading from $37–$56. Those aren’t bad gains but if Goldcorp were to take over something substantial, would that dramatically move the needle with those majors? Or are we going to need a merger of a couple of those large gold companies for that to happen?
MF: First of all, let’s talk about mergers of big gold companies. In my opinion, that really doesn’t create any value. You can look at Barrick Gold as an example. Since 1993, Barrick really hasn’t created much in terms of shareholder value, despite several large takeovers. Although mergers may occur, I think the big gold companies realize that getting too big is not all that advantageous.
Secondly, a gold company would be more likely to take over a deposit, because there’s great value enhancement from taking an undeveloped, or developed, project through to production. Companies gain accretion from that; they just can’t pay too much for those assets. Some big gold companies have been paying a high price for some of those assets and may not benefit much from the acquisitions. Goldcorp’s Andean Resources acquisition is a good example. Gold producers are going to be active in the mergers and acquisitions market. They’re going to acquire because there’s a huge amount of cash on their balance sheets.
TGR: You mentioned Goldcorp buying Gold Eagle, but there have been some other transactions in Canada’s junior gold space. In 2011, Osisko took out Brett Resources, and Kinross Gold Corp. (TSX:K; NYSE:KGC) bought Underworld Resources. In 2007, Agnico acquired Cumberland Resources and its Meadowbank gold project, which is now a gold mine in Nunavut. The latter deals involved mid-tier producers buying some promising gold projects in mining-friendly jurisdictions. Do you see more of these deals happening in 2011? Is that part of your investment thesis in terms of your coverage sector?
MF: Not really. I do see some potential takeovers by those sorts of companies, though. Detour Gold Corporation (TSX:DGC) might be an example. Its shares are very highly priced; therefore, it may take over lower-priced or lower-valued shares of another company in an all-share takeover.
I see the Osisko-Brett takeover as being a weak transaction. You don’t tend to get a non-producer taking over another non-producer unless it has some risks associated with its own deposit being brought into production. The biggest upside for Osisko, in my view, would’ve been just to get its mine into production and not bother taking over other producers. I see that type of transaction as being rather sporadic. If there are takeovers, we’re more likely to see a big gold producer or a mid-sized gold producer taking over a company that has a gold project close to the feasibility-study stage.
TGR: That’s twice you’ve alluded to potential problems with Osisko’s Canadian Malartic Mine. Do you believe there could be issues there?
MF: It’s not that I believe there are fundamental problems for Osisko at Malartic. It’s just that the company is mining a very low-grade deposit. If it’s wrong on the grade that goes through the mill by 10%, then there’s a lot of risk associated with it. There aren’t that many open-pit gold deposits in Canada. I just find Goldcorp’s timing in disposing of its shares interesting.
TGR: I would suspect that people like Osisko CEO Sean Roosen were none too happy with Goldcorp selling at this point, but let’s move on to your coverage area and some small- and micro-cap names. You have a Speculative Buy rating on Fire River Gold Corp. (TSX.V:FAU; OTCQX:FVGCF) with a 12-month target price of $1.40. Considering the company is currently trading at around $0.53, that would be a gain of more than 210%. FAU is scheduled to relaunch production at the Nixon Fork Gold Mine in Alaska later this year. It bought the property after Saint Andrews Goldfields (TSX:SAS) was forced to close the mine in 2007 due to production problems. What makes you think Fire River has solved those problems?
MF: First of all, let’s talk a little bit about St. Andrew. These comments are not really about today’s St. Andrew because it’s a different company now than in the past. But previously, St. Andrew had a pretty poor mining record. It also had problems with another project in the Timmins area of Ontario. I think that in those days St. Andrew’s management was heavily weighted toward miners and less so toward geological engineers. The real problem at Nixon Fork was the lack of understanding of the deposit’s geology. By the way, St. Andrew wasn’t the only operator of the Nixon Fork Mine. Consolidated Nevada Goldfields Corporation (now Real del Monte Mining Corporation, a private company) operated the mine in the 1990s and actually made profits.
Moving forward to today, what can Fire River do differently from St. Andrew? One point is that it has a little bit of time. Financial obligations forced the company to produce, but Fire River actually has time to do some drilling. It’s currently doing 28,000 meters of drilling in order to really understand the Nixon Fork ore body—that is the key to that operation. It’s a very low-tonnage mine, so the company needs to have good control over the geology. That’s the focus that Fire River is taking and I’m betting that it’s going to get that right. The mere fact that there are very high-grade resources is going to give Fire River some leeway if it has any problems associated with the grade.
TGR: In your discounted cash flow (DCF) model for Fire River, you used a 5% discount rate and a $1,400/oz. gold price. I would say, generally, that the discount rate is a little bit low and the gold price is probably a little high. Why did you choose those numbers?
MF: The discount rate has always been a topic of conversation in the industry. What discount rate does one use? Traditionally, analysts use 5% discount rates for gold companies; and, actually, some use 0% as a discount rate. The reason is that the DCF method is very inflexible. It doesn’t really tell you the potential for increases in reserves or resources or the potential for rises in the gold price. Therefore, if you do a DCF of 5% on a lot of producers, you’ll find that they actually trade at premiums to that discount rate. In fact, I use 5% on just about every company out there.
TGR: What about the $1,400/oz. gold price?
MF: I don’t think that’s a bad gold price to use. I think we’re going to soon see gold closer to $1,400/oz., and then a year later, it will be over $1,400/oz. I’m bullish on gold. I don’t see any reason to change that view. I guess the biggest risk on gold is interest rate hikes. I just don’t think that’s going to happen. I think that $1,400/oz. is a very good price to use; but, even if gold went to $900/oz., I still believe Fire River would make a small but reasonable profit.
TGR: Fire River released its Preliminary Economic Assessment (PEA) of the Nixon Fork Project on February 17. We can also expect to see drill results from that 28,000m drill program you mentioned. What are you expecting from that scoping study?
MF: I’m expecting a robust scoping study. It may not show the same level of net asset value (NAV) that we calculated because the NAV that we calculated assumes some additions to the resource. So I think the scoping study will be a little bit less than the NAV we’ve used. The other thing is that the scoping study will use $1,200/oz. gold, not $1,400/oz. gold. Nevertheless, I think we’re going to see a fairly robust situation. I do have to warn people that we may not see the same level of value that we calculated because we used a higher gold price. We also assumed that Fire River would find extra resources through the drilling that’s taking place.
TGR: You’re projecting $36 million in cash flow in 2012 once Nixon Fork reaches production. Do you believe Fire River could become a takeover target at that point, or is that scenario is more likely before Fire River reaches production?
MF: No, I don’t think it’s going to happen before the company reaches production. I want to point out that there’s a lot of skepticism out there about this story. We’re banking on it working out. That is probably one of the most fundamental reasons to buy the stock right now. It could be a takeover target if it’s successful in production. But I have a feeling that it might be the acquirer down the road rather than the acquired. Fire River will be a relatively small producer; if it works out as we expect, the company may be in the market for a merger with another small producer.
TGR: That’s certainly not the only company you cover. You have Speculative Buy ratings on Richfield Ventures Corp. (TSX.V:RVC), Clifton Star Resources Inc. (TSX.V:CFO) and Fortune Minerals Limited (TSX:FT). Why do you like those stories?
MF: Let’s start with Richfield, which has drilled about 100 holes in Blackwater Gold Project—a low-grade, bulk-tonnage target. It’s had consistently good results and I it looks to me as though we’re heading toward 4 million ounces (Moz.) or more in the ground for that deposit. We haven’t had a resource estimate from the company, but the company is planning a PEA in the fall. I suspect that we’re going to get some very good numbers from that study. Richfield is trading at a fairly low valuation, and with further drilling I expect to see that increase.
TGR: Richfield has had some impressive drill results at Blackwater. One was 72 meters of 1.6 grams per ton (g/t) gold; another returned 183m of just a little over 1 g/t gold. Those results would indicate a bulk-tonnage target, but what is the ownership situation with Silver Quest Resources Ltd. (TSX.V:SQI)? Richfield optioned that property from Silver Quest, but it’s not quite that clear-cut, is it?
MF: Well, it’s pretty clear-cut. The northern half of the project is actually part of a 75/25 joint venture (JV) with Silver Quest. But the bottom half of the project is 100% owned by Richfield Ventures and most of the drilling has been on the ground that Richfield owns. Now, I suspect that the two parties are talking to try to get the best value for their shareholders from that deposit. In the future, I think you may well see some news regarding a revised deal with Silver Quest for the northern half of the deposit.
TGR: Please tell us about Clifton Star.
MF: Clifton Star Resources is working on the Destor Porcupine fault zone on the Quebec side of the border with Ontario. The Destor Porcupine fault has produced more than 100 Moz. gold, so we’re onto a great location. The infrastructure is there and it’s in Quebec, the best location in the world for finding a mine.
Osisko is actually earning a 50% interest in this project. Clifton Star is trying to find a large, bulk-tonnage deposit. At the moment, it has close to 3 Moz. gold in terms of NI 43-101 reports. But, quite frankly, I think we could be well over 5 Moz. as a result of the drilling done with Osisko. Again, this is an undervalued situation. I see some upside potential in Clifton Star.
TGR: Maybe one more for our readers?
MF: I’d just like to mention Fortune Minerals, which is a different type of story. Fortune has two deposits. One is a gold-cobalt-bismuth deposit in the Northwest Territories, which has about 1 Moz. gold. The other is a coal project in BC. The coal project is interesting because coal is very hot right now. The price of metallurgical coal is about $250/ton. Fortune’s coal contracts are being written as we speak, so that coal deposit is very valuable. Fortune’s NICO Deposit in the Northwest Territories is totally undervalued in terms of our DCF model. I would say there’s about $5 of value in those two projects, and that’s not even using today’s prices of coal, cobalt or gold. We are really excited about that company.
TGR: Most of the companies you like have projects in Canada, as you said, it’s one of the most mining-friendly places in the world.
MF: I like Canada. Richfield is in a good spot; it’s close to infrastructure. Clifton Star is close to infrastructure. Infrastructure at Fortune Minerals, however, is not as good; though it is in Canada. I’m very bullish on Canada.
TGR: What can our readers expect in terms of the number, or size, of deals that could happen this year? Of course, it’s pure speculation but what do you think will happen?
MF: I think there are going to be a lot of deals in the $1–$10 billion range and maybe even down to the $500 million range. I expect a lot of activity. The big gold producers are looking for good deposits with some upside potential, but one of the best ways of generating shareholder value is through exploration, not acquisition—resource expansion by the drill bit. So, look for bigger exploration budgets from these gold producers. It makes a lot of sense economically; it just takes time to generate a mineable deposit.
TGR: Thank you for talking with us today, Michael.
Michael Fowler, senior mining analyst with Loewen, Ondaatje, McCutcheon Ltd., has worked in the investment industry since 1987 as a base and precious metals mining analyst for numerous high-profile firms. His coverage list includes the major North American gold mining companies. Previously, Michael worked as a geophysicist involved in mineral exploration for 10 years. He was involved in the discovery of the high-grade Cigar Lake uranium mine in Northern Saskatchewan in the early 1980s. Michael holds an MBA from Cranfield University, UK, an M.Sc in mineral exploration from Leicester University, UK, as well as a B.Sc in geology with geophysics from Liverpool University, UK. He is a member of the Institution of Materials in the UK and a member of the Canadian Institute of Mining and Metallurgy.
By Rok Spruk, on March 16th, 2010
Here’s a list of interesting readings for this week.
In NY Times, Paul Krugman discussed (link) the painfulness of financial crisis in Ireland and the U.S and suggesting what we should learn from banking regulation in Canada to prevent future crises of similar proportions.
In Waging War on Black Teens, Richard W. Rahn and Izzy Santa wrote (link) about the high unemployment rate among young African Americans. Furthermore, they suggest that minimum wage mandate is the main cause of steep unemployment rise thereupon.
The Economist (link) summarized the estimated total cost of reconstruction after the earthquake in Chile at $20-30 billion (13-19 percent of the GDP). Chile’s sovereign wealth fund has just over $11 billion saved during the pre-crisis period of high copper prices which, at that time, stood at record levels.
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By Rok Spruk, on November 24th, 2009
A study by June O’Neill and Dave M. O’Neill (link) suggests that the U.S health care system provides more choice, efficiency, better delivery and capacity than the Canadian system:
“Does Canada’s publicly funded, single payer health care system deliver better health outcomes and distribute health resources more equitably than the multi-payer heavily private U.S. system? We show that the efficacy of health care systems cannot be usefully evaluated by comparisons of infant mortality and life expectancy. We analyze several alternative measures of health status using JCUSH (The Joint Canada/U.S. Survey of Health) and other surveys. We find a somewhat higher incidence of chronic health conditions in the U.S. than in Canada but somewhat greater U.S. access to treatment for these conditions. Moreover, a significantly higher percentage of U.S. women and men are screened for major forms of cancer. Although health status, measured in various ways is similar in both countries, mortality/incidence ratios for various cancers tend to be higher in Canada. The need to ration resources in Canada, where care is delivered “free”, ultimately leads to long waits. In the U.S., costs are more often a source of unmet needs. We also find that Canada has no more abolished the tendency for health status to improve with income than have other countries. Indeed, the health-income gradient is slightly steeper in Canada than it is in the U.S.”
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