By The Energy Report, on January 20th, 2012
 With oil reserves less and less accessible to western majors, producer stocks can carry significant geopolitical risk. In this exclusive interview with The Energy Report, First Asset Investment Management Inc. Senior Vice President John Stephenson explains why service-oriented companies are smart selections for risk-averse energy investors. No matter what happens in the oil and gas business, the companies doing the drilling have solid prospects in this market environment.
The Energy Report: 2011 was a pretty exciting year with oil prices all over the map, largely fueled by the European debt crisis. What do you expect are going to be the hot topics affecting energy commodities in 2012?
John Stephenson: The spread between Brent and West Texas Intermediate (WTI) prices, which was a big story in 2011, will continue to play a role. I expect a lot of talk about how WTI has once again resumed its place as the global benchmark. Another big topic, as it always is, will be the continuing geopolitics of oil, be it a possible Arab spring in Saudi Arabia or Iran’s nuclear program and how that impacts the world. In terms of possible black swan events, the Environmental Protection Agency (EPA) or other regulators could limit horizontal drilling and fracking. However, that could be very positive in the short run for natural gas prices.
TER: What caused the big spread between the WTI and the Brent prices?
JS: Everyone used to look at WTI as the main global benchmark for crude oil prices, and Brent historically traded at a slight discount. Then, over time, Brent started trading at a premium to WTI. What people have to understand is that these benchmark contracts specify grade and location. The delivery location of the WTI crude contact is Cushing, Oklahoma. Because it’s landlocked, you can’t get crude in from the Gulf region, which actually traded in line with Brent. There also wasn’t enough pipeline capacity to get the large inventories of crude that had built up in Cushing out to other global markets. So it really was an infrastructure issue that caused the price spread. Now, various companies have gotten together and proposed pipeline alternatives that would alleviate this glut of oil at Cushing. Therefore, you’ve seen the spread go from $25 to about $11.40, where it is today.
TER: Your management company, First Asset Investment Management Inc., manages a variety of different commodity-focused funds. What is your 2012 energy outlook?
JS: Our outlook is very supportive and positive for oil. One of the interesting things about oil is that despite the dire headlines, mainly out of Europe, oil has held in as well as it has. In fact, it’s been hitting eight-month highs recently. Why is that? Partly because demand is so strong. We saw record demand globally in August and near-record demand in October and November and continuing strong demand despite the fact that Europe appears to be dipping into recession and growth is potentially slowing a little in Asia. This is why I’m very positive on this and expect to see oil go higher.
Natural gas, on the other hand, is very weak. It’s sub-$3/million cubic feet (MMcf) right now, and I think it will continue to be weak. Historically the period between December and March is when natural gas trades at a premium to its summer prices. This is actually the first winter I can recall seeing it trading at a discount.
TER: Weak natural gas prices are a result of increased shale gas production through fracking, which has created a significant oversupply in the last year or so. Is this going to continue, do you think?
JS: Yes, the U.S. has 200–250 years of reserves of shale gas at current production rates. I don’t see any reason at all for it to change unless, of course, the EPA or someone else were to rule that fracking was detrimental to the environment and there was a moratorium placed on drilling. That could be a black swan event and could change things. If things continue the way they are, there’s no doubt that prices will stay low. Now, clearly, there is some opportunity to export this, but that means building a liquefaction terminal, probably on the Gulf Coast or some other part of the country where people are willing to have a liquefaction facility. That would turn natural gas into a liquid to be transported to Asia or potentially to Europe, where the prices are much higher than they are in North America.
TER: So even though we may have hit peak oil, we certainly haven’t hit peak gas.
JS: No, I don’t think we’ve hit peak gas. Four years ago, the talk was that we were running out. They were going to build terminals on the Gulf Coast to take liquefied natural gas from Trinidad and other places, gasify it and put it in the U.S. pipeline system and supply the northeast in particular with natural gas. Now we’re finding we have so much of this stuff in various shale deposits that we have the potential to become a huge energy exporter. Hopefully that will be the case, but for now we don’t have the infrastructure in place to make that happen.
TER: In some respects it’s a happy turn of events compared to previous supply concerns.
JS: Not if you’re a producer of natural gas, but if you’re a producer of oil, it’s great. If you’re a consumer of electricity, then it’s great.
TER: As far as your portfolio selections and your outlook for this year, you’re clearly leaning much more toward oil and gas liquids. What other factors do you think are going to be affecting prices this year and into the future?
JS: What impacts prices for commodities is supply and demand. I think you’re going to see that demand continues to grow. The reality of why we’ve hit record world demand is not because consumers in the U.S. are doing so much driving. It’s rather because consumers in Asia are doing so much driving. China is now the number-one car market in the world. Who would have thought? If you look at total energy consumption, including coal and other sources, China has overtaken the U.S as the number-one consumer of energy in the world. That trend will continue and put upward pressure on oil prices over time.
The other theme that I think is important for investors to understand is that most of the majors have had real trouble finding replacement reserves to keep producing at the same level. Most of the industry has run from one country to another, where they’ve been kicked out. When Lee Raymond was running Exxon, he ran over to Russia, then to Nigeria, then Venezuela. The settlement that Venezuela was willing to offer Exxon for its assets was a pittance. This is typical of what we’re starting to see around the world. It’s very hard for most of the majors to find new reserves and to continue to produce at the same levels because most of the world that has energy is not open or friendly to the West. This creates a huge problem for these companies.
Given that backdrop, investors need to find companies with reserves in geopolitically stable locations, or where companies are not in the business of generating the reserves; they’re in the business of helping oil companies produce those reserves. That leads you to the service sector, which I think is a lower-risk area. Investors can stay in North America and invest in companies they know and understand without worrying about geopolitics.
TER: What are some of the names that you like in the service sector?
JS: I think if Saudi Aramco, the largest oil company in the world, is going to do a job and it’s going to produce a new field, it will call in Halliburton Co. (HAL:NYSE) or Schlumberger Ltd. (SLB:NYSE). It’s not going to call in Exxon Mobil Corp. (XOM:NYSE). It doesn’t need Exxon’s expertise or capital. But it does need Halliburton’s or Schlumberger’s expertise. These global majors are going to do well on the service side. In the last 25–30 years, the industry has gone from positive bullish cycles to bearish cycles. The people who had the expertise in down-hole seismic techniques, who understood how to operate drill bits at various angles and how to cement and case wells and all of these other things became outsourced to the service industry. The true oil business expertise is in the service industry; that’s why I see it as a sound investment.
TER: So if I may make a mining metaphor, it’s the guys that supply the shovels to the miners that are going to make the money, not necessarily the miners.
JS: Absolutely. It’s the California Gold Rush all over again, except it’s the global energy rush, and you want to be in the picks and shovels business, not necessarily in the prospecting business laying claims. If you’re a Western company and you’re laying claims, chances are you’re laying claims in some part of the world that doesn’t want you there and that may kick you out down the road. Then what do you have?
TER: What are some other companies in your portfolio holdings that you particularly like at this point?
JS: One area to look at is the smaller energy service companies, like Calfrac Well Services Ltd. (CFW:TSX) and Trican Well Service Ltd. (TCW:TSX). Again, there is an increasing amount of drilling that’s happening, even on the gas side. It’s just happening with these new horizontal drilling and fracking techniques. These are the guys who supply this equipment. That’s very strong.
I also think you want to look at the oil companies that don’t have problems with reserves and short reserve life, including some of the Canadian oil sands producers. I would recommend Suncor Energy Inc. (SU:TSX; SU:NYSE) and Canadian Natural Resources (CNQ:NYSE; CNQ:TSX). These stocks are cheap. They’re trading as if oil were $55 or $60/barrel (bbl) when it’s over $100/bbl. These low valuations offer a great opportunity.
TER: Looking at your portfolio in your First Asset Energy and Resource fund back at the end of last quarter, Sept. 30, you were about 78% in cash. Was that a strategic decision? Have you changed that cash into equities at this point?
JS: No. We were very defensive at that time, and I think the reason was pretty simple: Europe was blowing up and when any major economic zone is blowing up, I don’t think you want to be in commodities or commodity producers. Now we’re seeing that the market has stabilized, and you’re going see growth going forward. Valuations certainly never got ahead of themselves in either individual stocks or in any energy sector, so I expect valuations to move higher at this point.
We’re no longer at that same cash level. Our position at that time reflected an overall nervousness about the world. When you have these dominant issues, you need to take your money off the table, which we did. Ultimately, the trade was to the downside, and we preserved value by doing that. I’m very proud that we were able to raise so much cash and be truly defensive at a time when the market was dropping quite substantially.
TER: Are there any of your other attractive portfolio holdings that you’d like to discuss at this point?
JS: I think in terms of other commodity themes that are working well, certainly Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) would be a great name—that’s on the copper side; it is the largest pure copper producer out there. On a similar vein with a little bit better growth and a little bit more sensitivity to the market—meaning it will move a little more dramatically than the market itself—would be First Quantum Minerals Ltd. (FM:TSX). That’s another name that I think does very well.
We haven’t talked a lot about the agricultural names. If we’re talking about the broad resource base, it’s been a tough time in the agricultural space, particularly for the fertilizer companies. But I continue to think Potash Corp. (POT:TSX; POT:NYSE) looks attractive, especially at this level. Agrium Inc. (AGU:NYSE; AGU:TSX) looks attractive at this level. It’s a little more defensive than Potash. The Mosaic Company (MOS:NYSE) has struggled. I would probably recommend CF Industries Holdings Inc. (CF:NYSE) over Mosaic. Those are the areas that I would look to.
Also, in terms of other oil and gas producers, Canyon Services Group Inc. (FRC:TSX) does well. Transocean Ltd. (RIG:NYSE; RIGN:SIX), a big supplier of offshore platforms, will do well in this environment. Even Baker Hughes Inc. (BHI:NYSE) is transitioning its fleet to more horizontal drilling from straight vertical drilling. Those are all names that we have held and will continue to hold in the future and expect to do well.
TER: To sum things up as far as the energy outlook for 2012, what would you like to tell us?
JS: I would say that energy remains the most important of all the commodities. It will be the most important in 2012 and likely in 2020. Even though we’re over 100 years into the energy era, we are still very much dependent on oil. While it may seem expensive when we’re filling up at the pump or when we look at the futures prices, it’s still cheaper than orange juice on a volumetric basis. There is no substitute for oil, at least no good substitute. There is no technology right now that is commercially viable enough that could change the industry in the way that horizontal drilling and fracking changed the natural gas world. So I think you’re going to see oil prices move considerably higher.
Demand no longer is being driven by America; it’s being driven by Asia and predominantly by China. That trend will continue. In many parts of the world where demand is growing the fastest, namely the Middle East as well as some parts of South America and Asia, fuel prices are subsidized. In an environment where gasoline prices are subsidized, the consumer isn’t feeling the full impact that we feel here in North America. So for those reasons, I think we’ll see oil prices move higher, stay higher and exit 2012 at least $130/bbl. Natural gas prices, on the other hand, will remain range-bound in the $2.50–3, maybe $4, range. It’s very hard to see a successful investment strategy for investors there, other than with the service companies that are going to be the beneficiaries from all of that drilling.
TER: I think that pretty well sums it up. We appreciate your thoughts and input today.
JS: My pleasure.
John Stephenson is a senior vice president and portfolio manager with First Asset Investment Management Inc., where he is responsible for a wide range of equity mandates with a particular focus on energy and resource investing. He has been recognized by Brendan Wood International (BWI) as one of Canada’s 50 best portfolio managers for the past three years. He is the author of The Little Book of Commodity Investing (John Wiley & Sons, 2010), which has been translated into five languages and Shell Shocked: How Canadians Can Invest After the Collapse (John Wiley & Sons, 2009), and writes a free bi-weekly investment newsletter, Money Focus, which reaches a global audience of more than 125,000 (www.reportonmoney.com).
Stephenson is regularly quoted by Bloomberg News, Reuters, The Associated Press, The Wall Street Journal and The Globe and Mail and is a frequent guest on Bloomberg TV, CNBC, CNN, Fox Business and Canada’s Business News Network (BNN), Sun TV and the CBC. He is frequently the keynote speaker at investment conferences throughout North America. Stephenson holds a degree in mechanical engineering from the University of Waterloo, an MBA from INSEAD, as well as the Chartered Financial Analyst (CFA) and Financial Risk Manager (FRM) designations. He lives in Toronto.
By The Gold Report, on November 14th, 2011
 In an environment of declining steel prices, Geordie Mark, mining analyst with Haywood Securities in Vancouver, nonetheless believes that iron ore juniors are poised for a rebound. Read his reasons for optimism in this exclusive Gold Report interview.
The Gold Report: About 37% of the world’s population is in China and India, countries in the early stages of their use of steel and, thus, iron ore. You’ve said their infrastructure requirements should trend up “for a number of years, if not decades.” Yet, benchmark prices for steel are down 15% since March. Is this price weakness a short-term problem or is there cause for concern?
Geordie Mark: I think we are looking at a shorter-term issue related to a tightening in money supply in China, particularly affecting the smaller mills. These smaller mills need to moderate output or get injections of commodities at lower prices. But we are still looking at underlying demand growth to meet the needs of increasing industrialization in the advancing economies, particularly in China and India.
TGR: Even though iron ore stockpiles are within 3% or 4% of record levels?
GM: We believe that stockpiles in ports and so forth are higher largely because steel demand is higher, and there is a coincident increase in iron ore imports. Compared to last year, China’s year-to-date crude steel production is up ~12%. If we measure inventory in terms of a proportion of steel output, we see that this higher inventory level has formed a plateau over 2011.
The recent pricing downturn for iron ore appears to correlate to a short-term issue in money supply where steel mills are sitting on more expensive inventories. This pricing scenario has witnessed a rebound over the last week where renewed demand and restocking has been taking place in China at cost and freight prices of $130/ton (t). The relative drop in China’s inflation rate announced on Tuesday also provides us some solace for an increased potential fiscal loosening in China.
TGR: Some producers have shut down furnaces because of an excess amount of steel in the market.
GM: We usually see some seasonality at this time of year where demand tends to plateau, particularly in Europe, from August through the end of the year. However, we have witnessed some demand softening outside Asia, but we expect that this will pick up again at the beginning of the year with renewed orders.
TGR: Iron ore swaps, based on anticipated first quarter prices at the Chinese port of Tianjin, are trading at about $129/t. Clarkson Securities says iron ore swaps are showing no price rebound until about 2013. In June, you were forecasting average freight-on-board Brazil prices of 62% iron at $124/t in 2012. Has your forecast changed?
GM: We are forecasting $130/t for 2012, based on our assumptions of continued demand from China together with potential increases in export taxes on iron ore in India, which are expected to place limitations of exports from that country. We think that underlying demand, as well as moderation in metallurgical coal prices, will help move the price higher in the shorter term and marry with our expectations.
TGR: Infrastructure growth in North America is stagnant. Is this a drag on the share growth of North American junior iron ore miners, despite the continued steady demand in iron ore use in the BRIC countries (Brazil, Russia, India, China)?
GM: For the time being, across the equities, we see a move away from risk largely independent of commodity. The juniors, in particular, suffer in the interim, independent of where commodity prices are going. Iron ore juniors have obviously dropped recently, but we do expect prices to rebound when commodity prices recover and risk appetite returns to the market.
TGR: In your coverage sector, you have 12-month target prices on more than one iron ore junior that could see its share prices quadruple from current levels. What’s the thesis for rebounding prices in this sector?
GM: Our thesis is continued demand growth. The world’s two most populous nations still require fundamental components for continued industrialization and urbanization. Other economies witnessed comparable infrastructure growth paths over their infantile stages of industrialization, such as the U.S., Germany, Japan and South Korea. In comparison, China has not reached the levels that those countries did in the past, and India still has an appreciable way to go if it is to reach the zenith of infrastructure investment intensities of the other economies.
In future support of our thesis toward growth in steel demand and maintenance of elevated iron ore prices, we see that India’s concern over the future needs of its domestic steel sector has resulted in the government looking to impose even greater tariffs on iron ore exports. Such a move, together with lower iron ore prices, is expected to temper Indian exports and provide a mechanism to moderate seaborne iron ore prices going forward.
In addition, while we see growth in demand from China, partially aided by the country’s domestic program of low-income housing development, the market sees risk in the housing sector beyond that supported by government investment.
TGR: Let’s get to your coverage sector, beginning with Alderon Iron Ore Corp. (ADV:TSX; ALDFF:OTCQX). You have a Sector Outperform on the company with a 12-month target of $5.80/share. Alderon is trading below $3/share now. Please map out how Alderon’s share price could be catalyzed between now and the spring.
GM: Our valuation anticipates that Alderon’s project will move into production by 2015. Over the next year, the company is expected to achieve a number of key milestones that could move it toward our price expectations. Those milestones include the company increasing its underlying resource base at Kami, lowering project risk at the deposit by completing a feasibility study and bringing an offtake partner onboard.
Alderon has increased the depth of management expertise in the iron ore sector recently. The company is making the right moves to lower risk and bring on partners.
TGR: Who are some potential offtake partners?
GM: I think the usual suspects, particularly steel utilities out of Asia, such as China and South Korea. Utilities are looking for security of supply and for access to supply at cost, which obviously moderates their ability to supply steel and lower steel price environments. These steel utilities also want to become less reliant on the big three iron ore producers: Vale SA (VALE:NYSE), Rio Tinto (RIO:NYSE; RIO:ASX) and BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK).
TGR: Would an offtake agreement inhibit a possible takeover?
GM: If structured in the right way, I don’t think so. Earlier this year, when Cliffs Natural Resources Inc. (CLF:NYSE) acquired Consolidated Thompson, the underlying offtake agreements that Consolidated Thompson had and its partnership with Wuhan Iron and Steel Corp. (WISCO) on a project and ownership basis didn’t limit the deal.
TGR: You are also bullish on Northland Resources Inc. (NAU:TSX), which plans to start mining iron ore in northern Sweden in late 2012. Most of the operations in Québec’s North Shore ship iron pellets, not concentrate. Do you have a preference as to what form the iron takes?
GM: I think the most important elements to consider here are what product captures the most value for a particular project and what is the proximity of the market that the company aims to sell into. An especially pertinent factor to consider for the iron ore sector is the generation of a project with the potential to feed into the market over the long term. On this basis, projects that can deliver higher iron content products—say 62% and above—are probably better positioned if they can moderate operating costs.
TGR: Your 12-month target on Northland is $6.80/share and it is currently trading at less than $1.50/share. That seems like a pretty bullish target. What are the catalysts?
GM: There is an overhang in the market related to the ongoing situation in Europe. Also, Northland must continue to finance project construction. The company is aiming to complete the raising of a syndicated $400 million in senior debt facility by the end of 2011.
We believe Northland’s Kaunisvaara project is on time and on budget for completion of construction by Q412. Completing the debt deal would be a significant catalyst because it removes significant uncertainty. Project completion in Q412, commencement of mining in Q412 and initial concentrate sales in Q113 are big catalysts for this company.
TGR: Northland recently worked out a deal to use Narvik as its port facility. Once the company starts shipping concentrate and seeing some cash flow, what will it do with that cash?
GM: We understand that Northland will re-inject its cash back into the company to facilitate organic output growth. It will look to increase output at Kaunisvaara, and then potentially develop the Hannukainen iron-copper-gold deposit just over the border in Finland.
TGR: Do you expect to see significant byproducts from the gold and the copper in that deposit?
GM: Northland’s predominant revenue generator is iron, but, certainly, copper from Hannukainen is likely to be a significant component. In the end, Northland is an iron ore company.
TGR: Once it achieves production, Northland will become the second-largest iron ore producer in Northern Europe. If an up-and-coming junior iron ore company can become the second-largest iron company overnight, that speaks volumes about how much room there is in this market.
GM: That is correct. In part, it has to do with Northland’s proximity to available infrastructure and the location of its deposits, which geologically reside within the same family of deposits that LKAB, Northern Europe’s largest iron ore producer, is exploiting today. It will be a big step for Northland to get into that 5 million ton (Mt) capacity.
TGR: Champion Minerals Inc. (CHM:TSX) has iron ore projects in the Labrador Trough. Your 12-month target there is $4.20/share, and it is trading at less than $1.40/share. Its Fire Lake North, Bellechasse and Harvey-Tuttle properties have a combined Measured and Indicated (M&I) resource of 400 Mt, grading about 30% total iron. There’s another 1.82 billion tons (Bt) at about 25.4% total iron. How does that resource compare with companies at similar stages of development, for example, Alderon?
GM: I think Champion compares directly with Alderon and Consolidated Thompson in terms of having ample resource size to consider a potential production path. Consolidated Thompson’s Bloom Lake resources had similar grade, but with more than 2 gigatons (Gt) of defined and compliant iron ore resources in its portfolio in the Fermont mining district, highlighted by more than 1 Gt on its flagship Fire Lake project, Champion is well positioned to use its resource portfolio to go into and expand on production.
TGR: What’s the likelihood that Champion will get its M&I resource above 1 Gt at around 30% iron within a calendar year?
GM: I think Champion has a good likelihood of graduating its resources into the M&I category. We expect to see a number of resource updates across the portfolio coming up. I would expect an updated preliminary economic assessment on Fire Lake North later in November.
TGR: Is 30.6% total iron a low grade for this sort of deposit? Is that a concern?
GM: It is similar to that exploited by Consolidated Thompson at the Bloom Lake mine. Many other features play a significant part if the underlying economics of a deposit (e.g., mass recovery and grind size). For instance, a measure of effective mass recovery is very important for iron ore resources as it can give you a gauge of the mass needed to be mined and processed to produce a certain amount of product of a particular quality. Mass recovery can vary significantly between deposits with similar iron content, so the figure plays an important role in evaluating the potential of an iron ore resource. You need to look at more than iron content to judge resource exploitation potential.
TGR: Do you cover any other iron ore stories our readers ought to know about?
GM: Talon Metals Corp. (TLO:TSX) is one that we have been keeping our eye on. It is included in our Junior X-Report. In late 2010, the company acquired a couple of iron ore exploration plays in Brazil, basically on the doorstep of Vale’s Carajás iron ore mine. Talon rapidly developed those projects and within a year moved it up to more than 1 Gt of defined iron ore resource.
We see a lot of catalysts going forward on Talon’s fairly rapid resource expansion and metallurgical definition programs. More resource expansion is likely to be announced via the publication of a number of resource updates over the next six months, and a preliminary economic assessment is expected to be completed in mid-2012. The company has now defined new resources of outcropping iron ore that look as though they have size potential in a region that is being actively mined for iron ore.
TGR: If investors want to add only one iron ore junior to their portfolio, how should they choose among the companies you’ve named?
GM: It all relates to their comfort with risk and geography, and whether they like to look at junior companies with resource expansion and development potential, or iron ore producers with output growth on the horizon. If investors are looking for resource expansion, Talon, Champion or Alderon deliver resource expansion and development potential. If they are looking for projects further along the development pipeline, New Millennium Iron Corp. (NML:TSX.V) and Northland are on the development path with their respective projects in Canada and Sweden. If they are looking for exposure to Canadian iron ore production, there is Labrador Iron Mines Holdings Ltd. (LIM:TSX) or Cliffs Natural Resources Inc. It just depends on where your risk comfort lies.
TGR: Geordie, thanks for your time and insights.
Dr. Geordie Mark, a research analyst with Haywood Securities, focuses principally on iron ore, coal and uranium companies involved in exploration, development and production. He joined Haywood Securities from the junior exploration sector, where he served in an executive role concentrating on exploration across Canada. Immediately prior to joining the exploration industry full-time, Dr. Mark lectured in economic geology in Australia and served as an industry consultant. He completed his doctorate in geology in 1998 at James Cook University’s Economic Geology Research Unit in Australia, specializing in aqueous geochemistry and igneous petrology applied to ore-forming systems.
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By The Energy Report, on October 28th, 2011
 Headlines scream gloom and doom, but Vikas Ranjan of Ubika Research sees brilliance on the horizon. As emerging markets develop, opportunities for profit abound: it’s only a matter of identifying the most in-demand commodities. Meanwhile, cleantech companies are creating commercial solutions to keep the lights on and the water flowing. In this exclusive interview with The Energy Report, Vikas discusses the new Ubika Mining 30 Index and some companies ready to feed the need.
The Energy Report: Vikas, Ubika Research launched its Mining 30 Index on October 1, during a time of less-than-robust projections for the global economy. Why commodities, and why now?
Vikas Ranjan: It is true that in the short term, the global economy does look sluggish. However, we are very optimistic about the longer-term health of the global economy, especially the emerging markets. Countries like China, India, Brazil, South Africa, Russia, Indonesia and Vietnam will continue to grow at a robust pace. Commodities are a big part of that growth story. At this stage, a slight economic downturn creates an opportunity to spot undervalued assets.
TER: How did you choose which commodities to focus on?
VR: Because our investment thesis concerns broad-based growth in emerging markets, we looked for commodities that are used in a range of industries. We asked ourselves what particular emerging markets will need the most in the next five to 10 years and which commodities will meet those requirements. Base metals like copper, nickel and zinc address the need to expand infrastructure, and agricultural commodities like potash and phosphate are key to feeding an increasing population.
TER: About 19% of the index is coal companies. Why did you allocate such a large percentage of the index to an energy source that governments are increasingly trying to phase out?
VR: Coal is going to be in use for a long, long time. More than two-thirds of the world’s energy still comes from coal. China sources 80% of its energy from coal, as does India. In fact, the largest market cap company in India is Coal India Ltd. (COALINDIA:NSE), which went public about a year ago. In the next five to 10 years I don’t see any energy source coming close to coal. Beyond electricity generation, coal is also used to produce steel. Coal may be phased out in the future, but that future is far, far away.
TER: Could the Ubika Mining 30 Index serve as an indicator of global economic health, similar to copper, the so-called barometer of global markets?
VR: Copper will still play its role as an early indicator, a bellwether, for the direction of the global economy. There really is no substitute. However, a broader index, like the Ubika Mining 30, may provide a more decisive indication of the health of the economy, though it may take time for its performance to reflect what is happening in the global economy.
TER: Since its launch, the Ubika Mining 30 is up roughly 12%. Which companies on the index do you believe will continue to outperform the broader market?
VR: All 30 companies are highly prospective, with solid fundamentals and strong management. We’re pretty optimistic about most of them. Of course, we will keep a close eye on their performance and make changes as needed.
Having said that, we have more in-depth research on a few of them: Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX), Rodinia Lithium Inc. (RM:TSX.V; RDNAF:OTCQX), Glen Eagle Resources Inc. (GER:TSX.V) and Champion Minerals Inc. (CHM:TSX).
TER: As of June 20, you had a model price of US$2.56 on Allana Potash. At that time, the company had about US$60 million (M) in cash. How much does the company have now, and will it be enough to carry it through the bankable feasibility study?
VR: Allana is our top pick in the junior potash exploration field. It has a strong prospect for a potash mine in Ethiopia.
Its price has come down quite a bit; it’s now trading at US$1.02. This is what happens when expectations run ahead and when markets in general tumble, causing more high-profile stocks like Allana’s to get impacted negatively. But we will stay by our model price. The resource estimate far exceeded our expectations. It has more than 1 billion tons (Bt) of potash resource at its projects, most of it in the measured and indicated (M&I) category. We think that Allana has close to US$50M in the bank, and it’s fully funded to move forward with a bankable feasibility study. If anything, Allana is less risky than it was 18 months ago.
TER: In your research report, you note the possibility of a takeover. Do you expect that to happen before the bankable feasibility study or after?
VR: At current levels, I suspect Allana would probably not consider a takeover offer because the price does not reflect its true value. I think it will continue to build value in its assets and its share price will reflect that.
After the bankable feasibility study, once the value of those deposits are proven, bigger players will start to show serious interest in Allana’s exploitable potash.
TER: Let’s move on to Rodinia Lithium. Its flagship project is the Salar de Diablillos Project in Argentina. Rodinia recently had positive brine processing reports, yet the stock, which is trading at US$0.21, didn’t move at all. Why is that?
VR: Lithium is a little out of favor right now. Although it has other uses, lithium’s major role is in electric vehicle batteries. Demand is generally down now, and this is reflected in lithium exploration stocks. General economic conditions have also impacted stock valuations.
Rodinia is moving ahead. It has been getting very good exploration results and has had some good results on the processing side. We believe in Rodinia’s prospects; it has good projects and a good management team. The company is focused on its Argentinean project right now, but it also has land in the U.S. The stock will likely bounce back once the general sector regains strength.
Another advantage for the company is the strategic investment from Shanshan, China’s largest lithium-ion battery materials provider. It shows that the company is attracting right type of interest. Rodinia has a good technical team with previous experience in lithium projects and process development. So we remain optimistic about Rodinia’s prospects.
TER: There are quite a few salars in that region of Argentina, and other companies are working on brine projects there. Do you foresee consolidation?
VR: I would assume so. That is typically what happens when junior companies like Rodinia develop these assets. It’s much less likely that it will produce the deposits. If a company has built a good deposit base, has moved the project along and advanced it, it will have better chances of attracting outside interest. Rodinia is in the right place, in one of the most prolific belts for lithium deposits.
TER: Glen Eagle Resources has several projects based in Québec, Canada; a very safe jurisdiction.
VR: We’re very excited about Glen Eagle. The company is focused on phosphate. It also has a reserve on a lithium project next to Canada Lithium Corp. (CLQ:TSX; CLQMF:OTCQX).
Glen Eagle recently announced an option agreement to acquire 100% of the Moose Lake phosphate property. It’s immediately adjacent to a phosphate property called Mirepoix, which is controlled by Arianne Resources Inc. (DAN:TSX.V; DRRSF:OTCBB; JE9N:Fkft). A grab sampling and initial work were very promising. Glen Eagle is currently developing its Lac Lisette phosphate project. It is presently drilling on it. The Lac Lisette property is 40 km away from Arianne Resources’ Lac à Paul property, and shares the same main road.
Phosphate, like potash, has tremendous use in agriculture and is in high demand. Glen Eagle is very undervalued because not many people know about that resource. Its market cap is about US$18–20M. Right next door, Arianne Resources is roughly a US$140–150M market cap company. We see Glen Eagle closing that valuation gap once it starts to prove up the deposit. We have a model price of US$0.96 on that stock. It trades at about US$0.43. We started covering Glen Eagle when it was about US$0.30.
TER: The last company you mentioned is Champion Minerals. That’s trading at about US$1.25. What’s your model price for that one?
VR: We don’t have a model price, because Champion Minerals isn’t part of our in-depth research. We had it as a stock-watch list pick.
This is an iron-ore exploration company with some very good properties in the Labrador/Québec area. It has been getting some really good results and management is good. They’re in a very prospective area for iron ore exploration, near other majors and prospective companies. For example, Consolidated Thompson Iron Mines Ltd. (CLM:TSX) acquired Quinto Mining Corp., which had properties next to Champion Minerals’ property. We feel this project could be a prospective inclusion candidate.
TER: You also operate the Ubika Cleantech 30 Index. As of December 31, 2010, the combined market cap of the companies on that index was US$7.8B. By October 14, 2011, the value had fallen to US$5.8B. Why is this sector underperforming?
VR: It has been a rough year for cleantech. Our index has fallen along with other benchmark indexes, in similar proportions or even more, for various reasons. Most of the companies in our index are very early-stage companies. Most have no revenue because they are at a pre-commercial stage, and they fluctuate more widely. It’s a classic case of market euphoria and high expectations taking hold and running ahead of fundamentals.
Cleantech is a very broad sector, so not everything is performing badly. The energy side of it, such as solar and wind, has not proven to be as commercially viable as anticipated. Investors are getting disillusioned, wondering if these companies will become commercial. It’s a classic research-and-development (R&D) situation. Some of these companies come out well, but many will fall by the wayside. It hasn’t helped that there have been some high-profile failures.
TER: Has Solyndra’s bankruptcy hurt the credibility of the renewable energy/cleantech sector as a whole?
VR: It has tarnished the industry. It was certainly not good for the cleantech sector. It also shows you that it is risky for the government to get too involved, for example, in selecting prospective winners or losers in a sector that is still at such an early stage. The better approach is to provide a conducive environment, one that spurs more innovation and R&D, but that ultimately lets the market decide.
TER: What’s your outlook for the sector?
VR: Winners will emerge. Investors are looking for companies that can solve a particular problem countries face, especially emerging countries. Examples are companies that have solutions for water pollution, for helping countries improve the livelihood of their population.
TER: Which companies fit this description?
VR: Westport Innovations Inc. (WPT:TSX) is developing fuel technology to reduce emissions by reconfiguring diesel engines to use compressed natural gas (CNG) or liquefied natural gas. That is an example of a company with clean technology that is both retrofitting and allowing new commercial vehicles to use CNG-based engines. Natural gas is still a fossil fuel, but it’s a lot cleaner than, say, diesel. In the last year or so, Westport’s stock has gone up 40%–45%. It’s a good example of a commercial company with rapidly rising revenue that will continue to do well.
Clearford Industries Inc. (CLI:TSX.V) is another example. The company developed a patent for a small-bore sewer system. Centralized sewage systems push everything to a single location for treatment. These centralized systems place heavy demand on water, and they are inefficient and costly for emerging countries like India, China and Peru.
Clearford developed a solution that treats sewage in a localized environment, suitable for a small community or a collection of small communities. It has anchored its technology in India, where it won a major contract with a large real estate developer that will use the technology for a development of something like 6,000-plus houses or apartments. Once Clearford gets that commercial proof, it should do very well. Getting the first contract under the belt is the biggest challenge. On August 11, 2011, Clearford announced that it has signed a memorandum of intention with Engineers India Ltd., a major engineering consulting firm owned by the Indian government, to jointly pursue projects using Clearford technology in India. This clears the path for the company’s growth among municipalities and cities.
TER: Any others?
VR: I still like H2O Innovation Inc. (HEO:TSX.V), a major player in Canada’s water treatment industry. It designs and produces environmentally friendly water treatment systems, especially for wastewater and industrial processed water. It has been performing relatively well even in the downturn. This is one of the fastest-growing companies in Canada. Its revenue has grown through acquisition, and it has a client base of over 500 installations worldwide. This is a good example of a commercial company solving a real problem.
TER: Do you have any parting thoughts for us?
VR: I would conclude by saying that we don’t believe the global economy is dipping into a double-dip recession, which was a major concern in the summer and early fall. We believe the markets made their lows for the year in August, and we see better times ahead. Yes, there is a slowdown, and developed countries are struggling, but the growth story in emerging markets is intact.
TER: Excellent. Thank you.
Vikas Ranjan, a principal of Ubika Research, has over 15 years’ experience in investment management, finance, customer analytics and research. His experience includes management positions with TAL Global Asset Management and Bank of Montreal. He holds a Bachelor of Arts in economics, a Master of management studies from University of Mumbai, and a Master of Business Administration in finance from McGill University. Vikas co-founded P2P Systems Inc., which was acquired by Microforum Inc.
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By Claus Vistesen, on September 26th, 2011
If investors were hoping that the strength of commodities was sign that decoupling, led by Asia and Latam, were running on course to help the global economy expanding, events last week must surely have extinguished such hopes. Indeed, it was always a question of commodities and emerging markets catching up to the ongoing slaughter in Europe.
Indeed, what seems to be main question now is whether the US economy will avoid a recession and, as a consequence, just how bad it has to get before the Fed starts another round of shock and awe QE. In this sense, I also always thought that expectations of emerging market foreign exchange reserves bailing out Europe and/or central banks easing aggressively to support the global economy were pinned on expectations that after all were too high.
(Quote Bloomberg)
The world’s largest emerging economies will not act as a bloc to ease Europe’s financial crisis, Russian Deputy Finance Minister Sergei Storchak said.“It’s impossible, I’m certain of that,” Storchak told reporters today in Washington. “If the BRICS are going to act to overcome the euro zone’s financial problems, then it will be based on the possibilities presented by working through the International Monetary Fund.”Finance ministry and central bank officials from Brazil, Russia, India, China and South Africa met before this week’s IMF annual meeting to discuss coordinating policy as Europe reels from a sovereign debt crisis and growth slows in the U.S. There is a “high” danger that Greece will not fulfill all of its debt obligations, Storchak said.
As for the EM tightening cycle I think that while we may certainly see an easing of pace or perhaps even a full stop of tightening measures I think a reversal is out of the question. This is especially the case as the recent strong correction in commodities and the global slowdown is likely to make inflation a non issue going forward. However, inflation lags the cycle and if the central banks are fixed on this measure it will take some time before the data allows decisive action unless of course the future is suddenly discounted in a radically different way due to rising downside risks.
In India, the tightening cycle is surely near its end with the yield curve already flat as a pancake, but with sticky inflation and fiscal policy continuously loose, there is limited scope to the central banks’ ability to maneuver.
(Quote Bloomberg)
India’s central bank is close to the end of its record series of interest-rate increases as inflation will probably slow next year, Deputy Governor Subir Gokarn said.“You could say that the cycle is nearing its end,” he said, “given the projection that inflation will start coming down and will continue to move down from December onwards.” He declined to specify when the Reserve Bank of India may stop raising rates.
Worryingly, recent news out of China appears that the country may be turning Indian or at least that the expected easing may not come as expected. Especially, it is bad news for the global economy in the near term (but perhaps good in the long run?) that Chinese authorities seem to be engineering a crack down on property developers which will not only lead to an acceptance of lower growth in order to effectively quell off balance sheet lending.
It seems that investors hoping for emerging markets to drive forward the global economy may, for the moment, be guilty of too high expectations.
By Claus Vistesen, on September 7th, 2011
 One of the stories that caught my attention this week was the Bloomberg piece about how banks in London and New York are starting to jump ship on the old finance hubs due to fear of effects from planned regulatory tightening.
Quote Bloomberg
Banks in Europe are exploring ways to cut costs by routing more of their trades and other business through overseas subsidiaries, a plan that may shift tax revenue away from London and loosen European regulators’ influence over the lenders.Nomura Holdings Inc., HSBC Holdings Plc (HSBA) and UBS AG (UBSN) are among lenders preparing plans to book as much business as possible through legal entities in jurisdictions where tax rates are lower and rules on capital and liquidity are less onerous, the banks and lawyers and accountants working with them say.
(…)
Banks could record as much as 30 percent of the value of their trades through Hong Kong, Singapore and other jurisdictions instead of hubs such as London and New York without running into trouble with regulators, Matten said. Such a move would hurt traditional hubs such as London because assets are treated for tax and regulatory purposes in the country where they are booked. It would also allow banks to sidestep the U.K. bank levy, introduced last year to raise 2.5 billion pounds ($4.1 billion) from lenders operating in Britain, as well as any financial transaction tax imposed by the European Union.
Perhaps this is a sign of the times in the sense that both banks and market participants seem to be looking increasingly outside the boundaries of the developed world for growth, profit and eventually prosperity. Having just moved to the Big Smoke I would not necessarily lament a downsizing of the finance sector even if it is the pond that I also do my fishing for the daily meal ticket. Perhaps, if fast moving financiers chose to go to Singapore instead of London, the residents of the latter would not have to endure paying 300.000 GBP for a studio flat in Canary Wharf [1].
Of course, it may all be a red herring but it could also be part of a number of tentative signs that the locus of global activity on a variety of fronts is moving to new epicentres. Let us hope they do not travel entirely in our foot steps.
More generally, we just put out our monthly report and the outlook is very much wishy-washy. Surely, our leading indicators are pointing down, but after the market puke in August it seems to me that the end of the world had almost been priced in as the S&P500 hit the 1100 marker. In this sense, do not be surprised to see it ticking towards 1250 even if the recent job data were abysmal, but beware. The old range has been broken and we are finding a new lower one. Market prices have a tendency to become “normal” after a period and with global economic activity visibly slowing the fundamentals are not really on the bulls’ side even if they point to the merits of chasing a counter trend rally after a 10% drawdown.
More generally as I noted before, the divergence between respectable analysts is widening which always makes me take a few steps back. On the one hand I see both buy side and sell side analysts rather stubbornly sticking to their year-end S&P500 targets of 1300-1400 while other independent analysts put the fair value of the index at 900-1000. Both will obviously have an axe (or maybe even a book) to grind, but part of my job is to synthesize the consensus into a fairly straight road map for our clients, and it is getting difficult.
I tend to side with the pessimists if only because I find it difficult to see how US corporates can continue to operate as efficiently as they have been doing so far. Gerald Minack had some excellent points on this in his latest report;
A big medium-term uncertainty for DM equity investors is the sustainability of earnings. A decade ago, the big uncertainty was whether valuations could be sustained. They weren’t . The de-rating may have further to go, but clearly valuation is less of a headwind now than at the TMT-inspired peak. Earnings, on the other hand, are very high. Profits are now near an all-time high as a share of global GDP, and the real return on equity has followed . What’s not able, however, is not the cycle rebound, but the elevated level of earnings (and real returns) over the past decade. The forward-looking issue is whether those elevated returns can be sustained. At a global level, the answer may be ‘yes’ – for the simple reason it’s now possible to make profits in places where previously it was not. What’s not clear is the sustainability of high earnings in the developed world.
In particular, I would would point to the contradiction between continuing ultra low unit labour costs and the need to now see growth moving from cost cutting to topline growth. Something does not add up.
Real unit labour costs are now at 60-year lows. This matches the decline in wage share of GDP to a 50-year low. Arithmetically, this is the most important support for high profits. As I’ve discussed in prior reports, it’s not clear how long households can support consumer spending at near 70% of GDP with labour income at multi-decade lows. That’s been possible recently due to massive transfers from the public sector, but that support appears unsustainable.
In my opinion, this is big elephant in the room in relation to the US stock market. It will be difficult for earnings (and margins) to stay at current levels going forward. It follows naturally from the fact that if all companies cut costs and this improves margins this will only work for a limited period time as there are decreasing returns if everyone follows this strategy at the same time. Now we need to see topline sales growth for margins to be sustained, but this is obviously difficult with the current macroeconomic backdrop, so something has to give.
Globally, coincident data is already slowing visibly across the globe with headline PMI readings and trade data coming in steadily lower. In that sense we are up against the wall again only so shortly after the shock of 2008/09 and this time, the ability of policy makers to respond is limited.
However, I would be weary about calling this another 2008. One of the effects of experiencing a balance sheet recession with subsequent deleveraging is that trend growth falls and thus that the economy becomes liable to more frequent recessions. This applies to the US in particular but essentially also to the whole of OECD. This means that we will see more frequent but also essentially shallower recessions. The only qualifier here is really that some parts of Europe are now stuck in a depression locked in a vice of dysfunctional institutions and a lack of willingness and political capability to deal with the problems.
As such, within Europe also lies the potential source a Lehman like shock should the crisis prompt a rapid and violent default of one or more sovereigns and/or financial institutions. Certainly, euro area banks are feeling the pinch as USD funding is getting cut off and if anything it seems to me that the EURUSD is looking a bit too strong for its own good given the backdrop of the mess in the euro zone. As cash levels at euro zone banks are drawn down the currency will adjust to fundamentals not to mention of course the fact that the ECB is slowly but steadily being pushed into full blown QE and monetisation of peripheral debt.
The latest G&F provides a good summary;
(…) The risk of a dollar rally against the euro in coming months is growing. This is because, sooner or later, the ECB will have to reverse its recent insane monetary tightening. Trichet made a start in this direction this week in his usual ponderous manner. Thus, he told the Committee on Economic and Monetary Affairs of the European Parliament in Brussels on Monday that “risks to the medium-term outlook for price developments are under study in the context of the ECB staff projections that will be released early September.” The issue here is whether markets will allow Trichet to save face and not performs an abrupt U-turn before his scheduled departure from the scene on 31 October.
More generally, the recent comments from the IMF that euro zone banks need additional capital is once more a case of stating the almost obviously obvious. The transmission mechanism here is very simple. The market is now effectively pricing in a default of Greece and possibly other peripheral economies and this means that the attention must now turn to the losses that creditors will bear or, alternatively, the size of the bailout if we stick to the old mantra of no losses. As a good friend of mine pointed out recently,
All trough last month’s banking shares’ collapse, I have been thinking that perhaps, equity investors are worried that the recapitalization will be different this time, with either the taxpayer (wrong solution) or the bondholder (rightly, through a bond-for-equity swap), massively diluting the shareholder. Politicians obviously do not have the stomach, nor the muscle for new bailouts.
Or to put it differently, there are no easy solutions left. One solution is the Brady Bond plan which is currently being floated in the case of Greece. The problem as I see is that it is fudged precisely when it comes to the current valuation of the bonds. Basically, there has to be pain today for the creditors, otherwise we are just kicking the proverbial can down the road as recapitalisation is avoided today but made worse for tomorrow. A solution for recapitalising banks today would naturally be for their creditors to accept a swap for equity and thus being moved into the frontline to absorb any losses that the banks would bear on sovereign debt, but that is not popular. Essentially, being degraded to equity holder in a bank with known sovereign assets in the European periphery is equal to taking a haircut on your initial investment, but all this then leaves the inevitable question of who and when someone will step up to take the lead in the debt restructuring.
Of course, the idea of substituting debt for equity is the same principle applied in the case of Greece posting domestic assets (islands, utility companies etc) as collateral for credit. We can then think about this collateral as Greek sovereign equity and as with creditors of banks, it is all good in theory but in practice, not so well.
Elsewhere, the game of Old Maid in global currency markets continue with the SNB still in the spotlight despite already having taken desperate measures to stop the appreciation of the CHF;
Quote Bloomberg
While the Swiss National Bank has so far avoided currency purchases in its latest bid to keep a lid on the franc, it may soon have no alternative but to follow through on its threat to intervene, economists and strategists said.
But what really caught my attention was comments by Brazilian Finance Minister Guido Mantega that lowering interest rates represents an effective antidote against an appreciating currency.
Quote Bloomberg
For “the next two or three years, the conditions will be there for rates to keep falling,” Mantega told reporters in Sao Paulo today. “Falling rates are a good antidote for the gains in the real.”
Allow me to quote myself from the post linked above;
Old Maid is a card game where the simple task is to avoid holding a given card (often the queen of spades) at the end of the game. Even in the company of good friends however, holding Old Maid at the end is not fun. Often, you have to buy the drinks, drop a piece of clothes, or endure other travails. And as it turns out, the global FX market is not unlike this good old game of cards where the Old Maid is proxied by having a strong currency on whose shoulders the correction of global macroeconomic imbalances must invariably fall. In this way, and although one sometimes get the feeling that everyone believes that everybody may actually export their way out of their current misery, buying one country’s currency means selling another and thus, someone (be it an individual economy or a group/basket of economies) must end up holding Old Maid.
The easy investment advice here is naturally to buy the Old Maid which means that just as the global financial punditry searching for clues as to what lies ahead for the global economy and the looming slowdown the SNB et al may have to skint yet awhile for light at the end of the tunnel.
—
[1] – No my dear reader, I am renting and I would never touch these things but they are there and they are being sold.
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By The Gold Report, on July 21st, 2011
 Growth is where you find it. Taylor Asset Management founder and CEO Stephen Taylor is an active global investor who loves Latin America, China and certain event-driven natural resource plays that he expects will provide big growth to investors who have made a bet on his Taylor International Fund. In this exclusive interview with The Gold Report, Stephen shares his best ideas—ideas that have multi-bagger potential.
The Gold Report: You had an interesting career that included being a floor trader on the CBOE when you were at Lakota Trading. You mastered skills there that could never have been developed in any other way aside from being on the floor of the Exchange. How does that inform what you do today, considering that so many of your current equity holdings are micro-cap, small cap or China-related and may not have derivatives attached to them?
Stephen Taylor: I started on the floor back in the days of floor trading, when it was open outcry and traders stood next to each other yelling and screaming. This was before the screen-based computerized trading of today, and it allowed you to see the emotional elements of markets up close and personal.
TGR: That’s actually what I was getting at.
ST: When you were going down to the trading floor, you could hear the roar of the crowd before you got there. Depending on that tone and the volume you could tell if the market was up, if it was down, how fast it was moving. In the trading pit itself you saw those periods when fear or greed would take over. There’s nothing like seeing it up close and personal and watching individuals or firms panic and make trades that maybe with the passage of time would not appear to be completely rational. So, in that sense it was an invaluable experience.
TGR: Your Taylor International Fund is heavily weighted in natural resources and emerging markets. Given that this space has seen a pullback and is generally soft at this point, how is your fund pacing so far in 2011?
ST: Well, we’ve taken our lumps. We’re not too far behind some of the resource-related averages, such as the TSX Venture. We’re down a little bit over 10% this year. But, you know, volatility is something that comes with this space. It’s something we’re comfortable with as long as we believe in the companies and the management teams that we’re investing in. We maintain a long-term perspective. We seek out and encourage our investors to maintain a long-term perspective. So, we’re not really rattled or shaken by these sorts of pullbacks. It just goes with the territory.
TGR: Do you think of the volatility as your friend?
ST: In many cases, absolutely. Not everybody likes volatility. Not all funds are able to deal with it. But it does present some opportunities. I think we’ve seen some overdone selloffs in the resource space. We’ve seen some extreme selloffs in the China space. And that’s presenting some good opportunities, in our opinion.
TGR: Your China positions represented about half of your portfolio when you last spoke to The Gold Report six months ago. Some of these were private equity. The due diligence would be daunting to most people. How do you research and verify these assets, liabilities and valuations in what I might refer to as esoteric investments?
ST: As you know, diligence is an ever-present issue, not just in this China space, but in the resource space as well. We are big believers in looking at management teams that have delivered in the past. We look at the partnerships that management teams and companies have, and the banking teams that they choose to deal with. We look at the strategic investors that they bring along, as well as the firms doing their auditing and legal counsel. We do site visits, and repeatedly meet with management teams. We try always to look at what companies do, and not what they say.
TGR: Is there any China counterpart to Sarbanes Oxley Section 404, requiring executives to be responsible for their financials?
ST: Well, I would point out that SarbOx has certainly not been a panacea in and of itself here in the U.S. A number of the high-profile blowups here in the U.S. were Sarbanes-Oxley-compliant, or at least testified that they were. Ultimately, whatever regulatory structure you have is only as good as people backing it up. With respect to China, clearly it’s a developing market. Their financial markets are not as mature as those in North America or Europe, and it’s an ongoing process. I think you’ll continue to see some progress being made in that area over the next year or two, especially with respect to allowing for broader SEC investigation and actions in China and harmonization of accounting standards.
TGR: When you founded the Taylor Fund in November 2008, you had $10 million under management, I believe. How much do you currently have under management?
ST: We’re a little under $50 million at this point.
TGR: So, you have almost five times the assets you started with two and one-half years ago. Has that growth occurred mostly without new investment?
ST: It’s been a combination of organic growth, some new investment and some follow-on investment from existing investors.
TGR: Have you reopened the fund to new investors?
ST: We haven’t formally reopened the fund. I suspect that we may do that sometime in the fourth quarter. That’ll be our three-year anniversary and an appropriate time to take a look at it.
TGR: That’s when the lockup will end for your initial investors?
ST: That’s correct, at least for a portion of them.
TGR: In a fund of this type, you really have to be as comfortable with the investor as the investor has to be with the portfolio manager.
ST: Oh, absolutely. In an ideal world, all funds would be that way. As a manager, it’s vital to know the risk tolerance and financial profile of your investors. I couldn’t operate nearly as well if I were concerned that some of my investors were taking inappropriate risks for themselves. It really has to be a good match.
TGR: You have to walk a narrow path, where you hold enough different positions that you’re not dangerously under-diversified, but where at the same time you can potentially achieve outstanding capital appreciation. Currently, how many different securities does your fund own? How are you weighted by country and sector?
ST: We have approximately 45 positions right now. In terms of weighting, we’re probably 20% in the energy space, 20% to 25% in the mining space, and we have probably about one-third in China-related investments. We currently have a 2% or 3% weighting in the financial space, but I suspect that will change to about 10% in the next few months. And we have roughly 5% or 6% in cash.
TGR: In part, you buy very small companies, some of which are in the micro-cap range. In many cases, they probably require some tinkering or restructuring. Do you think of yourself as an active investor or an activist investor? How do you see yourself?
ST: We like to look at ourselves as being positive, additive, collaborative shareholders. We like to think of ourselves as always having a good relationship with management teams. Depending on that relationship, CEOs will reach out and may ask for our input from time to time. We like to work on a collaborative basis in a win/win situation. Having said that, there are times when we have had to become active.
One case that I mentioned in the December interview was the Chapter 11 case of Meruelo Maddux Properties, Inc. (OTCPK:MMPIQ). It unfortunately required a lot of time and effort on our part, and it’s something that we’re happy we did. As part of the confirmed reorganization plan, which we believe will be effective this week, I will be taking a board slot there. So, I’m going to restrict my comments on that for now.
TGR: You invest in event-driven situations, and I assume distressed situations as well. Can you describe events and other situations where you might enter a position?
ST: By event-driven, we mean company-specific events that we believe will drive increased shareholder value. That could be a new project. It could be drill results. It could be a financial restructuring. In the case of Meruelo Maddux, it was bankruptcy reorganization. Another company that we were involved in early, of which I continue to be a big fan, is Red Eagle Mining Corp. (TSX.V:RD). I love Red Eagle Mining. We participated in this company as a private venture and knew it would ultimately move toward an IPO, and that it would bring in some very attractive additional properties in Colombia.
TGR: What’s your favorite region?
ST: Central and South America, because of its mining companies. We are big fans of Lumina Copper Corp. (TSX:LCC), which has its Taca Taca project in Argentina. The drill results just seem to get better and better. Its recent spinoff of the royalty company was very shrewd in our opinion.
Anfield Nickel Corporation (TSX.V:ANF) in Guatemala has the same management team as Lumina and is very good. Also, Silvermex Resources Ltd. (TSX:SLX) in Mexico is ramping up production now and is very good. We continue to like silver here. We think these are terrific names.
In New Zealand, we like energy companies, including Tag Oil Ltd. (TSX.V:TAO) and New Zealand Energy Corp., which should be having an IPO in the near term. We’ve been an investor in three rounds of private funding in the company, and think it’s really worth a look at the IPO.
We like Miranda Gold Corp. (TSX.V:MAD) in the U.S. We like Largo Resources Ltd. (TSX.V:LGO) in Brazil and in Canada. Largo has made some great progress since we last spoke. It’s completed the financing on its Maracas vanadium project, and the drill program is now underway in the Northern Dancer tungsten-molybdenum project up in the Yukon. This company continues to make great progress.
TGR: What’s the near-term catalyst with Largo?
ST: I think you could see some drill results out of the Northern Dancer project. The company began the drill program for a pre-feasibility study up there. They will begin construction on the Maracas project. I think vanadium is a metal that we’re going to hear a lot more about in the years ahead, and Largo arguably has the best undeveloped vanadium deposit in the world down in Brazil—one of the best markets. So, I think you’ll keep seeing good things about them.
TGR: Silvermex acquired the La Guitarra silver mine and put it back into production. Is that the principle growth driver here?
ST: Yes. You saw the first quarter production coming out, and it’s ramping nicely. The company has a shrewd, experienced team. It’s a bunch of ex-Hecla Mining (NYSE:HL) guys.
TGR: Going back to Miranda Gold for a moment. It’s a micro cap; about a $22 million market cap. Is there an exit strategy for the company?
ST: I’ve known Miranda Gold President and CEO Ken Cunningham for a lot of years. It just seems like people are finding more and more gold closer to his neck of the woods in Nevada, where Miranda has a great land package. And I like to say that Ken has a good nose for gold—I think over the next few months the company’s going to find some. It’s a dynamic company, and it has some great JV partners. It’s shown the ability to get into new jurisdictions such as Colombia and Alaska. I have a lot of respect for Ken and his team. I think they know how to find gold.
TGR: Miranda shares have been strong over the past month—up about 15%. I presume this is about the initial drill results from the Red Hill Project.
ST: That could be a lot of it. That stock is down 30% or so since the first of the year. I just think it’s a bargain. It’s been way oversold. I think there’s good potential news coming out of Nevada; don’t forget the joint venture with Red Eagle on a number of Red Eagle’s Colombian projects.
TGR: You also like energy.
ST: Yes, I like Saratoga Resources Inc. (OTCQB:SROE). It’s a Louisiana-based oil and gas company active along the Gulf Coast. It was in Chapter 11 a couple of years ago and management just refinanced some long-term debt. It’s completed two equity rounds this year and we participated in both. It’s our understanding that The Blackstone Group LP (NYSE:BX) is a big participant in the most recent round. Management owns a substantial stake in the company and is highly incentivized.
As the company has emerged from Chapter 11, it’s been able to spend on the necessary capex to bring back online a lot of the existing production that suffered during the Chapter 11 process. We see the company’s production and revenue growing very sharply over the next few quarters. Now that refinancing is out of the way, I think that stock has a lot further to go.
TGR: Do you see this a distressed situation or as a turnaround story?
ST: It’s a little of both. It had been a distressed situation, and like a lot of companies that have found themselves in the last few years with good operations and good managements but weak balance sheets, it got caught in a bind. Often it’s just a case of needing to find the right type of investor to step up and lead that first equity round or to bring in a few partners and demonstrate some confidence in these companies and their management teams, and be willing to be the first person in the water. We felt we played a little bit of that role with Saratoga. We’re playing that role with Pan Pacific Bank. It’s the type of role we don’t shy away from, and we think we could really earn some outsized returns for investors willing to take that risk.
TGR: You mentioned Anfield Nickel a bit ago. The stock is flat over the past six months, but it’s up about 49% over the past year. Do you feel there’s a lot more to go there?
ST: I think there could be. The recent preliminary economic assessment on its Guatemalan nickel zone was very decent. But it also is only based on a portion of that deposit. We think the company may be positioning for either a full or partial sale. The presence of Lumina guys [Lumina CEO] David Strang and [Chairman and Founder of Pan American Silver Corp. (TSX:PAA)] Ross Beaty as significant shareholders in Anfield is a very positive sign.
TGR: What about a China play?
ST: In China, I think LianDi Clean Technology Inc. (OTC:LNDT) continues to show terrific results. I mentioned it in December. The stock has been overly beaten down here, and I think it’s a real bargain at these levels.
On the China space in general, a lot of the good U.S.-listed Chinese companies will not tolerate these extremely depressed valuations for long. I believe you’ll see them move to delist from the U.S. and relist in places like Singapore or Hong Kong in order to receive fair and higher valuations. I think that’s a move that a lot of investors may not fully appreciate. Certainly the shorts may not be fully thinking about that yet.
LianDi is trading for two times next year’s earnings here, but in a place like Singapore or Hong Kong, it could probably be valued at 8 or 10 times earnings very easily. If you’re a short, you might have a problem there.
TGR: This has all been very exciting, Steve. Thank you.
ST: Thank you very much.
Stephen Taylor is chairman and CEO of Taylor Asset Management, a Chicago-based investment management firm focusing on small-cap domestic equities and emerging markets. He also serves as a portfolio manager for the Taylor International Fund, Ltd., a small-cap equity fund. In addition to emerging markets, Stephen’s area of expertise includes private equity, restructuring and turnaround situations and both small- and mid-cap companies. He has considerable experience in the natural resources and finance industries in Canada and China.
By The Gold Report, on July 18th, 2011
 Gold is once again hitting new highs, closing at $1,589/oz. on July 14. In this exclusive interview with The Gold Report, Dr. Michael Berry, principal of discoveryinvesting.com and editor of Morning Notes, predicts $1,700 gold by year-end and points to the juniors that could bask in the enhanced glow of all the metals, including copper and zinc.
The Gold Report: Dr. Berry, you are going to go before the Federal Reserve and meet with Congressional representatives on July 18. Could you give our readers a Coles Notes version of what you plan to say?
Michael Berry: I go before the Federal Reserve twice a year. In this presentation on Monday, I’ll talk about the geopolitics of growth in emerging countries and issues related to the dollar, gold, convergence of the rest of the world and the weak global recovery.
Monday afternoon, I’ll head over to the House and meet with the Chairman of the House Natural Resources Committee and Senator Lisa Murkowski’s (R-Alaska) natural resource staff to discuss extractive resource policy, natural resource exploration in the U.S., critical metals and what’s really happening in the rest of the world regarding resource nationalism.
I also believe I’ll be meeting with Senator Murkowski’s natural resource policy representative, McKie Campbell. I’m trying to educate the Congressmen and Senators and their staffs on how important natural resources are to the U.S. and what’s going on in the world with respect to critical metals, metals supply and demand and what policies we need to enact in this country.
TGR: Do you feel you’ve made progress toward legislation that’s a bit more pro-mineral development or metal development?
MB: Yes, I think we’ve made some progress. It’s a long education process and it’s difficult to do because you have to be consistently in front of them. Congress has three bills pending now—two in the House and one in the Senate—that relate to natural resource development in the U.S. for critical metals. Not just rare earth elements, but a number of others as well. They also relate to exploration and development policy. I think we’re making some inroads with Congress and others in Washington. It’s very important that we keep that pressure up.
TGR: On Thursday, the price of gold for delivery in August flirted with $1,600/oz., going as high as $1,594.90/oz. before closing at $1,589.30. What is causing this continued upward climb and what does it mean for juniors going forward?
MB: There is just a tremendous amount of uncertainty regarding the debt ceiling and the U.S. credit rating. That is pushing gold and silver prices higher, which is positive for gold miners and exploration stocks. Look for $1,700/oz. gold by the end of the year.
TGR: What happens if there is no third round of quantitative easing and our elected officials come to an agreement on the debt ceiling? Does the gold price climb lose its momentum?
MB: Nothing is standing in the way of gold and silver going higher. There will be some accommodation on the debt ceiling and something will be done to try to keep the economy moving just because no one wants to see higher interest rates. In the meantime, investors have come to the realization that precious metals play an important role in the portfolios of individuals, institutions and countries, which are now buying large quantities of gold. It will continue to hit new highs as the 250-day moving average is increasing beautifully.
TGR: In the second quarter, we witnessed a significant sell-off in speculative positions in both gold and silver. Do you believe a portion of that speculative money could find its way into copper?
MB: There’s tremendous pent-up demand for copper around the world because of emerging economies. It is also much more difficult to make world-class discoveries today. I think copper prices will be very strong. Metals like zinc are also really starting to look very attractive to the exploration industry. There’s a lot of potential for discovery investment flows into some of the base metals, including copper and zinc, and some of the special metals such as manganese, vanadium and graphite.
TGR: Any discussion about copper has to include China. Beijing recently raised interest rates to fight inflation, but the economic indicators in China continue to improve and that ultimately means greater demand for copper there. Will supply disruptions converging with greater demand push the copper price above $5/lb. this summer?
MB: That is certainly possible. I can remember when copper was $0.65/lb., so obviously there is real upward momentum. Copper is a “quality of life” metal. Infrastructure can’t be built-out without copper. I think that prices are going to be quite strong as we approach the fall season.
It is interesting to note that the Chinese started buying again as the price of copper fell in the last couple of months. Their demand is crucial. They are also bidding for copper companies around the world. I think we’re in the third inning of a very long commodity supercycle in the world. Copper rightly will take its place in that cycle. Copper miners in Indonesia and Chile are experiencing labor problems as well.
TGR: Recently, China’s Jinchuan Group trumped a $1B bid for the African-focused copper company Metorex Limited (JSE:MTX; LSE:MTX). Do you expect Chinese firms to take more runs at companies as a means to lower the cost of copper?
MB: I do, but I think the primary motivation of the Chinese is going to be infrastructure build out. It’s a huge country with a growing middle class. Somewhere around $4 copper is probably very cheap to the Chinese.
But it will be more than just the Chinese that come into this game. Companies like Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) are going to get involved because there just hasn’t been a lot of new high-grade discoveries that have been turned into reserves. It’s a very interesting game that’s being played. Africa is in play in terms of natural resources. No doubt.
TGR: Given the jurisdiction risk in Africa, could there be a bit of a premium on western copper plays?
MB: The Murkowski Bill, which passed in a unanimous, bi-partisan vote but hasn’t been signed by the president yet, should help ease exploration in U.S. Some of the discovery progress in Arizona and Nevada now is going to become increasingly sought after by companies like Freeport, Rio Tinto PLC (NYSE:RIO; Paris: RTZ.PA), even Barrick Gold Corp. (TSX:ABX; NYSE:ABX), and of course some of the smaller copper companies. I think there’s going to be a premium on what’s happening in the U.S., Canada and, to a lesser extent, Mexico.
TGR: Which companies do you think could benefit?
MB: One that I’ve followed for years and in which I own a big position is Quaterra Resources Inc. (TSX.V:QTA, NYSE.A:QMM). It just exercised its option to acquire the Yerington Mine, which was mined from about 1952 to 1978 by Anaconda. It’s the most significant land position in the Yerington District. Adjacent to it is Nevada Copper Corp. (TSX:NCU), which has a huge skarn find. Rio Tinto has a 13% position in Entree Gold Inc. (TSX:ETG), which acquired the Anne Mason Property in Nevada, also adjacent to the Yerington Mine.
Yerington is the newest and safest copper district in the U.S. It could realize 50 Blb. to 60 Blb. of copper. Anaconda mined 1.7 Blb. during its 25-year life. Quaterra went through the rigorous process of taking this mine and property out of bankruptcy. It now controls water rights and about 8 Blb. of copper. No one understands this story, so the QMM stock is very cheap. I estimate that Yerington, the Bear Deposit and its nearby open pit MacArthur mine are worth $3 to $4 per share of Quaterra.
Another company that I follow closely is Redhawk Resources (TSX.V:RDK; Fkft:QF7; OTCQX:RHWKF). Redhawk sits in the Copper Creek area of southern Arizona, actually Pinal County, where several big copper porphyries are located. It is drilling a huge defined copper and moly resource there. The stock is trading around $0.50, so companies like Freeport, BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) and Asarco Grupo Mexico, whose Hayden smelter is just a few miles away by road, are likely to take a big interest in Redhawk.
TGR: That property has been thoroughly explored before. Is it getting a second look because of where copper prices are right now?
MB: There has been a lack of new high-grade discoveries lately, so companies are coming back and readdressing some of the properties where maybe $0.65/lb. copper didn’t work, but $4/lb. copper works beautifully. These are places that already have a lot of infrastructure and safety isn’t a risk as in Africa or Indonesia.
TGR: Redhawk said in its scoping study that it’s going to need about $400M to build the mine and mill there. Is it going to have to do a joint venture or an off-take agreement?
MB: I would imagine that Redhawk will not raise that kind of money, but it may not have to build one. Several mills operate in the area, including Asarco’s Hayden mill, which would be a natural fit. There’s good transportation infrastructure and Pinal County is all about mining culture. My guess is that the company will strike a deal to use someone’s existing facilities or perhaps be acquired.
TGR: Quaterra and Redhawk are fairly mature. Do you have any earlier-stage prospects?
MB: Southern Silver Exploration Corp. (TSX.V.SSV; Fkft:SEG), southeast of Tucson, Ariz., is in the early stages of exploring for copper porphyries, specifically a Resolution-type target, jointly with Freeport-McMoRan. I think it has a good chance for a discovery at this stage on its Dragoon project. Freeport thinks enough of it to be drilling it at this stage.
It’s trading at about $0.17 a share, so it’s certainly what some of us would call a “penny dreadful.” But I like the management and I like their properties and they have several in addition to the Arizona copper target.
TGR: You recently went to Guyana with a group of Chinese investors. Guyana is starting to see some major gold projects come into development, such as Guyana Goldfields Inc.’s (TSX:GUY) Aurora Project and Sandspring Resources Ltd.’s (TSX.V:SSP) Toroparu Project. However, I see a few challenges facing companies looking to develop mines in Guyana. One is a severe lack of infrastructure and a pristine rain forest environment. Another is a shared border with Venezuela where several gold projects have been nationalized by the Hugo Chavez regime. Also, the Guyanese government is relatively unfamiliar with mining.
MB: You’re probably right about some of those concerns. There is a lack of infrastructure. For example, when we flew into the jungle to see GMV Minerals Inc. (TSX.V:GMV), we helicoptered in for about 70 miles. GMV has a huge land position. I think it has perhaps one of the better chances to make a significant discovery. I like the management team under Ian Klassen very much. They just have a good idea of what’s going on down there.
I don’t believe that Venezuela is a factor at all. I don’t foresee any problem with the Venezuelan government interfering in the internal affairs of Guyana.
There are some health risks. Malaria and yellow fever are a problem there. But I still think the glass is half full for Guyana. Especially, if foreign companies—primarily Canadian companies—bring their expertise, talent and jobs for the locals.
TGR: Is the government mining-friendly?
MB: We met with the Prime Minister and it’s fair to say that in every developing country there are going to be nationalist undertones. But the government is welcoming in exploration and development. Some of the big companies, like Teck Resources Ltd. (NYSE:TCK; TSX:TCK.A, TCK.B) and Barrick, are now looking carefully at Guyana primarily because Venezuela is so inhospitable. The government seems to know what it’s doing with mining law. I don’t foresee that the taxes will be more significant there than anywhere else in the world.
TGR: One of GMV’s properties is right beside Guyana Goldfield’s Aurora Project. Is that property likely to become GMV’s flagship operation?
MB: GMV has done the geophysics and flown almost the entire country and analyzed the data carefully. No other company has this database. The company has a better idea of where the gold veins are located than anyone else there. The property it’s working on now has tremendous potential. We were there when it drilled its first hole. It’s going to be a while before we really know much about GMV, but I really like its potential because it has a lot of targets to drill. I believe the company will farm out some of the properties and drill the best ones.
TGR: Can you tell us about Ian Klassen, GMV’s head, and his team?
MB: He’s an experienced hand in Guyana. He’s really done a thorough job of working with prominent local mining families, soil sampling, ground geophysics and airborne geophysics. He’s kept costs to $50/m on the drilling, which are relatively cheap. He’s just announced a deal with Canamex Resources Corp. (TSX.V:CSQ; FSE:CX6) for several million shares, where Canamex will take a GMV property that is about 10% of its land position. He’s very good at monetizing some of the company’s holdings that couldn’t be utilized in the near term due to the large size of its land holdings. Ian’s had a lot of experience in Ottawa with the Canadian government and is moving forward with Grande Portage Resources, Ltd. (TSX.V:GPG) on the Herbert Glacier where they have reported visible gold intersections. He’s ready to create value for GMV shareholders.
TGR: You visited Sandspring’s Toroparu gold-copper deposit in Guyana on your previous trip. That junior recently released the results of its infill drill program. Did you see those results?
MB: I did. The company is getting one and two gram gold and has a copper credit. It just needs to step out and keep drilling and it will find a lot more gold. There’s a lot of opportunity for the companies already in Guyana with camps set up. Sandspring has about 10 Moz. in various resource classifications from measured and indicated to inferred. I expect that it will get higher grades as it keeps drilling. I’ve owned that stock for about two years.
TGR: Sandspring shares reached $3 late last year, but fell back below $2.50. What’s going to be the next catalyst to push Sandspring stock above $3?
MB: The next catalyst could be the discovery of a higher grade system. Most of the share prices of these gold juniors, even the ones with NI 43-101 resources, came off significantly in the past few months. It wouldn’t surprise me to see Sandspring go back above $3. If the company keeps drilling and keeps adding resources, it’s going to get a significant premium on a takeout from a major player at some point in time.
TGR: Are there any other Guyana-focused juniors that you’re following?
MB: Sacre Coeur Minerals (TSX.V:SCM) was part of a controversial takeout by OAO Severstal (LSE:SVST; RT:CHMF) that ultimately fell through. The stock is very cheap. Coming down from a high of $1.57, it was recently trading at around $0.40. The company’s property is very close to GMV and Sandspring’s properties in eastern Guyana.
TGR: Recently, the Peruvian government rescinded Bear Creek Mining Corp.’s (TSX.V:BCM) permit for the Santa Ana Silver Project in Peru. Since then, the company’s share price has plummeted to about one-third of its previous value. Did that move send some shockwaves through the mining investment community in South America?
MB: Peru and Guyana are on the same continent, but they’re almost totally different in every respect. The Peruvian decision has sent shockwaves through the mining community there. There’s a lot of gravitation to places like Colombia and Guyana and away from places like Venezuela and Peru. However, Peru, Ecuador and Chile have some of the great deposits and a lot of investors are willing to take that risk.
When something like this happens, there are shockwaves and shockwaves scare investors. The Peruvian government is smart enough to know that they need to attract money into the country. I’m sure that Bear Creek will handle it well and its stock price will come back over time.
TGR: Is there a risk of anything like that happening in Guyana?
MB: There is an election forthcoming in Guyana and things could change. I don’t think that they will change for the worse in Guyana. The country recognizes the need to have their country developed, to have capital coming in, to increase investment and infrastructure. I expect the election will be favorable for mining and offshore oil work.
TGR: Any parting thoughts for us, Dr. Berry?
MB: Canadian Nobel Prize winner Michael Spence has written a book on the coming convergence of the emerging world. I think we have between 20 and 30 years. He thinks we have 50 years of this convergence of emerging country quality of life. If that is true, we have the next three to five decades of converging lifestyles. That means that the commodity and natural resource sectors, in particular the mining sector, will be a wonderful place to be invested. And we’re going to be there with the discovery investing opportunity. We’re going to focus and push very hard toward that down the road.
TGR: Thanks, Dr. Berry.
Dr. Michael Berry has lived in the U.S. for 36 years, but was raised in Canada. A math major at the University of Waterloo in Ontario, he earned an MBA at the University of Connecticut and obtained a Ph.D. specializing in quantitative analysis and investment finance from Arizona State University. He has specialized in the study of behavioral strategies for investing and has been published in a number of academic and practitioner journals. His definitive work on earnings surprise, with David Dreman, was published in the Financial Analysts Journal. While he was a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia, Michael spent considerable time with some world-renowned geologists on the Carlin Trend. While a professor, he published a case book, Managing Investments: A Case Approach.
Dr. Berry also held the Wheat First Endowed Chair at James Madison University in Virginia, and managed small- and mid-cap value portfolios for Milwaukee-based Heartland Advisors and Chicago-based Kemper Scudder. His Morning Notes publication, distributed worldwide, provides analyses of emerging geopolitical, technological and economic trends, as well as identifying opportunities for the Discovery Investing strategy he developed. Dr. Berry has presented testimony to a subcommittee of the Natural Resource Committee and U.S. House of Representatives.
By The Gold Report, on May 31st, 2011
 Gold is in the midst of a 20-year upward climb, according to The Great Super Cycle Author David Skarica. In this exclusive interview with The Gold Report, he points out the emerging market small caps that could profit from global economic swings.
The Gold Report: In a February interview with The Gold Report, you said, “We’re in the midst of a 15- to 20-year mega-supercycle for gold and gold equities.” You predicted $1,500/oz. gold prices and that gold would move higher through 2015 or 2020. Do you still believe that to be the case?
David Skarica: $1,500 was hit. Yes, nothing has changed my long-term view. These cycles usually move in 15- to 20-year periods. If you look at gold bottoming in 2001 or 1998, depending on your view, you can see we at the very least will move higher in 2013 and more probably into 2015 to 2020. The fundamentals back it up as the problems with unfunded liabilities and the U.S. deficit will continue to put long-term pressure on the dollar and upward pressure on gold.
TGR: In that interview and your book, The Great Super Cycle: Profit from the Coming Inflation Tidal Wave and Dollar Devaluation, you predicted out-of-control inflation due to pressure from overseas bond vigilantes. Do you see signs that that has begun and what does that mean for gold prices?
DS: We are seeing inflation. However, we have yet to see big spikes in interest rates. On the inflation front, the U.S. government is probably the biggest group of liars in the world when it comes to reporting inflation. If you look inside the metrics, the calculations they use are all designed to keep inflation as low as possible. Housing also has not been adjusted for the recent bust and is very over weighted in the Index. It is about the only thing not going up at the moment. In addition, the U.S. is about the only country in the world that just uses core prices. I find it interesting at the moment that everywhere in the world from China to India to the U.K. to the Eurozone is reporting higher inflation, but the U.S. has no inflation worries! Gap recently had terrible earnings due to increases in costs from commodities and costs that the Chinese had to pass on.
However, the problem on the rate front is that the Federal Reserve is manipulating the market through their QE program. They are the majority of the long-term bond market and a bit of the short-term bond market. Even when QE2 ends, they will just rotate the $1.2 trillion of securities they put into the market the past two years back into the bond market. I call it QE infinity. That money is never coming out. Now, at some point rates will spike as debt approaches near-Greece levels. However, because they have bought so many of their own bonds, it looks like reality will take longer than I initially thought to hit, but it will have an impact eventually.
TGR: What impact will economic instability in Europe, the Arab Spring and the specter of a new IMF chair have on gold prices?
DS: Firstly, let me get something out of the way. The United States is a bigger economic basket case than Europe. The entire European debt crisis is way overblown. Places like Portugal, Ireland and Greece are tiny. They would be the equivalent of Rhode Island and Alabama going under; that wouldn’t exactly take down the U.S. economy. In addition, Europe has such a bloated social welfare system that it can easily cut these expenditures. Also, Europeans, unlike Americans, are willing to pay taxes for government services. However, Europe’s policy of printing money to take care of some of these problems is another positive factor for gold.
Conflict in the Middle East is positive because gold is a flight to safety during times of turmoil. Also, problems in the Middle East cause oil to go out, which is inflationary and positive for gold.
The new IMF chair is irrelevant; one empty suit replaces another.
TGR: In recent trading, gold and the dollar both trended higher, how does that fit with your model that gold gains when the dollar tanks?
DS: Gold can trade up with the dollar. It did in 2005. The problem we have at the moment is no paper currencies are very solid. The dollar’s recent gains have more to do with Euro weakness. When people overblow the Euro debt crisis, the result is a rush to gold. The same dynamic can cause the dollar to rally up against the Euro. In the long term, the big trend for the gold cycle is the U.S. debt crisis and the printing of money to inflate its way out. Even if the dollar doesn’t eventually drop against the Euro, it will devalue against real assets such as gold, oil and other commodities.
TGR: In your blog, www.addictedtoprofits.net, you talk about the cycles that impact gold prices. Where are we in the current cycle and what can we expect next?
DS: The next part of the cycle is going to be very interesting, in my opinion. Because of the 2008 market and gold price crash the fact that everything rebounded together from 2009 to 2011, people think that gold moves with the market. However, I really think the next bear market in U.S. stocks will be caused by the weakening of the dollar and inflationary pressures. Therefore, I expect a situation where bonds go down in price, stocks overall go down in price and gold and gold stocks go up. In addition, I think that once people see that precious metals are the only game in town, this will allow the sector to attract more money.
TGR: In that February interview, you were bullish on small caps in general. What companies are you watching now in that space?
DS: I really like Tinka Resources Ltd. (TSX.V:TK; Fkft:TLD; Pksheets:TKRFF), a small exploration company in Peru that is in the midst of drilling. I was in Peru last August and met with the head geologist—a real old-school Peruvian who spent the 1980s risking his life by prospecting in the middle of a brutal revolution. Today, the stock trades around $0.50.
I also like Pebble Creek Mining Ltd. (TSX.V:PEB). They are developing their Indian copper project in the Himalayas. Things have gone slowly and they have had some management problems. However, the stock trades at $0.10 and there is virtually no downside, especially in a company that is expecting to go into production in the coming years.
TGR: You talked about Aberdeen International Inc.’s (TSX:AAB) role as a merchant bank that allows investors to have exposure to a number of gold and resource companies. Is their stock price representing their value yet?
DS: The blunt answer is no. Aberdeen continues to trade at a huge discount to their net asset value (NAV). The stock is trading at $0.80 as I write and the last report had their NAV at $1.37. So, you are getting the stock at around 60% of what it is actually worth. In addition, they recently announced a biannual dividend of $0.01 a share. That may not sound like a big deal. However at $0.80, that is a yield of 2.5%. So, you can buy a great company at a 60% discount to its NAV, which has huge upside potential and get more than what you get on 10-year U.S. Treasury bond in terms of yield.
TGR: Any other tips on companies to look at that might take advantage of the macroeconomic cycles pressuring stock prices?
DS: I would really look at Peruvian or Indian stocks here. Both have been whacked for different reasons. India gets hit because of worries over inflation and rising rates. Peru is neglected because of worries over the recent election where the socialist candidate was leading. However, it looks like Fujimori, the right-of-center, more business-friendly candidate, is now neck and neck in the runoff polls. If she wins, Peruvian stocks will probably rise quickly from their current levels.
I think one thing you have to understand is these emerging markets are growing fast and are leveraging, not deleveraging, like western economies. I was in Peru last summer and the growth there was amazing. I plan on visiting India in 2012. The India Fund (NYSE:IFN) and Ishares MSCI All Peru Capped Index Fund (MXPECAPD:EPU) are simple ways to play these economies.
At the tender age of 18, David Skarica became the youngest person on record to pass the Canadian Securities Course. Skarica, a Canadian and British citizen, is the author of Stock Market Panic! How to Prosper in the Coming Bear Market (1998), which provided thought-provoking arguments on why a great bull market would end in the most vicious bear market of all history. He is also the author of The Contrarian Who Saved the World, which explains how markets work. His new book, The Great Super Cycle: Profit from the Coming Inflation Tidal Wave and Dollar Devaluation, was published by John Wiley & Sons in November 2010.
In 1998, Skarica started Addicted to Profits, a newsletter focused on technical analysis and psychology of markets. From 2001 to 2003, Stockfocus.com ranked Addicted to Profits third out of over 300 newsletters in terms of performance. He is also the editor of Gold Stock Adviser and The International Contrarian services, which focus on gold and global investing. Dave has also been a contributing editor to Canadian MoneySaver and Investor’s Digest of Canada.
By Ajay Shah, on May 27th, 2011
The recruitment of the IMF MD has turned into quite a controversy. For an interesting set of views, see this page on the website of The Economist. In a remarkable development, the EDs of India, China, Russia, Brazil and South Africa came out with a clear
joint statement on the silliness that is afoot.
There are four perspectives on this question which are worth noting:
- There is an obvious gap between the power structure at the IMF, which reflects the way the structure of the world economy after the Second World War, as compared with the present reality. As an example, at present, the Netherlands has 2.08% while India has 2.35%. But the Indian GDP is now $1.6 trillion while Netherlands is at half that.
- The world would benefit from a competent and capable IMF. The best man (or woman) for the job will not be obtained by having any restrictions on nationality. As an example, in today’s world, a name that leaps out to me is Stan Fischer. But he’s not European, and hence was never even considered for the top job in the last decade. (As with Montek, he is now over age 65 and is hence not eligible for the job today). Given that a large fraction of the top economists of the world are not European, this rule yields a less capable IMF.
- I feel that a quota system where the IMF MD must now be from an emerging market is as bad as a quota system where the IMF MD is only recruited from a European country. The key is to get away from all these quota systems, to only recruit the best person for the job. The emphasis should be on technical capability. The person recruited should be a technical expert and not a politican. As an example, see how in the UK, they recruited an American into their Monetary Policy Committee.
- In the standard narrative, one hears the idea that in this crisis in Europe, the Europeans are gaining from their
control of the IMF. I feel this is absolutely wrong. In the Asian crisis, it was good for Asia that the IMF was not conflicted
by considerations of domestic Asian politics. Similarly, the IMF program in India in 1981 and 1991 was uncontaminated by domestic Indian political considerations. This helped produce a technically sound program, which helped jumpstart India’s growth. It is not accidental that we see structural breaks in India’s GDP growth around these two dates.
What Europe needs most is a tough IMF, which will be a stern taskmaster, which will force difficult political choices so as to heal the economy. Economic policy in Europe today needs to be cruel to be kind. Instead, by placing a string of career politicians from France into the IMF MD’s job, the valuable role which the IMF could have played in solving the European Crisis is being negated. This damages Europe. The wise thing for Europe today is to say: Give us a tough and competent taskmaster, and let him be
anything in the world but let him not be a European politican. The biggest loser from the present arrangement is Europe.
By The Energy Report, on May 24th, 2011
 Global Resource Investments Founder Rick Rule likes to look for unpopular investments because that usually means the prices are cheap. Today, that means oil, natural gas, uranium and geothermal. In this Energy Report exclusive excerpt from his talk at the Casey Research Conference in Baton Rouge, Rule explains the global forces that will lead to big payoffs in undervalued energy stocks.
The developed societies of the West are descending and destabilizing. People have come to believe that they are entitled to live beyond their means. I’m not an economist or a political scientist, but that perception leads to some very hard math. How can you add a column of negative numbers and come up with a positive? It’s not a uniquely American problem either. People in the old western societies, Canada and Australia suffer from the same delusion. We are old; we are fat; we are white and we are rich. Our collective problem was described by my grandfather in the following diddy: “When your outgo exceeds your income, your upkeep becomes your downfall.”
I’m not just talking about a problem of tax receipts or government spending or entitlements. It isn’t that we’re collectively stupid. It’s that we’re individually stupid. There seems to be a belief in the United States that a 55 or 56-year-old auto worker can make $55 an hour because he or she can employ technology better than a 22-year-old Indian auto worker. I don’t think so.
Another problem is that the root causes of the liquidity crisis of 2008 have still not been addressed. If you have a big problem that manifested itself in a fairly dramatic fashion and you haven’t addressed the causes, do you think it’s reasonable to be afraid of the fact that that probability may reassert itself? I do.
So, what’s the good news? The emerging and frontier markets—societies where people are un-free—are becoming a bit more free. As they become a bit freer, they become richer. Remember Chinese Communist Party Leader Deng Xiaoping, who famously said, “to become rich is glorious.” That phrase turned China loose. Make no mistake, we aren’t talking about an unending upward linear spiral. There is plenty of room for negative surprises. We have seen in places like Libya, Yemen and California that the road to freedom is uneven. But it is an undeniable force.
So we have descending destabilization of Western societies, which is not good for commodities. It’s not good for anything. But we also have ascending emerging markets. That is good for resources. When people get more money at the bottom of the economic pyramid, they buy things made of stuff. A poor person might trade a thatch roof for a metal roof. He might trade walking for a bicycle and eventually for a motor scooter. Old, fat rich people buy a nice dinner. Maybe we buy an iPod for a grandchild and load it with virtual songs. All good things, but they are not made of stuff. Selling stuff is what makes investors rich.
Think about it as two great weather systems coming together. Old, spoiled, rich and stupid meets this amazing demand for resources. What happens when two big weather systems collide? Stormy weather, turbulence, volatility. I think we’re going to see volatility on steroids. Volatility can cause strange things. Oil shoots up repeatedly above $100/barrel. Then there’s that other kind of volatility like in 2008 when things fell off a cliff. So, you have to manage expectations going forward. There will be more upward spikes and more down-spikes.
Now, volatility doesn’t need to be a risk. It’s up to you. Remember this. Perceptions of the future are set by immediate past experiences. That means in the near term, as Financial Author Jim Dines famously says, “a trend in motion stays in motion until it stops.” We often confuse a bull market with brains. Markets gain momentum and gain momentum and gain momentum and gain momentum. We buy a stock for $1.00. The stock goes to $2.00. What do we do? We double up. Think about this. Is this rational behavior? No, but it feels good. We’re smart. The stock went up. The sector’s good because the stock went up. The higher the prices go, the better we like it despite the fact that the value is eroding right in front of us. The contrarian thesis, of course, is to be brave when others are afraid and afraid when others are brave. It’s a wonderful slogan but it’s damn hard. When a company is selling for half it’s worth people complain that it never goes up. In other words, the fact that it’s cheap becomes a curse; a wonderful curse from my point of view. Unless, as occasionally happens, I’m wrong. What’s the biggest investment risk out there? Obama? Debt? Nuclear arms? No. The biggest investment risk you have is to the left of your right ear and to the right of your left ear. All of my worst financial experiences were self-inflicted.
The reality is that volatility is good because it represents a series of 40% off sales. It’s up to you whether you take advantage of volatility or whether volatility takes advantage of you. Common sense is the real determinant over whether you will do well. If something doesn’t make sense, very often it’s because it doesn’t make sense. Financier George Soros made almost all of his money finding widely-held premises that were wrong and betting against them. He famously decided in the year 2000 that the United States society was hubris infected. You remember the spectacular bull market of 2000. We had vanquished the Soviet Union and everyone thought nothing could go wrong with America. Soros bet against it. That’s the kind of common sense that will allow you to deal with volatility.
My approach is very simple. It comes down to this: “hit them where they ain’t.” Know this: A trade that’s popular, a perception that’s popular, an idea that’s popular is very likely overpriced. I’ve come to prefer underpriced. That’s why I concentrate on stuff that’s unpopular. Fortunately for me unpopular stocks are in fairly good supply. It’s an orientation that has served me well over the long term. Over the short term, however, this approach can be inconvenient from time to time. One thing that happens with lonely trades is that when you make a mistake, you usually make a fairly serious mistake. Your speculative portfolio isn’t trying hard enough if you don’t have a couple of positions lose 30% or 40%. I know this is hard to stomach, but it is true.
So, how do you create a portfolio that flourishes in the face of volatility when the resource market is no longer cheap? First case, create liquidity; have some cash. It’s ok if your cash is bullion, but have some cash. You have to have cash. When volatility occurs, cash will do two wonderful things for you. It will give you the ability and it will give you the ability to act in down markets. It doesn’t matter if stocks are cheap if you can’t do anything about it. Cash will also give you the courage to act. So, have some liquidity.
Then look for things other people aren’t looking at already. Ask yourself, “What’s unpopular?” I think energy is unpopular. Oil will be a major driver going forward. Globally, most oil is produced by national companies. It’s produced by the same people who can’t educate kids or deliver the mail. Governments are diverting oil revenue cash-flow to politically-expedient spending programs and not reinvesting in their oil business. I believe as much as 25% of the world’s supply of export crude will come off the market in five years. Specifically, I think that Mexico, Venezuela, Ecuador, Peru, Indonesia and, perhaps, Iran will cease to be oil exporters. So, think about some simple math. If worldwide export demand is growing at 3% compounded and worldwide supply falls by 25% remembering that prices are set on the margin, the outlook for the oil price has to be higher. And, oil drags all other forms of energy. Natural gas is already a third the price on an energy equivalent basis of oil. Natural gas prices are low and they are going to stay low for a couple of years. Natural gas is so unpopular in the Canadian brokerage community that gas might as well be a four letter word. No one wants to be near it. That means it is cheap. The same goes for uranium. What happened in Japan was a tremendous human tragedy. However, most of us, despite our fears about what happened in Japan, when we walk into a room and hit the switch prefer it if the lights go on. That is why global and Japanese use of nuclear power will continue to grow. I am also still positive about the prospects for geothermal. It is taking a long time, but that is why it is a good deal.
Good luck.
Rick Rule spoke at the recent Casey Summit “The Next Few Years” in Boca Raton, FL, along with 34 other renowned economists, investment pros and resource experts who shared their outlook for the future of the U.S. economy, the dollar, and the markets.
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