There is a war raging behind the scenes among the world’s currencies. Chris Mancini, an analyst with the $400-million Gabelli Gold Fund, believes that gold will emerge the victor. In this interview with The Gold Report, Mancini makes his case for why gold is a currency and not just a relic, and why his fund doesn’t own bullion. He also shares names of companies operating around the world that offer great upside potential.
The Gold Report: You recently wrote, “Gold mining companies are no different from any other company in that company managements must determine the most effective way to return capital to shareholders.”
In an environment where there haven’t been corresponding increases in equity prices to the price of gold, how does a management group effectively grow per-share value for shareholders?
Chris Mancini: If you’re too big and don’t think that you can grow on a per-share basis, the answer is to return some of the cash to shareholders through a dividend. If a company doesn’t have high-quality, high-return-on-capital, low-risk projects to deploy that cash flow into, then a portion should be returned to shareholders as a dividend.
TGR: We haven’t seen a whole lot of that.
CM: Take Barrick Gold Corp. (ABX:TSX; ABX:NYSE) as an example. It had a goal of eventually mining 9 million ounces (Moz) gold and should produce around 7.5 Moz in 2013, which is a difficult thing to do. Barrick has been focused on growing for growth’s sake. It undertook two very capital-intensive projects, Pueblo Viejo in the Dominican Republic, which is complete and should be producing commercially sometime next year, and Pascua-Lama, which is an enormous, capital-intensive project in the Chilean/Argentinean Andes, which the company is doing a poor job of building. That being said, it will be very cash-flow generative once it’s built.
“We are in a positive macroeconomic environment for gold.”
The question becomes at that point, once Pascua-Lama is built, what does it do with its cash flow? We’re getting a sense that it wants to be a leaner, meaner company and that it’s not going to focus on growing its very big production base. That’s a good sign that it might start distributing more of its cash in a dividend.
TGR: A lot of senior producers, and even midtiers, are focusing on grade. Irrespective of all things, the higher the grade, the better the economic return.
CM: That’s the key. A higher-grade deposit means processing fewer tons to get out the same number of ounces without the capital intensity of a big, bulk-tonnage, low-grade operation. The cost per ounce is also lower given that not as many tons need to be processed to recover the same amount of metal.
TGR: You don’t hear many pundits predicting a falling gold price in 2013, yet we continue to see volatility in the space. What’s your forecast for the gold price in 2013?
CM: We’re very constructive on the gold price in all currencies. All over the world, money is being printed, and gold is the one currency that can’t be reprinted or replicated. The money that’s being printed will ultimately lose its purchasing power, and gold should retain its purchasing power. Gold should continue to go up relative to currencies that will be losing their value. More debt leads to more money printing, and more money printing leads to continued devaluation of currency. It’s a positive macroeconomic environment for gold.
TGR: Some investors don’t view gold as a currency. They view it as a metal, a relic.
CM: Historically, gold has been the ultimate currency and, at some point in the future, will again be the ultimate currency. It’s not legal tender, but that still doesn’t mean it’s not something that will hold its value over time relative to paper.
TGR: Utah and a couple of other states have actually passed legislation that gold is considered a currency.
CM: In some states, you can bring in gold or silver and get goods for that gold or silver. The problem with that is federal tax. If you buy gold and it appreciates in value and there’s a gain on that gold, when you sell or transfer that gold, then there is a federal tax on that transaction. Until that goes away, it will be hard to use gold as a real currency in the U.S.
TGR: Even in a world that hasn’t descended to a serious level of crisis, gold can still be appreciating as a currency.
CM: It is a currency war. Currencies are devalued against one another. Recently, the Japanese elected the Liberal Democratic Party leader Shinzo Abe. One of his talking points during the election was that the Japanese economy is uncompetitive because the yen is too strong. Abe’s theme is more monetary and fiscal stimulus, and a weaker yen. He and the Japanese people think that the country needs a much weaker currency in order to be competitive in the world economy. That’s also why the Swiss agreed to their money printing exercise—in order to stop their currency from appreciating more and more.
TGR: It does feel like a race down the hill when you talk about it like that.
CM: If the Japanese, Swiss, and other Europeans print more and more money to make their currencies less valuable, ultimately the U.S. is going to be uncompetitive from a manufacturing perspective. It gives the U.S. impetus to also print more money.
TGR: We’re talking about trillions of dollars of deficit. It’s almost beyond comprehension. Because you value gold as currency, why don’t you hold any bullion in the fund?
CM: Gold miners are undervalued relative to bullion, and investors can get bullion cheaper themselves. They shouldn’t be paying us to own bullion. Bullion is a savings instrument. Gold equities are investments.
TGR: The fund’s No. 1 holding, at about 12%, is Randgold Resources Ltd. (GOLD:NASDAQ; RRS:LSE), which is heavily involved in Africa. I’ve traveled to Africa and was very impressed with the mineral wealth there. Yet some investors are not comfortable with that location. Why are you?
CM: When a company comes into a community, builds a mine and employs people, it liberates those people from poverty. They’re building skill sets that they have for the rest of their lives.
“While precious metals is an extremely volatile sector, it can be volatile on the upside, as well as the downside.”
A well-respected institutional mining company like Randgold comes into a region, employs people, educates people, liberates people—those people want that company to be there. It greatly reduces jurisdictional risk when you have that much local support.
TGR: Yet, there are places in Africa without that support. There are roving bands of thugs that are creating problems in the Democratic Republic of the Congo and Mali. Do you see these as temporary blips in an otherwise bullish and opportunistic area, or do you see this as a long-term thorn in the side of companies working in those areas?
CM: They’re not necessarily blips, but they’re not meaningful to the operations of Randgold. A place like Mali or the Congo is vast. As long as there are no specific problems near Randgold’s mines, it’s a non-event.
TGR: There are hundreds of kilometers of distance between the places where the problems are occurring and Randgold’s operations, and no connecting infrastructure.
CM: It’s extremely remote relative to political circumstances that may be transpiring around the country.
TGR: Your second largest holding is Fresnillo Plc (FRES:LSE), the No. 1 silver producer in the world. In a report you wrote that one of the things you like about Fresnillo is that it acts like an owner. “Unlike many other large precious metals companies, Fresnillo is an owner-operator company that’s 80% controlled by a family-owned Mexican conglomerate.”
CM: You have to ask yourself, as an investor, what’s the management’s incentive? For a large institutional-type precious metal mining company, their incentives may not be directly with the shareholders, whereas the owner of a company focuses on maximizing returns and cash flow.
TGR: Do you routinely look for companies with a lot of management ownership?
CM: That’s something that’s important to us. We look for skin in the game in the form of shares, not options, because we do want to see companies paying bigger dividends. If managers own shares, then they’ll benefit when dividends are paid out, too.
TGR: Is there another example of a company with vested management that you are particularly excited about going into 2013?
CM: Guido Staltari, the chief executive officer of Australia-based Saracen Mineral Holdings Ltd. (SAR:ASX), is the founder of the company, has an ownership stake in the company and is very invested in the company. Saracen should produce around 115 thousand ounces (115 Koz) gold at a cash cost of around $950/ounce (oz) this year. It’s in the process of expanding its operations. With an incremental spend of around $40 million (M), it should be able to increase its production by around 75 Koz/year and it should also be able to bring its cash costs down to around AU$850/oz.
TGR: That’s a name I’ve never heard of before.
CM: Saracen is producing now. It’s relatively low-risk growth and relatively high return on capital. The company has built a mill that needs some modifications. It has leases on its mining equipment, so it can upgrade the size and benefit from economies of scale that will come with using the new equipment without having to make a large capital outlay.
It also has some very prospective land that is relatively high grade where it is exploring. We hope that it will be able to increase its reserves. One of its deposits, Red October, is a higher grade than what it is currently mining. If it can grow the Red October deposit through exploration, then its average grade should increase, its costs should decline and its production should increase even more.
TGR: Are there any North America-listed names that are piquing your interest?
CM: One that has been hurt this year but has the potential within the next 18 months or so to do well is Kirkland Lake Gold Inc. (KGI:TSX). Kirkland Lake operates a mine in its namesake Kirkland Lake, Ontario, which is along the Abitibi gold belt. It’s an old mine in transition. As it increases its production, it should benefit from economies of scale. Kirkland is also exploring a new, high-grade portion of the deposit called the South Mine Complex. It won’t be without its fits and starts, and it’s not without risk because it’s a very difficult expansion that it’s undertaking. If Kirkland does succeed, its production should grow from around 100 Koz this year to around 250 Koz at full capacity. Its cash costs should decline from around $900/oz to closer to $600–700/oz.
TGR: Assuming operating costs stay the same.
CM: Kirkland Lake’s operational costs are going to go up, but not to the same extent that its production should go up. Right now, it is mining from 800–1,000 tons per day (0.8–1 Ktpd). The goal is to produce up to 22 Ktpd. It has around 900 workers underground now and wants to grow to 1,200 workers. It can more than double its production by just increasing its workforce by about 30%.
TGR: It’s trading near $6/share now, after trading as high as $18/share. This stock has been smacked.
CM: Kirkland Lake’s management has miscommunicated its production goals to the market. It has consistently changed its production guidance. First, it was going to be 2012, then 2013, and then 2014. The market doesn’t trust anything that it is saying. Yet, that’s why, over the next 18 months, it could do well, because the mine will be at a point where we will be able to see whether the company has been able to execute on its plan. The market wants to see consistent growth quarter over quarter and consistent decline in costs quarter over quarter. But given the nature of its operations, it’s going to be lumpy for a while until it gets to a steady state. The operations are at this point essentially paying for exploration and/or serving as a training ground for new underground miners at the operation.
TGR: Have you been there?
CM: Yes, I recently spent a day underground with Chief Operating Officer Mark Tessier getting a sense for the operations and the expansion project. It’s striking how many people go underground every day. It’s only going to ramp from there. A lot of the miners come to the operation without any mining experience. It takes a while for them to get up to speed and to productive capacity. Once they do, the company has the potential to be a midtier producing company in one of the best jurisdictions in the world, producing at reasonable unit cash costs.
TGR: With explorational blue sky.
CM: If the exploration does work out from the South Mine Complex, then its costs should be below average, at about $550–600/oz.
TGR: It did a $69M private placement in November.
CM: Yes, and it did another one in the summer for about $57M. Right now, it has around $120M of debt. That makes it more risky. The balance sheet is more levered. I still like it, but it’s not for the faint of heart.
TGR: What’s another company in a great jurisdiction you can tell us about?
CM: Another North America-listed gold name is Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.MKT).
TGR: That’s another one that’s had great success, but a few bumps in the road.
CM: Aurizon doesn’t necessarily have the growth prospects that Kirkland Lake does. However, it does have downside protection. It has a rock-solid balance sheet with $200M in cash.
“Our hope is that in the coming year, precious metals move fast and furiously on the upside and the environment is more constructive for gold and for gold miners.”
It has had some operational issues recently, but the market is not latching on to the essence of the story. It is mining an old area and it is going to start mining in a new area, Zone 123 at its flagship Casa Berardi mine. Once it starts mining the new area, it should get steady production and generate a good amount of cash flow. In 2014, the company should be producing 135–150 Koz/year gold at cash costs of $700–800/oz, generating a good margin, in a great jurisdiction in Northern Quebec.
TGR: Aurizon is not flashy or sexy, but it sure gets it done. It’s been impressive to watch that company.
CM: It has. The fact that it hasn’t done an acquisition yet with its $200M cash hoard speaks volumes.
TGR: One of the things that is compelling about a lot of midtier producers is that they are nimble. They can pare back a little bit. They’re small enough to decide to stick to where they’re having explorational success with their own assets. We’re seeing that with several of these midtier companies. As an investor, it makes them more attractive in some ways than the seniors.
CM: Yes, I agree. They don’t have the overhead of the seniors. The seniors almost have to buy something in Nevada, for example, because they currently have all of the overhead in Nevada and they have to sustain it. That’s not the case with these small, single-asset companies.
TGR: Let’s go to silver. Could you talk about a couple of silver names that you find compelling?
CM: The one that makes sense to talk about, given that we spoke about Fresnillo, is MAG Silver Corp. (MAG:TSX; MVG:NYSE). MAG Silver has 44% of the Juanicipio project, a property that is near Fresnillo’s namesake mine. Fresnillo has the rest of the project.
Fresnillo is the highest-grade silver mine in the world. Juanicipio has a similar geological structure to the Fresnillo deposits. These are epithermal vein systems. At Juanicipio, the company has delineated a deposit that is around 230 Moz silver at very high grades. It’s a silver equivalent grade of 700 grams per ton; this is an extremely high-grade deposit in one of the best jurisdictions in the world, Zacatecas state. Fresnillo is the best miner and developer of high-grade underground silver deposits in the world.
TGR: What needs to happen with Fresnillo and MAG Silver to unlock the value of MAG Silver for shareholders?
CM: Obviously, for Fresnillo to buy out MAG Silver’s 44% stake of the Juanicipio project. That’s the best-case scenario for both companies and for shareholders of both companies. They just have to sit down in a room, hash it out and come up with something that’s reasonable.
If they can’t agree to a price, MAG Silver could spin out the Juanicipio asset to shareholders, who would then get one piece of paper that’s 44% Juanicipio and another piece of paper that is all of MAG’s other exploration assets, some of which are very prospective. For that 44% in Juanicipio, ultimately the shareholders would get a cash call. They would have the option to either participate in the cash call to fund a portion of the capital expenditures for the project or get diluted down. Once Juanicipio gets built by Fresnillo, shareholders would still have the 44% stake in the cash flow from this operation that would be returned in the form of a dividend.
TGR: That’s an interesting idea.
CM: Yes. I think that it would be valued very highly in that it would be like a royalty company. It would be 44% of the profit from one of the best silver mines in the world, operated by one of the best silver miners in the world.
TGR: It might be easier from both companies’ perspectives if everything is separated that way.
CM: That’s true, too. The first step is separating the assets out. But value can be surfaced for a MAG shareholder even if Fresnillo doesn’t buy it.
TGR: Is this something that’s already on the table?
CM: I’ve spoken about it with management. Director Peter Megaw is a relatively large holder of MAG Silver. He is motivated to do what’s in shareholders’ interests. If it does spin this out, it makes what’s remaining a smaller company. It has to start over again, which is fine because Megaw is one of the best exploration geologists in the world at finding epithermal vein and carbonate replacement deposits.
TGR: It’s not really starting over because what it has outlined in its exploration assets is actually pretty compelling.
CM: That’s true. It’s not starting from nothing. It has delineated some exciting prospects at its Cinco de Mayo project in Chihuahua.
TGR: Do you have some final thoughts for us on the mining space?
CM: It’s been a difficult year. Yet, while this is an extremely volatile sector, it can be volatile on the upside, as well as the downside. Our hope is that in the coming year, it moves fast and furiously on the upside and the environment is more constructive for gold and for gold miners.
TGR: Excellent. Thanks for taking the time to speak with us today.
Chris Mancini is a research analyst at Gabelli specializing in precious metals mining companies. He has over 13 years of investment management experience, including research analyst positions at hedge funds Satellite Asset Management and R6 Capital Management. Mancini earned a bachelor’s degree in economics with honors from Boston College and is a holder of the CFA designation.
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In the midst of a global market lull, many companies are sitting on their hands, argues Mark Lackey of CHF Investor Relations. That’s why he’s scoping out smart management that’s keeping busy and making great progress—whether or not the markets are quick to notice. Learn who’s getting a running start in the uranium, oil and natural gas spaces in this Energy Report interview.
The Energy Report: It’s been a busy five months since your last interview in August. What’s your macro view on energy markets?
Mark Lackey: The problems in Europe were somewhat worse than most people anticipated regarding Greece and long-term bond rates in Portugal and Spain. Slower world economic growth wasn’t a disaster, but it was enough to knock the price of oil back down under $90 per barrel ($90/bbl). Natural gas had been climbing closer to $3.70–3.80/thousand cubic feet (Mcf), then retreated as well. And, of course, uranium got all the way down to $41.25 per pound ($41.25/lb). Part of the reason for that was that only two out of 56 reactors in Japan were actually operating, but I’m still bullish on uranium. The oil weakness experienced wasn’t terrible, but oil certainly went a little lower than I anticipated. Now that it’s back in that $88–89/bbl range, I’m anticipating somewhat stronger prices next year for oil, as well as for natural gas and uranium.
TER: Are you still expecting West Texas Intermediate (WTI) to average between $100 and $105/bbl next year, or has the supply/demand picture changed?
ML: I’ve lowered my expectation to more like $95–105, partly because the shale oil supply has been a little bit better than I expected with more Bakken production on-line. On the other hand, China, India, Indonesia, Japan and Brazil have all announced significant infrastructure spending programs for 2013, which will certainly increase the demand for energy.
TER: You talk with many people in the analyst community. What’s the current mood and outlook there?
ML: There’s a bit of a divergence. People on the street who agree with me believe that world growth will be fairly decent and that the five countries with the big infrastructure spending will, in fact, move the world forward. There are some who believe that both Europe and the U.S. will do better, and they’re seeing oil up in the $110–115/bbl range. Then, there’s a smaller group looking at an $85–90/bbl range because they think the U.S. economy will stagnate and the situation in Europe will continue to deteriorate. I would say that more analysts agree with where I am, but there’s more divergence in opinions out there than I have seen in the last few years.
TER: Natural gas prices have staged a strong comeback from last spring and now the main concern in the North American markets relates to winter weather usage. Any thoughts on that?
ML: Last spring, natural gas hit close to a 10-year low, under $2/Mcf. It bounced off of that to $3.90/Mcf largely due to increased industrial demand and gas substitution for coal in the electricity market. It’s since retracted a bit of that. In the very short run, if you’re looking solely at the winter, a cold winter could move the price higher.
Looking at fundamentals over the next year, I expect a better year for both the auto and chemical sectors. On the supply side, drilling activity for gas was down in November to a 16-year low in the U.S. but partially offset by horizontal drilling advancements. On balance I expect we’re going to see somewhat less gas than some people are anticipating, and I expect it to get back up to $4/Mcf by the end of 2013.
TER: Can you update us on some of the oil and gas plays you discussed in your last interview?
ML: We had mentioned Greenfields Petroleum Corp. (GNF:TSX.V), which operates in Azerbaijan. This is not wildcat drilling. Greenfields has been very successful reworking old wells and fields and finding oil and gas in established areas with past production. We see its production going up significantly this year. Being close to Europe, it gets a much higher price for natural gas as well—anywhere from $5–9/Mcf and also $15–20/bbl more for oil because it’s based on the Brent price, not the WTI price. Azerbaijan has had a lot of expertise in drilling and a good labor force going back to the Soviet Union days. It’s a very pro-oil and gas jurisdiction and clearly one of the best areas for that business.
TER: How’s the stock done since we last talked?
ML: It’s thinly traded and has gone down some, even though it beat expectations. With oil prices coming down somewhat, people were selling small- and mid-cap oil and gas stocks in the last three to six months of 2012. But I would suggest that people should now be looking at companies like this because of the lower entry point and better cash flow numbers in 2013.
TER: What about Primeline Energy Holdings Inc. (PEH:TSX.V)?
ML: Primeline Energy will have operations in the South China Sea and its partner is CNOOC Ltd. (CEO:NYSE), one of the largest oil and gas companies in the world. Production is expected late in 2013 and it has some significant upside in terms of cash flow and earnings, particularly into 2014. That’s when one analyst has forecast earnings of $0.24 and cash flow of $0.28 per share, which I agree with. An important point to remember about why it can see such good earnings is that it gets $15–16/Mcf for selling gas into China, or approximately four to five times what natural gas gets here.
TER: That’s definitely one to keep an eye on. You also talked about a company in the services business.
ML: Right. That’s Bri-Chem Corp. (BRY:TSX), which announced the takeover of Kemik Inc., a chemical blending and packaging niche company that will add to Bri-Chem’s cash flow and earnings. Bri-Chem has been very strong in the drilling fluids, cementing and steel pipe business sector, supplying the oil and natural gas service area. Now it will have even better earnings and cash flow in the next two years if U.S. gas drilling activity starts to turn up this year. And last week Bri-Chem closed another U.S. fluids wholesaler acquisition of General Supply Co. in Oklahoma. At this stock price level it’s certainly one that people should be looking at and expecting appreciation in 2013.
TER: Do you have any new names in the oil and gas sector that look interesting?
ML: We’ve started to follow a company called Strategic Oil & Gas Ltd. (SOG:TSX), which is a very interesting play in the Steen River area of western Canada. It has primarily light oil, which sells at a premium to WTI or Edmonton light. It’s done a great job of increasing production—more than doubling it in the last year. Another recent acquisition added approximately 10–12% to its production numbers. It’s well capitalized and with such a good balance sheet, we see it going forward in 2013 with work that can further increase its light oil production.
TER: So, where’s that one trading these days?
ML: It’s trading around $1.20 per share. When we first looked at it three or four months ago, it was trading at $0.70. It’s been a nice winner, given the performance of the rest of the TSX Venture market, which has gone from 2,450 in 2011 down to 1,200 at the end of 2012. Strategic Oil’s big increase in production and the fact it produces light oil has caught the attention of the marketplace.
TER: The other energy sector that seems to be coming back is nuclear. Prices had been pretty weak for several months and then suddenly jumped up to over $46/lb. Did the Japanese election have something to do with that? What’s the outlook from here?
ML: Yes, the Japanese election was the key factor in moving the price strongly in just a few days. Before that, people were only starting to wake up to the fact that the end of the Megatons to Megawatts program will take about 24 million pounds (Mlb) out of the marketplace by 2013 year-end. Clearly, the fact that the Japanese government won with a largely pro-nuclear position was a major catalyst. They need to stimulate the economy and will be facing potential electricity shortages if they don’t begin restarting more of their nuclear plants over the next year; mind you restarts require new environmental assessments that the government has now said will be done in June.
TER: So that’s expected to create enough demand to justify higher prices?
ML: That, and there are some other factors too. There are 66 reactors under construction worldwide as we speak. If the Japanese bring back even 20 of their 56 that are off-line in the next year and more new reactors built come onstream in the next one to two years, then you can see some significant demand increase for uranium. In addition to the Megatons to Megawatts program phaseout, Cameco Corp. (CCO:TSX; CCJ:NYSE) has deferred its Kintyre project in Australia and BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) has deferred expansion of Olympic Dam. Then Uranium One Inc. (UUU:TSX) canceled its Zarechnoye project in Kazakhstan. Higher demand and lower supply lead us to expect significantly higher uranium prices in the next one to three years.
TER: Have there been any interesting developments with the uranium developers you talked about in August?
ML: Fission Energy Corp. (FIS:TSX.V; FSSIF:OTCQX) had some very good drill results in the Athabasca Basin, at Waterbury Lake and Patterson Lake South. This caused the stock price to almost double in about a week and remain close to that peak. One of its properties is very close to the Hathor property that was ultimately acquired by Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK), so we view Fission as a potential takeout candidate. It’s going to do more drilling to define additional resources, but it’s a company that has some pretty good potential.
TER: A lot of companies are working the Athabasca Basin, where most of the North American uranium development has taken place.
ML: Right. The two other big areas are Wyoming and New Mexico, where another company we mentioned and have followed for a number of years, Strathmore Minerals Corp. (STM:TSX; STHJF:OTCQX) has projects. Its Gas Hills project is in Wyoming and the Roca Honda project is in New Mexico. I’ve liked Strathmore over the years because, whenever management told me they were setting certain milestones, they met them. I’ve spent a number of years in the uranium business and always thought the Gas Hills project area was one of the best in the U.S., and it’s now owned by Strathmore. I also really like its New Mexico play, and the company has considerable depth in its property portfolio for a junior. Strathmore expects to see production in the next three or four years; that would make it a relatively low cost and fairly significant uranium producer in the U.S. If I’m right about uranium prices going a lot higher in the next three years, this stock will be trading at considerably higher than present levels.
TER: Do you have any new companies that look interesting?
ML: Forum Uranium Corp. (FDC:TSX.V) is one I’ve watched for a while. Its two main projects are in the Key Lake area of the eastern Athabasca Basin near Cameco’s Key Lake Mill. It’s also on-trend with Hathor’s Roughrider discovery and Forum has two plays in the western Athabasca. Its management team of President, CEO and Director Richard Mazur; Vice President of Exploration Ken Wheatley and Chief Geologist Dr. Boen Tan are three of the best guys that I’ve known in the whole Athabasca area. These guys have actually discovered over 300 Mlb of uranium throughout their careers.
The company also has a very interesting play in the North Thelon, in Nunavut. I think there’s some significant upside there, and it just announced some very good drill results. Many juniors aren’t doing much these days, but these guys are out there drilling, raising money and moving their projects forward. That’s important, because if we get the uranium prices I suggest, the markets are going to be looking at players who have been forging ahead.
TER: Does it have money in the till to be able to do more work?
ML: It has some money to do part of its next work program but will likely look to raise more. The company consolidated its shares Jan. 3. This is an interesting play also because of its partnerships with Rio Tinto and Cameco. I used to look at about 60 small uranium explorers and now I’m down to only about 10 that I think have a legitimate chance of doing something down the road. Forum is definitely one of them.
TER: Any other ones?
ML: There’s Purepoint Uranium Group Inc. (PTU:TSX.V), which is also a player in the Athabasca Basin and has done a lot of work this year. It signed a joint venture agreement with Cameco and AREVA (AREVA:EPA) on its Hook Lake uranium project and completed an NI 43-101-complaint technical report there and on its Red Willow project. Purepoint just raised some money and Chris Frostad, Purepoint’s president and CEO, is continuing to move it forward. He’ll be doing a lot more drilling over the next year with some big people behind him. Again, it’s a micro-cap company, but if you’re going to buy some micro-cap companies, buy the ones with active management, good properties, some money in the bank and good joint venture partners. Then you at least have a good chance of success down the road.
TER: These didn’t all start out being micro caps.
ML: No they didn’t, and that’s an interesting point. I can remember when it was trading at $1.60 back in the better uranium days. It’s way more advanced now at $0.07, which shows you what happens when you have such a bad market environment. The market doesn’t seem to differentiate, at this point, between uranium players that have stronger odds at being successful and those that don’t. They’re all in the same basket. Once we get better uranium prices, I think investors will start to focus on which companies actually have not been sitting on their hands.
TER: So what does the year ahead look like for energy stock investors and where do you feel they should be focusing their attention for maximum upside?
ML: I’m expecting a moderate upward movement in oil prices, but certainly not a boom. North American natural gas should move higher. Natural gas prices in Europe and China offer some pretty exceptional opportunities for companies selling into those markets. My three-year outlook on uranium is way above the consensus. I actually see uranium trading this time next year at $65/lb, compared to the current spot price of $44.75/lb. Then I see it at $80/lb at the end of 2014, and $90/lb in 2015, all based on the supply and demand factors I mentioned earlier.
TER: That would certainly bring life to a lot of these cheap uranium stocks. People are going to be all over uranium again if you get a double in the price.
ML: A lot of people may think I’m overly optimistic, but I would point out that when we first liked uranium at $10/lb in 2001, we thought there was some pretty good upside. I never expected it to go to $135, like it did in 2007. But, it does show you that when the uranium market starts to move, it usually moves fairly significantly and can create some definite investment opportunities.
TER: So there’s something that people certainly should focus on in the next few months to a year. We greatly appreciate your time and input today, Mark.
ML: Thank you.
Mark Lackey, executive vice president of CHF Investor Relations (Cavalcanti Hume Funfer Inc.), has 30 years of experience in the energy, mining, banking and investment research sectors. At CHF, Lackey involves himself with business development, client positioning, staff team coaching and education, market analysis and special projects to benefit client companies. He has worked as chief investment strategist at Pope & Company Ltd. and at the Bank of Canada, where he was responsible for U.S. economic forecasting. He was a senior manager of commodities at the Bank of Montreal. He also spent 10 years in the oil industry with Gulf Canada, Chevron Canada and Petro Canada.
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Violent strikes and supply disruptions in South Africa put platinum in the headlines last year, and the metal spent 2012 selling at a discount to gold. Is a platinum discount the new normal? How will the market shift in the labor strike fallout? And will mining asteroids transform supply fundamentals? CPM Group Platinum Analyst Erica Rannestad met with The Metals Report to share her price and cost forecasts for 2013 and discuss the supply and demand trends to watch this year.
The Metals Report: Across the mining sector, investors are concerned with rapidly rising costs. How did the 2012 strikes in South Africa affect operating costs in the platinum group metals (PGM) mining industry specifically?
Erica Rannestad: We expect a 12% decline in PGM output in South Africa. These lower output levels are expected to have the most significant impact on cash costs. Cash costs are a key performance measure used in the mining industry and are typically stated on a per-unit basis. Cash costs mostly refer to direct mining expenses such as labor, fuel and electricity.There are many variations for the calculation of cash costs, so it is important to keep in mind that this measure is not exactly comparable across companies. Because it is stated on a per-unit basis, cash costs can be quite unpredictable, especially if operations are located in high-risk countries. Input costs, particularly labor and electricity costs, significantly increased in 2012, which amplified the already strong increase in cash costs as a function of lower output. In summary, the majority of the increase in cash costs is due to lower overall annual production with the balance coming mostly from labor and electricity cost increases.
TMR: What is the average cash cost for South African producers?
ER: We monitor cash costs on a C1 basis, which standardizes cash cost statistics. C1 cash costs refer to a standard definition of what figures must be used to calculate cash costs, making the measures comparable across the board. Last year, South African cash costs per ounce of PGMs were about $753 per ounce ($753/oz). Cash costs outside South Africa was much lower at about $570/oz. But you need to consider that South African PGM production, or output value, is relatively higher in platinum, which is why the cash cost is higher than the global average.
TMR: Is your analysis based on the combined output of platinum, palladium and rhodium?
ER: Yes. Other metals would be considered by-products.
TMR: What is the trend for cash costs in South Africa next year?
ER: For 2012, we have a preliminary estimate of a ~25% increase in cash costs to $940/oz. The key point here is much of that increase is due to the significant drop in output. The actual increase in cash costs could range between 15–25%. There are several ways companies can mitigate costs, such as mining higher-grade regions.
Cash costs of $925/oz puts some of the high-cost mines in the red in the near term. The near-term cash cost increase doesn’t suggest that these mines will close, because in most cases they were profitable during prior years. This year was unusual and very event driven. However, the current cost environment puts these operators at a higher risk.
TMR: Your report states that two of the five highest-cost PGM mines were already shut down in 2012. What is the story there?
ER: Those are the Everest and the Marikana mines. Both of them are partially owned by Aquarius Platinum Ltd. (AQP:ASX), which had quite an interesting and trying year. Those operations were closed, with Aquarius citing an adverse operating environment and low PGM prices. Management expects to restart operations when conditions improve, which may not be until 2014 at best. Another notable high-cost mine is the Bokoni mine. That operation is undergoing some restructuring between Anglo American Platinum Ltd. (AMS:JSE) and Atlatsa Resources Corp. (ATL:TSXV; ATL:NYSE.MKT; ATL:JSE). Its medium-term success depends on how smoothly that restructuring proceeds.
TMR: Are there other mines at risk for near-term closure either due to labor or infrastructure issues?
ER: Anglo Platinum’s Rustenburg operations may be at risk of temporary closure, or at least some shaft closures. This operation suffered a six-week-long strike that began in September. Costs are expected to increase significantly in 2012. These examples aside, most of the mines in South Africa, while at risk of poor operating performance due to the inherent issues unique to South Africa, are fairly positioned for the current price environment to continue operations in the long term.
TMR: What could happen to prices if output reverts to pre-2012 levels?
ER: This year the market reacted in two different ways. First, supply shocks increased uncertainty about supply, cut off supply flows and drove prices up sharply and rapidly. Platinum had a 24% trough-to-peak price increase during the Lonmin strike, for instance. Second, prices would drop nearly as fast upon the resolution of an illegal strike as investors started focusing on the dismal demand picture once again. My forecast is for a narrower price range in 2013. There’s less uncertainty about supply shocks—we have experienced strikes at all the major operations in South Africa and we have seen how the market reacted. The probability of a repeat of 2012 is low. But there still is a lot of pessimism about demand. As a result, I’m targeting approximately $1,450/oz for platinum as a low and $1,800/oz as a high for 2013.
TMR: What are your expectations for the demand side? Can you explain the major market segments and what is driving them?
ER: The largest user of PGMs is the auto industry. Auto demand will be driven by an improvement in Europe’s economy, possibly in H2/13. Expectations for improvement in the U.S. and Chinese economies this year would also be positive for fabrication demand. Overall, we expect positive, but tepid, demand growth for PGMs from the automotive sector. In auto catalysts there’s very little substitutability outside the PGM complex. Alternatives have been tried, but nothing else is as reliable and efficient. The auto makers are going to be buying PGMs despite the price for the foreseeable future.
The second-largest source of demand for platinum is jewelry. Platinum jewelry demand is dominated by China. We expect a lower growth rate compared to previous years—positive, but growing slower. Lastly, we expect modest growth from electronic fabrication demand, which mostly applies to palladium. Overall, we are looking for modest growth relative to 2012 levels.
Jewelry users of PGMs are much more price sensitive. Platinum is the largest jewelry component in the fabrication demand portfolio. When prices rise, jewelry demand typically comes off. Jewelers try to keep their price points stable for customers and one way to do that is to reduce metal content, which translates to the industry buying in lower volumes.
TMR: Investors are increasingly participating in the PGM markets—how is 2013 market sentiment looking?
ER: Especially in the case of platinum, investors in 2012 looked to the economy in Europe for clues about PGM market direction. That resulted in a very negative view. Currently, there are expectations for improvement in H2/13 for the European economy that should improve the outlook for PGMs. There may be buying activity in anticipation of that economic growth.
Slightly stronger growth in China and the U.S. obviously would also be positive for investor views on PGMs. PGMs are seen as a way to play an overall increase in industrial and economic activity.
TMR: PGM exchange traded products (ETPs) have grown globally in the last few years. Are the ETPs a significant force in the market yet?
ER: The introduction of the physically backed PGM ETPs has helped to expand marketing efforts for these markets. The PGM markets are much smaller than the gold or silver markets. The ETPs have really contributed to an overall expansion of the PGM investor base. Specifically, they have provided retail-level investors with a lot more access to these markets.
TMR: Platinum has been hovering at roughly a $100 discount to the price of gold for the last several months. Is this a transient condition or the new normal?
ER: The run-up in gold prices above platinum makes sense because of all the layers of uncertainty in the global financial markets in recent years. The historically large premium that gold has over platinum at present reflects the unusually high level of uncertainty about future economic growth, fiscal deficits, monetary issues and the host of other problems that came to light during and after the financial crisis. We believe a lot of the run-up in gold prices based on these layers of uncertainty are priced into the market now. Once these layers of uncertainty begin to dissolve, we expect to see the platinum price move above gold once again. In the long term, we see platinum’s fundamentals as more positive than gold, so we expect to have platinum prices rising, whereas we see a lot of potential for gold prices to decline in the medium term. Potentially as early as 2014, we could see the annual average price of platinum exceed that of gold. On a daily basis, this could happen sooner—perhaps by late 2013.
TMR: Besides bullion or ETPs, another option for investor exposure would be mining equities. What companies are you watching?
ER: Despite a lot of exploration spending in Canada, the main area of interest remains South Africa. Approximately 85–90% of the pipeline for future PGM mine production is located in South Africa with the remainder completely in North America.
In North America we expect several miners to develop PGM projects over the next 10 years. Those include Stillwater Mining Co.’s (SWC:NYSE) Marathon project, Polymet Mining Corp.’s (POM:TSX; PLM:NYSE.MKT) NorthMet project and Panoramic Resources Ltd.’s (PAN:ASX) Thunder Bay North project.
TMR: Because prices have been strong for some time, the PGM recycling rate is high. Does PGM recycling compete with mine supply?
ER: At this point it’s not competing (albeit it is a critical component of supply in today’s market), but we expect strong growth in platinum and palladium recycling rates over the next 10 years. Palladium began to be used more in gasoline engines in the late 1990s, with or replacing platinum. Many of those converters are due to be recycled, so growth in palladium recycling is expected to be stronger relative to platinum recycling over the next few years. Secondary supply will account for a much larger portion of total supply in the future. We see it rising from a current 10–15% of supply to 20–30% over the next decade.
TMR: What are the major differences between platinum and palladium in terms of price performance?
ER: Palladium prices respond much more strongly to investor views on industrial activity. Platinum will trade somewhat as a financial asset like silver and gold. Palladium is much more an industrial play.
TMR: At present, are investors or industrial users the main driver of the PGM market?
ER: While investors might be a marginal component in terms of absorbing supply, they are critical in rapidly adjusting the market price. Investors have driven PGM prices this year. The 2012 price chart looks like a roller coaster—clearly influenced by supply shocks when investors were bidding up the price. When the supply shocks were resolved, investors would focus on their views about economic conditions. That resulted in reevaluating fabrication demand expectations, which were very negative based on the state of the economy.
TMR: Do you expect a similar situation going forward?
ER: Yes. I expect investors to attempt to capture any upside in the market that develops due to supply constraints and/or positive demand expectations. That said, we expect volatility to be somewhat reduced from 2012 levels.
TMR: Many or most platinum equities have had dismal stock market performance in 2012 —much worse than their underlying commodities. Is there a light at the end of the tunnel for equity investors in the PGM mining sector?
ER: The PGM mining sector is still the mining sector. It has been a tough time, but especially bad for the PGM miners because of the huge reliance on South Africa. A bad mining industry environment plus illegal strikes and large increases in cash costs equals poor equity performance. One way mining companies have attempted to address this is changing management. The CEOs in the top-four largest PGM companies all changed in 2012. Lonmin Plc’s (LMNIY:OTCBB) Ian Farmer stepped down due to illness and was temporarily replaced by Simon Scott, CFO. Aquarius’ former CEO, Stuart Murray, was replaced by Jean Nel, former chief operating officer for the company. Impala Platinum Holdings Ltd.’s (IMP:JSE) David Brown was replaced by Terence Goodlace, the former CEO of Metorex Ltd. (MTX:SJ). Finally, Anglo Platinum CEO Neville Nicolau resigned and was replaced by Chris Griffith, who was CEO of Anglo’s Kumba Iron Ore Ltd.
TMR: It’s a similar phenomenon to what has been taking place among North American senior gold miners.
ER: It is a sign that the industry is taking a more aggressive position in seeking solutions to its challenges.
TMR: New mining frontiers have made headlines in 2012, both underwater and airborne. Asteroids have come into focus as a potential source for PGMs. What’s your view on this topic?
ER: Asteroid mining is a novel idea. I get asked about novel technologies in the PGM sector all the time. The central point to remember is that these technologies are not near-term potential contributors to the market. In this case, there would be a tremendous amount of equipment development required and staggering logistical requirements. That’s going to take decades.
Commercialization of new and novel technologies takes much longer than many people might think. One example, which is also an emerging application of PGMs, is fuel cells. Fuel cells were developed over 100 years ago, but they’re only now being applied to commercial-scale markets. Mining asteroids for platinum is interesting. . .but is a long way off.
TMR: CPM Group publishes excellent market commentary. How can investors access those?
ER: We produce a monthly Precious Metals Advisory and a Base Metals Advisory, both of which contain price projections, relevant market information and supply and demand tables. It is released in the third week of the month. These are annual subscription products. More casual market participants can join our distribution list to receive free market commentaries. CPM Group also publishes three precious metals Yearbooks that are effectively the “year in review” for the gold, silver and PGM markets, released during the first six months of every year.
TMR: Thanks for your time—it has been interesting.
ER: My pleasure.
Erica Rannestad is a commodity analyst at CPM Group. Rannestad covers the precious metals and agricultural softs markets as well as currency markets. She is responsible for building CPM Group’s supply and demand statistics for the precious metals Yearbooks and Long-Term Outlook reports. Rannestad is currently most closely monitoring the silver and platinum markets, providing near- and medium-term price forecasts for these metals in CPM Group’s Precious Metals Advisory, a monthly publication. Rannestad also often contributes to and supports CPM Group consulting projects and regularly presents CPM Group’s market views at conferences and seminars around the world. Rannestad holds a Bachelor of Science degree in finance from Fordham University’s Gabelli School of Business.
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Gold has been produced in Africa for thousands of years in places like Ghana and neighboring countries whose names have changed over the centuries. One thing that has not changed is that there’s still a huge amount of gold to be found and mined in West Africa. That’s what Mark Lackey likes about the area and in this interview with The Gold Report, he talks about companies that are or will be producing significant amounts of the world’s prized metal.
The Gold Report: When you last spoke with The Gold Report this past March, gold had just dropped from its first peak of the year, from $1,781/ounce (oz) at the end of February to $1,660/oz in a matter of three weeks. Now it’s looking for support at $1,700/oz. The trading range you predicted for 2012 looks good in retrospect. What are you projecting from here?
Mark Lackey: I’m looking at a range from $1,680/oz to $1,850/oz, and moving up over the year so that by December I am expecting to see the gold price at $1,850/oz.
TGR: But you don’t see a big breakout past $2,000/oz that some people are predicting?
ML: It’s possible, but for the gold price to go much higher than $1,850/oz there needs to be a good reason, such as a big decline in the value of the U.S. dollar or major gold buying by central banks. While I expect the dollar will weaken somewhat in 2013, I don’t expect a huge decline. Over the next few years we’ll get above $2,000/oz, but probably not in 2013.
TGR: What do you see as the market drivers for gold at this time?
ML: Significant trade and fiscal deficits remain in the United States and the country is continuing to use quantitative easing, which tends to lower the value of the U.S. dollar. Investors are going to look at the U.S. dollar and the euro and decide that there are other financial options they would rather own. Some investors will buy gold as an investment alternative to paper currencies.
“I believe that jewelry demand will continue to increase as a result of the growing middle class in Indonesia, China and India.”
In addition, I believe that jewelry demand will continue to increase as a result of the growing middle class in Indonesia, China and India. Those are the demand factors that will move the price of gold higher in the short run. We also anticipate that some of the gold projects that are expected to begin production in 2013 will be delayed due to regulatory and permitting issues and this will lower the supply of gold on the world market and therefore push up the price of gold.
TGR: What’s the next concern that might become the focus for precious metals investors?
ML: I don’t think Europe’s problems have gone away after allocating over $300 billion to Greece. We cannot count on Europe to have the kind of economic growth it once did, but as long as it doesn’t crater dramatically, there’s still going to be demand for gold and other commodities. I’m looking at a modest recession in Europe in 2013. I do think the Spanish banking system will be bailed out but as long as Spain’s sovereign debt doesn’t have to be bailed out, Europe will muddle through.
TGR: Despite the relative strength of gold over the past year, the performance of gold stocks has been pretty disappointing. When and how is the turnaround coming?
ML: If you look at the performance of the gold markets, the one area where we’ve actually made some good returns was in the mid-cap gold producers and near-term producers that did rally with the price of gold. The problem for many of the larger producers was that they didn’t reach the production numbers that they had forecast and their production costs were also above what they had planned. Thus their earnings and cash flows were below expectations and this resulted in share prices that did not follow the rising gold price.
“We expect that with gold prices going higher in 2013, investors will be buying the well-run junior companies.”
There are a number of smaller gold companies that do not have much cash left on the balance sheet and found it difficult to raise money in this past year so this prevents these companies from moving their projects forward. The Toronto Venture market has declined from a level of 2,450 in April 2011 to 1,200 at end of 2012, so it is not surprising that many junior mining companies have had a difficult time trying to attract new financing. Many of those companies saw significant declines in their share prices especially at the end of 2012 as they were hit by tax-loss selling.
We believe that there will be share price appreciation in 2013 for those junior gold companies that still have money (or can raise it) and have good projects. We expect that with gold prices going higher in 2013, investors will be buying the well-run junior companies, especially those that may have declined or lagged behind in 2012 due to the overall market conditions.
TGR: Where do you see the best opportunities for investors in gold stocks these days?
ML: We look at three or four factors when we try to make a decision on a gold company. We like to see an experienced management team with a project or projects in a jurisdiction that does not have significant political risk. We also look for companies that have a mining-friendly terrain and have access to transportation, power and water. We prefer the companies to be producers or near-term gold producers. We are concentrating, as we mentioned earlier, on mid-cap and junior companies that have cash in the treasury and are also looking for those companies that are potential takeover candidates. My company, CHF Investor Relations, has several clients in gold.
TGR: Last time you talked mainly about companies active in Africa. We know there is lots of potential there, but it seems that there’s also been some unrest lately that might cause concerns for some investors. How does the current picture look to you?
ML: The gold opportunities tend to concentrate in West Africa, where three of the four countries, Senegal, Ghana and Burkina Faso, are quite stable by anybody’s standards and have had no problems with political unrest or indigenization of resources. In Mali, the problem is with the Tuareg rebels and Islamists in northern Mali. The mining companies are in southern Mali, hundreds of miles away.
“West Africa has a lot of advantages compared to some of the more traditional mining areas.”
Last month the UN Security Council voted to have 3,300 African troops sent to Mali to remove the rebels from the northern part of the country. The mining employees who we have talked to in Mali have told us that their mining operations have not been impacted, either in production or exploration, by the problems in the north. There have been problems in other parts of Africa, but we have been watching West African projects closely. CHF has no clients in West Africa, by the way.
TGR: So what are some of the most interesting stories you’re looking at now?
ML: One we like is Teranga Gold Corp. (TGZ:TSX; TGZ:ASX), which is in Senegal. Teranga says it will exit 2012 with production between 210,000 oz and 225,000 oz for the year and in the third quarter cash costs were down to $594/oz. The company has its own mill, which is the only one in Senegal, and Teranga also has the largest land position in the country. It has a strong balance sheet having cash equivalents of $31.2 million (M) at Nov. 1, 2012, and reported a record high third quarter profit of $21.3M. The company says it will eliminate its hedge book by August and will have increasing gold production along with lowering costs of production. Teranga will focus on producing the gold ounces that will provide the best returns.
TGR: What else do you like in West Africa?
ML: Another one we’ve been looking at is Orezone Gold Corporation (ORE:TSX), which is developing the Bomboré project, the largest undeveloped gold mine in Burkina Faso. It has a strong development team and large near-surface tonnage, so it’s going to be a relatively low-cost producer. It has 2 million ounces (Moz) in oxide resources in the top 50 meters, and 80% of its resources are within the top 80 meters from surface. The property is close to the national highway and has nearby water, power and a large labor force, which should translate into reduced development and operating costs.
TGR: Those are some pretty world-class resources.
ML: Orezone’s recent NI 43-101 released in October 2012 contained 4.1 Moz of Indicated and 1 Moz of Inferred resources. This will be a significant gold producer in the next few years.
TGR: Or possibly get taken out.
ML: That’s certainly possible. Given the increasing drilling activity and the increase in gold reserves in Burkina Faso, Senegal, Mali and Ghana, many major and mid-size gold producers will be looking to acquire some of these companies. Orezone is one of the companies that could be taken over.
TGR: What’s been going on with some of the companies you talked about last March?
ML: Riverstone Resources Inc. (RVS:TSX.V) announced on Dec. 19 that it had completed its takeover of Blue Gold Mining. This will add some very strong talent to an already very good management team working to advance the Karma project, its flagship play in Burkina Faso. Riverstone also has three additional properties. Recent drilling activity has been very good. This is another miner that we think will have production in the next few years.
TGR: Was this a strategic merger?
ML: Yes. I think the idea here was that if these two teams got together, they could make a much stronger company. Combining the management teams and their financial resources will, in our view, lower the execution risk of their projects and significantly improve the company’s ability to finance itself in the future.
TGR: What else do you have here?
ML: We talked about Channel Resources Ltd. (CHU:TSX.V), which has the Tanlouka property in Burkina Faso. We like Channel as it could become a mid-term producer of approximately 100,000 oz by 2018. The present Indicated and Inferred estimate at Mankarga 5 is 1.2 Moz. Channel has some other excellent exploration targets and we believe that the projects at Manesse and Tanwaka have the potential to host gold deposits similar to Mankarga 5. The additional exploration could eventually define a resource above the 2 Moz level. This exploration team has done an excellent job as it has been successful in defining a major gold resource. We like these oxide deposits for their metallurgical properties, since it usually means that the deposits can be mined at a low strip ratio.
TGR: What else looks interesting?
ML: The next one is African Gold Group Inc. (AGG:TSX.V); the company is developing the Kobada property in southwest Mali. We think African Gold can begin production in 2015, and by 2017 we are projecting annual production of 125,000 oz of gold. One of the big advantages in this part of the world is the highly oxidized rock, which is relatively cheap to mine and mill and also lies close to the surface. It has other exploration opportunities with the large sulfide resources below the oxide layers, which can significantly increase reserves.
In addition to the Kobada property, the company has other promising exploration targets at Gossokorodji, Diaban and Foroko North. African Gold has been in Mali for years and has personnel who have developed other gold mines in Mali.
TGR: What’s next on your list?
ML: Volta Resources Inc. (VTR:TSX) is a company that has really moved forward, having nine exploration projects. It is currently transitioning itself from explorer to producer in Burkina Faso, at present to converting its flagship asset, the Kiaka gold project, into a producing gold mine. The present NI 43-101 contains 4.1 Moz in the Measured and Indicated categories, and 1 Moz in the Inferred category. Given the size of the resource, I would think that, down the road, Volta could be a potential takeover candidate. Given its excellent resources and $21M in cash and no debt, Volta will have no concerns about having to raise money anytime soon. That’s a significant plus in this market.
TGR: What else do you have?
ML: A lot of people know Pelangio Exploration Inc. (PX:TSX.V) because, going back in its history, it developed the Detour Lake Gold Mine in northern Ontario and that ended up becoming a big winner for shareholders. It now has two properties in Ghana where it has completed some drilling that has recently started to show some interesting results. Its Manfo property lies between the Ahafo mine, which is operated by Newmont Mining Corporation (NEM:NYSE), and Kinross Gold Corp.’s (K:TSX; KGC:NYSE) Chirano mine. You would think Pelangio has a good chance of being on strike with the producers on either side. If it can continue to do more drilling and produce more similar results, we might see some pretty interesting resource estimates come about for this project.
Pelangio also has another very good property, the Obuasi property in Ghana, located adjacent to AngloGold Ashanti Ltd.’s (AU:NYSE; ANG:JSE; AGG:ASX) Obuasi mine, which has already produced 30 Moz of gold. This is an interesting play because of management’s extremely successful track record and because it has added a number of individuals to the management team who have significant experience with mining operations in Ghana. We’ll have to follow and see how the drilling results go, but certainly it is a very interesting play with major upside potential.
TGR: That’s another one to keep an eye on.
ML: The last one I’ve got in Africa is Roxgold Inc. (ROG:TSX.V), which had a proxy battle last summer. Ultimately a deal was completed and I give credit to Oliver Lennox-King and Rick Mazur. Mazur was the executive handling the restructuring and then left when it was done. They put together a strong board and a good management team. This is important because I’ve seen these sorts of proxy battles in the past that ended up destroying some companies.
Roxgold is presently developing three mining properties in Burkina Faso. The company is advancing a high-grade gold discovery at its flagship property at Yaramoko. At the 55 Zone there is an initial resource estimate of 354,000 oz of gold, that graded 17.8 grams/ton (g/t) in the Indicated category and 306,000 oz of gold that graded 7.7 g/t in the Inferred category. These grade are not typical in Burkina Faso where most projects are big volume but low grade. The company has raised $65M to date, so it’s well capitalized for its 2013 drilling program. If the company can continue to increase its high-grade tonnage, it will certainly be a takeover candidate.
TGR: Do you have any wildcard plays anywhere that people might be interested in, either in precious metals or otherwise?
ML: We’ve been looking at a number of zinc plays and probably our favorite right now is Chieftain Metals Inc. (CFB.TSX), which has properties in northern British Columbia. We like this one because, first of all, it has a very experienced management team, which is critical to understanding the metallurgy and the mining in northwestern B.C. Second, with all the zinc mines that are going to close in the next few years, taking millions of pounds out of production, we believe there’s going to be an upward move in the price for zinc, certainly by 2014–2015. Chieftain has recently completed a financing and it should be publishing its feasibility study later this month.
Within a couple of years we think that the zinc price will increase up to $1.40 a pound. That makes a number of zinc plays attractive, especially Chieftain, given its potential to become a zinc producer.
TGR: Where do we go from here, and how should our readers be positioning themselves for what lies ahead in 2013?
ML: As I said, CHF has a number of clients in gold, some low-cost producers, too, but generally speaking, in the gold sector, we would concentrate primarily on jurisdictions we like. West Africa has a lot of advantages compared to some of the more traditional mining areas. One factor is that it is easier to get mining permits compared to some of the jurisdictions in North and South America. West Africa is also flat and dry, has water, power, transportation and a good labor force. In addition, we want experienced management teams that have experience in the jurisdictions where they are exploring.
TGR: Thanks for the ideas and updates, Mark, and we’ll stay tuned and hope for the best in 2013.
ML: Thanks for the opportunity.
Mark Lackey, executive vice president of CHF Investor Relations (Cavalcanti Hume Funfer Inc.), has 30 years of experience in energy, mining, banking and investment research sectors. At CHF, Lackey involves himself with business development, client positioning, staff team coaching and education, market analysis and special projects to benefit client companies. He has worked as chief investment strategist at Pope & Company Ltd. and at the Bank of Canada, where he was responsible for U.S. economic forecasting. He was a senior manager of commodities at the Bank of Montreal. He also spent 10 years in the oil industry with Gulf Canada, Chevron Canada and Petro Canada.
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Energy investment is about more than just the commodities; it’s about growth. That’s why, for example, the emerging economies theme has been an important one for investors who know that every business and modern home in Brazil, Russia, China or on the African continent will need to keep the lights on somehow. But the next big thing for 2013 may be in our own backyards: the drive toward U.S. energy independence. How feasible is this goal, and how can investors profit from it? With this question in mind, The Energy Report looked back at some of the most memorable interviews of 2012 for expert advice on how to get positioned.
Oil and Gas
Here’s a little energy investment 101: when oil moves up, so does the dollar. Energy bulls bet on increasing momentum, whereas gold bugs amass hard assets for the day the dollar collapses. Well, that’s the way it used to be; global energy markets have become so schizophrenic that this once self-evident correlation is about as reliable as India’s power grid. But one indisputable fact remains, as Porter Stansberry pointed out in his Dec. 13 interview, “End the Ban on US Oil Exports“: “One of the biggest drags on the U.S. dollar over the last several decades has been the trade deficit resulting from petroleum imports.” Wacky oil and gas differentials aside, outsourcing energy production has taken its toll on the national budget and the dollar itself.
But if the U.S. doesn’t rely on international imports, could it make do with domestic supply? Potentially, argues Rick Rule in his Nov. 27 interview, “A Global Perspective on U.S. Energy Independence.” Responding to the I.E.A.’s predictions that the U.S. could reach self sufficiency by 2035, Rule responded, “We stand a very good chance. . .the U.S. is endowed with spectacular natural resources and we remain the epicenter for extractive and exploration technology. Our advantages in terms of the cost of capital, the application of technology and our legal apparatus are uniquely suited to unlocking the potential of our geology.” Even John Williams of Shadowstats.com sees some upside here: “If domestic oil production could replace foreign production, you could still have a positive domestic demand environment. I’d push for that as much as possible.”
So if we need the goods, and we have the goods, the next logical step would be to scout out the domestic producers who can come through with supply—at the highest margins possible, experts suggest. There’s no shortage of recommendations on mid-, micro- and large-cap producers who may fit that bill, and investors with a bullish outlook on domestic oil and gas would do well to keep checking in with The Energy Report to hear why Josh Young invests exclusively in mature oil fields (”There is an old adage: ‘The best place to find oil is an oil field.’”), why Darren Schuringa looks to MLPs to generate returns on investment in North American oil and gas infrastructure (”Consistency is very important for investors, especially for those who are looking for alternatives to fixed-income instruments.”) or how John Stephenson chose the energy stocks that yielded 30% growth for his portfolio year over year (”Look for producers who are good at managing the cost side of the business.”)
Fracking: Miracle or Mirage?
But the energy independence story doesn’t end here. Weaning the U.S. economy off petroleum imports doesn’t begin and end with domestic oil and gas production. For one thing, U.S. regulations haven’t exactly made for an open season on extraction (or transport). Stansberry commented: “We have archaic laws about oil because we had long believed that oil was a strategic resource and that the world was going to run out of it in the short term. Unless we change our laws to allow exports of crude oil, none of this magnificent new supply is going to aid our economy at all.”
One expert, Bill Powers, made waves in his Nov. 8 interview “U.S. Shale Gas Won’t Last 10 Years,” when he delivered a scathing critique of various public and private organizations that, he argues, drastically overstated the extent of U.S. reserves. (He nonetheless sees a bullish future for energy producers scraping the bottom of the barrel.) Powers represents a minorty voice in the shale debate, but even those who are bullish on North American reseves understand that the roads to returns include complications. How can investors plan for the detours?
The U.S. Energy Mix
One horizon we’ll continue to watch is the outlook for uranium producers. Nuclear power is still a controversial subject, but its proponents point out its ability to deliver low-emissions energy in vast quantities—cheaply. Germany may still be saying “Nein danke,” to the power source (although it’s fine with purchasing it from its neighbors) but sector analysts argue that Japan istelf is moving toward a broader restart, and China, Russia and emerging economies around the world are by no means turning their backs on the efficient energy source. Could the U.S. cover a greater share of its energy needs through nuclear power? Analysts David Talbot and Alka Singh see brighter times ahead in the space, both emphasizing the looming expiration of the U.S.-Russia Megatons to Megawatts program and the need for new producers to fill the supply gap. A number of U.S. producers have been getting their ducks in a row to commence with large-scale, low-cost uranium production.
Whether you believe in peak oil or simply the absence of cheap oil, diversifying your assets is a sound investment move—both from a public policy and private investment perspective. U.S. energy production is already a fairly diverse mix from state to state, as a quick glace at the Department of Energy’s interactive map shows. For this reason, The Energy Report will continue to deliver expert opinion on a spectrum of energy sectors, from oil and gas E&Ps to the service companies that keep them operating, to innovative players in the energy technology and alternative energy spaces and promising natural gas, uranium and coal producers ready to deliver to domestic utilities.
A number of our expert interviewees suggested that risk-hungry investors may want to place their bets further out on the energy supply horizon with alternative energy plays that could likewise reduce dependency on foreign oil. Biofuels have earned some support from energy investors, in part because they do not necessitate a nation-wide shift to electric vehicles. But it just may encourage the transition away from petrol imports. As analyst Ian Gilson commented in his June 12 interview, “Enzymes and Algae May Spur a Biofuel Boom,” “Biofuels are really many industries. . .but they share some common ground in that they could reduce our dependence on foreign fuels.”
Raymond James Analyst Pavel Molchanov echoed the multifaceted nature of alternative energy companies in his March 29 interview, “How to Play the Cleantech Energy Boom,” noting that many names in the space are very diversified, so it can be hard to find a pure-play investment. For potential investors, Molchanov emphasized that “Within every industry, there are companies that are in a better competitive position than others. So we have to look at everything case-by-case. It’s very hard to make a universal, far-reaching call regarding whether a particular subsector is now the right or wrong place to invest. For example, the solar industry is facing a lot of headwinds and yet there are still companies in that space that are quite profitable and successful.”
As we move into 2013, we’ll face the global economic forces that ultimately result in upside and downside momentum, continuing the conversation with the experts that share their wisdom with The Energy Report and its readers—you. Exciting, isn’t it? Many happy returns in 2013.
The past year was a very tough one for the junior gold mining sector. In this interview with The Gold Report, Brien Lundin, CEO of Jefferson Financial, says that the past year has, in fact, put many gold mining companies on the bargain basement shelf. He shares some advice on end-of-year portfolio repositions and talks about some of his favorite stocks that he believes are poised for a rebound in 2013.
The Gold Report: Brien, in late October you and your company Jefferson Financial hosted the New Orleans Investment Conference. What were some of the commodity-related themes consistently making the rounds there?
Brien Lundin: The buzz was that the underlying fundamentals for precious metals would remain bullish regardless of who won the election. But if President Obama were re-elected, then all of the factors favoring gold and silver would become dramatically more bullish.
TGR: You wrote about that in the November edition of Gold Newsletter. Here’s a quote from that edition of your newsletter: “The bottom line is that President Obama’s re-election means that you need to buy gold and silver, and things that will retain their value as the dollar loses its value.” Why were things different on Nov. 7 than they were the day before?
BL: Even before the election, the economic and fiscal situation for the United States was pretty dire. In my view the only hope of recovery and reform, without a major ongoing crisis and very significant inflation, would be if the Paul Ryan plan were to be put into effect immediately.
“When the perceived risk is one of long-term currency debasement, gold is the preferred safe haven. “
Instead, we now have the same administration that took the emergency one-year spending levels enacted to keep the economy from crashing during the 2008 credit crisis, and has now made those massive spending levels the new baseline going forward. The difference is that the Obama administration is now unrestrained by the prospect of another election, so the trajectory of government spending is actually being steepened.
TGR: In another passage of the same edition of Gold Newsletter you wrote: “The coming inflation will be similar to what we’ve experienced in recent years. Huge pools of loose money will continue to flow into commodities and financial assets.” What makes you certain that we won’t see another round of risk-off sentiment if things go as badly as you suggest they will?
BL: The risk-off episodes that seized the investment markets over the past few years are in reaction to potential fiscal crises in the U.S. and Europe. This headline risk sent investors running to the safety of cash, specifically to the U.S. dollar. This seems counterintuitive, but investors are looking for short-term safety.
When the perceived risk is one of long-term currency debasement, then gold is the preferred safe haven. My whole bull market thesis for gold is based on a developing consensus that neither Europe nor the U.S. is going to face collapse anytime soon. Rather each will be kept afloat on a sea of new money printing by both the Federal Reserve and the European Central Bank. In such an environment, gold and silver are going to absolutely take off.
TGR: Do you think that lack of practicality of gold hampers its status as a safe haven?
BL: Not today. Gold is very liquid. A lot of speculators use the exchange-traded funds (ETFs), which I recommend for trading the metals. But I don’t recommend ETFs for core holdings.
In fact, one of the things that is keeping the market buoyed currently is the tremendous retail investor demand for the metals. That comes in the form of skyrocketing physical sales of coins and bullion, and in the ETFs. Metals holdings of the ETFs are at record levels. Coin demand is at near record levels. Yet we see the price moribund due to the whims of speculative demand.
TGR: It’s interesting that you’re pro ETFs, because most gold bulls aren’t. Is this a new tack for you?
BL: Not really. You know a lot of the hard-core goldbugs are somewhat doubtful of whether the EFT gold is actually there. I recognize those concerns, so I don’t recommend ETFs for core physical metals holdings, just for trading.
TGR: When should equities enter the mix for a retail investor?
BL: Simply put, right now. The junior resource stocks have been absolutely decimated over the past year. There are bargains galore right now if you have cash to buy them.
TGR: Are these bargains mostly market related or is this part of tax-loss selling season?
BL: I don’t really distinguish between the two. We’ve had a lousy year for the equities. When we have had risk-on environments, they have not lasted long enough to where it filtered down to the highly speculative junior resource equities.
We also have an unusual situation this year where we have not only tax-loss selling but also tax-gain selling as investors take profits to avoid higher capital gains taxes next year. When you combine that with the junior stock market that has been depressed all year, some incredible bargains emerge. I’m pinpointing a number of them in Gold Newsletter right now.
TGR: Let’s talk about some of the equities that you follow. You said in a recent edition of your newsletter that Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE) has “opted to forego” the prospect-generator model in an effort to develop the promising Ixtaca gold-silver deposit in Mexico that’s part of the Tuligtic project. Is that your opinion?
BL: Yes. I have never been a big believer in the prospect-generator business model as an absolute. It should be a business model, not a religion. So when a junior explorer comes across a prospect that is particularly exciting and can provide rapid value advancement with relatively little risk, then I think the company should explore that project fully.
Almaden was the poster child for the prospector-generator model for years. But Morgan and Dwayne Poliquin had the vision and the foresight to see that Ixtaca could be different. Their decision has paid off in spades. Almaden right now is one of my top recommendations and I think that deposit is going to get much bigger than the company’s current market cap is indicating.
TGR: Almaden has about $36 million (M) to continue to develop Ixtaca. Do you think that it will sell that project, dividend the money out to shareholders, and then continue on its way? Or do you think it will sell the whole company? Or would it do something similar to what Virginia Mines Inc. (VGQ:TSX) did when it took all the other projects out of that company, put them in a new company, and sold that company to Goldcorp Inc. (G:TSX; GG:NYSE)?
BL: Typically in a case where a company has a number of earlier-stage projects, and it has one major project for which it is primarily being valued, then management will sell the company. Usually you’ll see a spin off of those other projects into a new vehicle so that shareholders can keep the benefit of that other property portfolio that really isn’t adding value to the transaction. That’s a process to fund that new company as well.
TGR: You’ve also written that Brigus Gold Corp. (BRD:NYSE.MKT; BRD:TSX) looked “undervalued” in early November after Brigus bought back much of its gold royalty stream from Sandstorm Gold Ltd. (SSL:TSX.V). Tell us about that deal and the market’s reaction to it.
BL: There are a few keys to Brigus Gold and the opportunity it presents. First, the company ran into operational problems when it was trying to ramp up production at its Black Fox Mine, prompting a decline in the share price.
“The junior resource stocks have been absolutely decimated over the past year. There are bargains galore right now if you have cash to buy them.”
Those production hiccups have been solved and production is now growing. Yet the company’s shares are on sale. In addition, there is the exploration drilling the company is doing on its Grey Fox property near the Black Fox Mine. In particular it is getting tremendous results from a high-grade zone called the 147 Zone. Those results are normally enough to absolutely catapult the value of a junior explorer. But the results are getting lost in the shuffle because Brigus is a production story. In fact, this Grey Fox property will become the company’s next mine.
TGR: Another company you follow is Comstock Metals Ltd. (CSL:TSX.V). You see more promise in the recent drill results from the company’s QV project in the Yukon than the market does. Give us your thoughts on that.
BL: Comstock is a case where expectations were really high before the first drill results came in. The results were actually quite good, but not quite up to the elevated expectations. So the share price sold off, which was unwarranted.
The first results showed the potential for a nice sized deposit at the VG Zone. Importantly, the company also outlined a number of other drill targets from soil sampling and trenching. The real key for Comstock will come with next year’s exploration program. The company’s geologists plan to mount a comprehensive attack on all those highly prospective targets.
“Once we get through these end of year trading games and that fiscal cliff fiasco, the markets should settle down into an environment where everyone recognizes that massive money printing will continue for years to come.”
I think Comstock is a longer-term story. It’s not going to be built on a few drill holes or even a couple of rounds of drilling. It’s a project that has a number of very exciting targets. It’s a cross between the Underworld Resources story, which had the Golden Saddle deposit just about 10 or 11 kilometers to the south, and the Kaminak Gold Corp. (KAM:TSX.V) story not far away. Kaminak had a number of anomalies that it had to drill off and is only now starting to connect those anomalies with mineralization.
There’s a lot of potential in Comstock. I see some very exciting analogs in the area and the mineralization that it has seen so far is very, very similar to that at the Golden Saddle discovery by Underworld. That discovery was a big winner for Gold Newsletter readers, when Kinross Gold Corp. (K:TSX; KGC:NYSE) took over Underworld at a big premium.
TGR: One hole cut 89.9 meters of 2.34 grams per tonne gold. Could this be a bulk tonnage starter?
BL: That wasn’t a very deep intersection, so it could be bulk tonnage. People tend to feel that the grades in the Yukon have to be very high even for a bulk-tonnage or an open-pit deposit for the economics to work. But this whole area is becoming ripe with new discoveries and infrastructure will follow, and, at some point, it’s also going to be ripe for consolidation. So I think that the current grades are very close to what a company would need to make a deposit work in the Yukon.
TGR: What did you make of the recent friendly merger between Keegan Resources Inc. (KGN:TSX; KGN:NYSE.MKT) and PMI Gold Corp. (PMV:TSX.V; PVM:ASX; PN3N:FSE)?
BL: It was a great deal for both companies. Everyone’s been waiting for one of the majors to come in and scoop up one or both of these juniors and consolidate the projects in this area of Ghana. But those takeovers never happened. So these two management teams essentially decided to do it on their own.
In the near term, this isn’t a big share-price catalyst. But considering that the combined companies can now fully find the development of the more advanced Obotan project of PMI and get into production, the financing risk is removed essentially for both projects.
Obotan should get into full production by 2015 at around 200,000 ounces (oz)/year. By 2017, Keegan’s Esaase project will get added to the mix and bring production up to around 385,000 ounces annually. The bottom line is that we now have either a must-have acquisition by a major or the emergence of a new midlevel producer with the potential to continue consolidating the region.
TGR: Do you see this as an investible theme? Companies with nearby development-stage projects that are suffering from markets that aren’t all that flush with cash getting together?
BL: In this case, both of these companies are fairly well funded. I see them as being potential aggressors in a new round of merger and acquisition activity. These companies also have additional exploration potential. Keegan just made a new, very important property acquisition. It was a property swap with the Ghana government that it’s been working on for years and where the company sees the potential for some sizable extensions to the Esaase mineralization. So the story could get bigger on every front.
TGR: You recently added some companies to the rather lengthy list of ones that you cover. One of them is Precipitate Gold Corp. (PRG:TSX.V), which is seeking gold in the Dominican Republic. Does it concern you that it has only $1.8M in exploration capital?
BL: Not really. That amount is actually a decent treasury compared to the peer group. There are hundreds of companies in the junior resource sector now that only have a few $100,000 in the treasury. The company, though, will have to raise more money to advance its projects in the Dominican Republic.
There is potential for further dilution, but the share structure is fairly tight. There’s only about 24–25M shares outstanding, no warrants overhanging the stock, and the company is well-held by a strong group of financiers. Bottom line is I don’t think they’ll have any problems raising additional funds if needed.
TGR: Another company that’s exploring the Dominican Republic is GoldQuest Mining Corp. (GQC:TSX.V). It recently had some less than ideal drill results and the market reacted negatively to those. Was Precipitate affected adversely by association?
BL: Absolutely. GoldQuest was another case where the expectations were raised really high. The first few drill holes from GoldQuest were just phenomenal and it would have been very difficult to continue that. GoldQuest really hit the honey holes right at the beginning.
But now the hype has definitely died down from the whole Dominican Republic play and Precipitate did suffer from that. The hype over the Dominican Republic helped obscure Precipitate’s outstanding property portfolio in the Yukon and British Columbia, where it has about 19 highly prospective properties that were acquired for really valid geological reasons. That’s the side of the company where I expect the next really important exploration news will come from.
TGR: What are some other companies that you follow that could see a rebound in 2013?
BL: The list is starting to grow a bit long. But there are really some remarkable bargains right now as the year draws to a close. Investors should concentrate on companies with either proven resources and/or the likelihood of big news on the near-term horizon.
Some of the prime examples that I would throw into this category are Cayden Resources Inc. (CYD:TSX.V), International Tower Hill Mines Ltd. (ITH:TSX; THM:NYSE.MKT), Gold Standard Ventures Corp. (GSV:TSX.V; GDVXF:OTCQX), Kaminak Gold, and Lion One Metals Ltd. (LIO:TSX.V; LOMLF:OTCQX; LY1:FSE).
TGR: Let’s start with Cayden. That’s a story that’s largely unfamiliar to our readers, with the La Magnetita target in Mexico.
BL: What’s important about Cayden is that there are a few aspects to the story. There’s the property position that it has at the Morelos Sur gold project. It actually partially surrounds and transects the largest producing gold mine in Mexico, Los Filos, which is owned by Goldcorp.
That mine has to expand, and in fact, it’s already encroaching on the surface onto Cayden’s property position. That means there’s going to have to be some kind of a financial accommodation done there and it could be significant for the company.
In addition, Cayden has the land between the two producing pits on Goldcorp’s mine and Cayden has drilled that. It has shown that there is mineralization trending from between those two pits at depth on its property. So Cayden has proven mineralization and an obvious natural buyer for whatever it can prove up.
Then you have the La Magnetita target. The key to that is that every mine and discovery in the Guerrero Gold Belt has been identified through geophysical means. Importantly, La Magnetita is the largest geophysical anomaly in the belt. To date Cayden has gotten some outstanding sampling and trenching results, and is now drilling, so I’m very excited about that potential.
TGR: International Tower Hill is a story that took off a few years ago and seems to have stumbled more recently. What’s happening with the company now?
BL: Its Livengood gold project is a case of a really large project with lower grades. The project is still economical, but you have to get the majors out there ready to buy up such a project. That will likely happen, but only when we have a sense of normalcy in the market that we haven’t had in the last 18 to 24 months.
TGR: How about Kaminak? We talked a little bit about the Yukon with Comstock and Kaminak’s right there too in the White Gold District.
BL: Yes, it is connecting all of these various anomalies on its property and building up a resource that, in its recently released maiden resource estimate, is already totaling over 3.2 million ounces of inferred resource.
Kaminak has come off a good bit and could be a prime takeover candidate. It’s being derisked with every drill hole. The company has had incredible success so far and it has just completed one of the most aggressive drill programs to be seen in the junior resource world in many years.
At the current price levels, it’s hard to get hurt in Kaminak.
TGR: Gold Standard Ventures, which owns the Railroad gold project in north central Nevada, is a made-in-America story. What’s the next catalyst for Gold Standard?
BL: This was a slow motion discovery. When the company first came public, I didn’t recommend it in my newsletter because I thought it was too expensive.
The company’s first results weren’t spectacular by any means, but they were technical successes—not market successes. However, once you understood the story and talked to the geologists, you understood that the company was vectoring in on something that could be big. We were able to get our readers in on the stock before the big run up, which was just wonderful timing, after it had declined a bit after it first came public.
The geologists kept vectoring in on the mineralization while proving up the geological concept, until they eventually found the higher-grade mineralization. At this point, it is still trying to fully understand the mineralization and get a much better handle on it. I think what you’ll see is that Gold Standard will be able to advance the resource to a much greater degree over the coming months. This is another example of those very hot stories that have come back a good bit, yet have a proven discovery, and the company will just keep drilling to prove up a resource.
TGR: What’s happening with Lion One?
BL: Lion One is progressing with permitting and development of its Tuvatu gold project in Fiji, a project with upside potential that I don’t believe is being valued by the market at all. Over $30M was spent on this project by Emperor Mines Ltd. in the late 1990s, including over 85,000m of drilling and 1,600m of underground infrastructure.
All Lion One has to do is dust off and update an existing feasibility study, and get the necessary permits to get into production. It is doing that right now, and will use proceeds from Tuvatu to fund exploration of the multimillion-ounce potential of the project.
Management, including legendary financier Walter Berukoff, owns about 40% of the company, so it has solid support going forward. It’s a great buy at these levels.
TGR: It’s the end of the year and some retail investors are wondering what to do with their portfolios and if they should make some changes. Is there a process that you go through at the end of the year?
BL: The end of the calendar year is a natural time to clean up a portfolio and rationalize things. But it is also the time of the year that you typically have tax-loss selling that creates a dampening effect on the markets and sometimes creates some pretty attractive bargains. This year, as I said, we’ve had some screaming bargains created.
I think what investors need to do, and we’re doing it with our Gold Newsletter portfolio as well, is to look at the number of companies that you can adequately follow. If you’re able to find some really attractive opportunities in this kind of an environment, you need to start switching into these faster horses in exchange for some of the slower horses in your stable. Just turn over the portfolio a bit, rearrange it and get prepared for the future.
It’s especially important if you can find companies that are better positioned going forward than the ones you have in your portfolio and you can realize some tax losses going forward. There’s no reason to play the psychological games of holding on to a loser just so you can get back what you paid for the stock. Be ready to break emotional ties, sell a company and put the money on a better bet going forward.
TGR: We’d be remiss if we didn’t ask a gold bull like yourself to tell us what you think the coming year has in store for gold. Please give us your thoughts on that.
BL: It’s going to be a very good year for precious metals and mining stock investors. Once we get through these end of year trading games and that fiscal cliff fiasco, the markets should settle down into an environment where everyone recognizes that massive money printing will continue for years to come. This is the fundamental story that’s going to drive metals prices higher and in this environment the equities will begin to benefit once again.
There’s also a very powerful technical picture developing. Both gold and silver are tracing out a cup-and-handle formation similar to the ones they formed during the 2008 credit crisis and the subsequent recovery from that crisis. After that, the metals rocketed higher out of those cup-and-handle bottoming formations. I fully expect a similar performance this time around, which would be a pretty exceptionally profitable situation for gold bulls.
TGR: Thanks, Brien, for your insights.
With a career spanning three decades, Brien Lundin serves as president and CEO of Jefferson Financial, a highly regarded publisher of market analyses and producer of investment-oriented events. Under the Jefferson Financial umbrella, Lundin edits and publishes Gold Newsletter, a cornerstone of precious metals advisories since 1971. He also hosts the New Orleans Investment Conference, the oldest and most respected investment event of its kind.
There are probably diminishing returns to this investment strategy, but aping the rich is not a bad idea, at least in this case:
Investors worried that inflation and financial market turmoil will wipe out the value of their cash have poured money into gold over the past decade. Prices have gained almost 500 percent since 2001 compared to a 12 percent increase in MSCI’s world equity index.
Sales of gold bars and coins were worth almost $77 billion in 2011, up from just $3.5 billion in 2002, according to data from the World Gold Council.
“The rich are buying standard bars or have deposits of phsyical gold. People that have less money are buying up to 100 grams,” said Michael Mesaric, CEO of Valcambi “But for many people a pure investment product is no longer enough. They want to be able to do something with the precious metal.”
If people who make their money in stocks don’t think that stocks are going to be very profitable for much longer, then one of two things is the case: either we’re about to see a very impressive opportunity for making money in the stock market because all the experts are collectively wrong, or it’s time to buy gold. I’ll let the reader decide which scenario is more likely.
Surveying reality from his perch on Vancouver Island, Leonard Melman is a veritable sage in the world of metal mining analysis. In an interview with The Gold Report, the economic philosopher is troubled about the direction of the global economy. However, there are a few bright spots for eagle-eyed junior metal investors, he reports, and names some of his favorite picks.
The Gold Report: Leonard, what are the most pressing issues facing investors today?
Leonard Melman: Let’s start with the fiscal cliff. If America falls into this abyss, the combination of tax increases and spending reductions will slow down economic growth. Interestingly, political leaders in Europe are calling for increasing taxes and decreasing spending in order to solve their problems. I find it amusing that the solution to economic problems being proposed by leaders on the European side of the Atlantic is thought to be the problem on the American side of the Atlantic.
TGR: How do you account for the disconnect?
LM: It is due to a philosophical inconsistency and a lack of economic understanding on the part of the world’s political leaders, most of whom are not well qualified as economic thinkers, nor as philosophers for that matter.
TGR: How important is a philosophical stance to making a cogent economic analysis?
LM: Adhering to a strong underlying philosophy can guide leaders through difficult times. Unfortunately, demands by the public for more and more government services are making politicians even more reluctant to come down on the side of austerity, particularly in America. The results are uncontrollable deficits and a massive national debt. The statutory debt limit of the U.S. government is $16.394 trillion. The national debt of the U.S. as of mid-December was $16.337 trillion. Therefore, a mere $52 billion remained before the ever-rising debt reaches the statutory limit.
TGR: What will happen if no measures are taken to change the debt limit?
LM: According to law, portions of the government must cease operations once the limit is reached. Nobody wants to see that happen, least of all politicians. So I believe they will likely agree to increase the debt limit by another couple trillion dollars.
TGR: What will happen if the two-party system fails to agree on tax and spending cuts? How will the market respond?
LM: The market operates in two different directions. The precious metals market historically has regarded instability as a plus. The financial markets have historically regarded instability or uncertainty as a minus. If the parties fail to resolve either the fiscal cliff or the debt limit problem, I believe the financial markets will react negatively, but the precious metals markets will most probably react positively.
TGR: Then why has the price of gold bullion during the last year been so out of sync with the deflated price of junior gold mining stocks?
LM: In late 2007 and early 2008, the price of gold hovered near $800/ounce (oz). It’s over $1,700/oz now—more than double the earlier price—and yet the three most popular mining share indexes, the Philadelphia Gold and Silver Index (XAU), the NYSE Arca Gold BUGS Index (HUI) and the Market Vectors Gold Miners ETF (GDX), are all below their late 2007 and early 2008 levels. That is rather astonishing. The reason is that the nature of mining—especially for the juniors—has undergone dramatic changes in recent years, none of which are positive. Increasing energy, transportation, geological and licensing costs make it now more expensive to mine for metals, but the most pressing problem is that the time that it takes to put a newly discovered mine into operation has increased at a rapid rate.
“The precious metals market historically has regarded instability as a plus.”
I’ve been in this business for four decades. In the late 1970s, a mine could anticipate rapid progress from the time of discovery. A junior simply raised money, put the money into the ground, proved up the asset, got construction financing and went into production. Now a series of lengthy bureaucratic processes are making it difficult for mining companies to raise new funds in the financial markets because that causes share dilution.
Share dilution tends to knock down share price, which makes it difficult to arrange the next round of financing, which then makes it even more difficult to advance exploration and development and a most difficult spiral ensues that makes it very difficult for miners to generate revenue from production.
TGR: Are environmental regulations the only cause of slowing timelines for new mine development?
LM: There are other obstacles. In Canada, we have an aboriginal problem. The courts have literally given many aboriginal tribes the ability to interfere in the progress of a mining venture. Companies are required to “consult” with them at various stages of progress. Consultation is expensive, it’s time consuming, and it can be interrupted by legal procedures at almost any time.
TGR: Do you see any changes in the near term?
LM: The near term remains very difficult. In the long term, I’m fairly optimistic, because the world needs metals to survive, plain and simple. You can’t cook food, you can’t drive anywhere, you can’t process energy, you can’t run computers, you can’t have medical instruments and you can’t do almost anything that we do in modern life without metals. When genuine metal shortages begin to develop, we will see pressure build for a revision in these policies.
TGR: Are there any North American gold juniors that can weather these difficulties?
LM: There are some. I’ve developed an interest in Balmoral Resources Ltd. (BAR:TSX.V; BAMLF:OTCQX). A while back, I got to know Darin Wagner, and he struck me as a very competent individual. He successfully sold a company called West Timmins Mining Inc. (WTM:TSX), and now he’s the president of Balmoral. He understands the value of obtaining properties with a high likelihood of success. The old adage is that if you want to develop a new mine, acquire property in the vicinity of an old mine. Balmoral is working in the Detour Gold Trend along the Québec-Ontario border, which has four different multimillion-ounce projects. Wagner has a great chance of success there.
“Share dilution tends to knock down share price, which makes it difficult to arrange the next round of financing.”
Another company that I like is DNI Metals Inc. (DNI:TSX.V; DG7:FSE). It is working to develop black shale deposits in northern Alberta fairly close to the shale oil deposits and those black shales contain an enormous variety of metals. DNI has proven up very sizeable ore bodies at two locations on its properties, Buckton and Buckton South, and its current work involves resolving metallurgical problems. It’s obviously a high-risk investment. The shares are about $0.18/share right now, but there could be a very substantial return if the project works out.
TGR: DNI’s shares have fallen from a high of about $0.65 a year ago. Why is that?
LM: The same thing we’ve been talking about: the prolonged period of trying to prove up the resource during which time a firm has to keep raising funds to satisfy all operational and regulatory requirements. And the longer it has to keep looking for new funds, the more shares are outstanding, which tends to dilute the value per share.
TGR: So now would be a good time to buy DNI?
LM: From a risk/reward ratio, I believe it is a good time to acquire the shares—being fully cognizant of the risks and, of course, an investor should always do his own due diligence, but I think the potential gains outweigh the potential risks.
TGR: What about investing in bullion as opposed to investing in gold stocks?
LM: As noted earlier, during the last four years, investing directly in gold bullion would have provided a 112% gain. Investments in a variety of mining shares would have, on balance, stood still. But in the past, the opposite dynamic has applied. Looking forward, if the world monetary situation keeps declining, there could be a truly powerful gold bull market in front of us. That also applies to silver, platinum, palladium and some of the base metals. It is necessary for investors to clearly define their specific goals. If the general motive for investing in gold and silver is safety and preservation of purchasing power in case currencies break down, as they have done before, then one wants physical possession of the metals. But for trading gains, shares can be advantageous. Aside from shares, if a player desires to get in and out of the gold market quickly, exchange-traded funds work well. It depends on the investor’s objective.
TGR: What about silver?
LM: I like silver more than gold as a trading vehicle, because when precious metals are rising, silver tends to rise at twice the rate of gold. Of course, when the prices fall, silver falls farther; but if one anticipates a bull market in metals, then silver has real advantages.
“I like silver more than gold as a trading vehicle, because when precious metals are rising, silver tends to rise at twice the rate of gold.”
There are a couple of silver mines that I truly like in Mexico. Orko Silver Corp. (OK:TSX.V) has a very substantial deposit in Durango State of up to 200 million ounces of Indicated and Inferred reserves. Orko developed the property for about eight years before Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ) bought into the project. It created a joint venture with Pan American, which provided expertise and at least $18 million (M) of capital for exploration. But then Pan American decided that the project did not fit its needs, so it abandoned it.
The net result is that Orko obtained, at no cost to itself, $18M worth of exploration, which enabled it to publish a resource estimate, and allowed for a substantial increase in holdings. There was a bit of a shock to the share price when Pan American pulled out, but the stock now seems to be moving in an upward trend. The project is huge. Orko can either sell it to a major, or develop it into a very important and productive mine.
NOTE: Immediately following this interview, on December 16 First Majestic Silver Corp. issued a Press Release that announced that it had just concluded a friendly takeover of Orko, which afforded Orko shareholders a 69% gain over the present market value of Orko shares.
SilverCrest Mines Inc. (SVL:TSX.V; SVLC:NYSE.MKT) has a property in production in Sonora State, Mexico, called Santa Elena. It is throwing off a substantial amount of cash flow to further develop the Santa Elena resource, plus another property, La Joya, in Durango State. SilverCrest is expanding resources and increasing production, and doing it thanks to the cash from Santa Elena without suffering from the stock dilution that has been so harmful to other companies. It has managed to create a substantial cash reserve of about $20M.
TGR: Cash flow may be one of the most important things for investors to keep in mind.
LM: Cash flow improves the likelihood of a firm advancing its project by increasing production or discovering new resources without encountering potentially ruinous share dilution.
TGR: The share price of many specialty—or “rare earth”—metal mining corporations has disappointed investors during the past year. What will it take to reverse that trend?
LM: The world of rare earth elements is incredibly complex and potholed with variables. There are an enormous number of elements and each has its own attributes and its own uses. It takes full-time study to get a grip on how to identify demand, and how that demand can be met, given the network of variables. The rare earth miners definitely need to make a better effort to educate the public about the nature of their business.
And there is the same problem, as with all metals, of having to spend money without being on a clear path toward production. Some of the critical metals juniors went up very sharply a few years ago, after the Chinese announced they were suddenly limiting exports. Although the U.S. military establishment requires a stream of rare earth elements and other markets for rare earths are growing, many juniors have made little progress toward achieving production. The reputation of several of these companies has been hurt. The industry must more clearly identify to investors the positive attributes of rare earth elements and step up the pace toward production.
TGR: Are there any names worth watching in the critical metals space?
LM: Commerce Resources Corp. (CCE:TSX.V; D7H:FSE; CMRZF:OTCQX) is unique in that it has two specific projects with preliminary economic assessments. It has the Blue River tantalum-niobium project in British Columbia and a rare earth element project called Eldor in northern Québec. Each project appears to be capable of standing on its own merits; the company is attracting interest from potential end-users and possible joint venture partners. The price of the shares has come down recently, but I believe it’s reached the point where the potential rewards truly outweigh the risks.
TGR: Are there any holding companies in the metal mining space that investors should investigate?
LM: I enjoy Zimtu Capital Corp. (ZC:TSX.V) in Canada. Its game plan is to fund early-stage companies with developable projects. By funding and forming new companies, it is able to offer its own investors a chance to participate in early-stage share offerings at an advantageous price before the initial public offering (IPO). When Zimtu funds a project it normally receives a substantial block of shares. If the general market environment goes up, then the asset values of Zimtu go up, and that should lead to increases in its share price. It is a good game plan and if the market environment for the whole junior mining sector improves, then Zimtu stands to profit substantially.
TGR: Returning to the start of our conversation, how do your political and ideological preferences affect how you identify opportunities in the markets that you cover?
LM: I am a deep believer in limited government. There should be simple and easy to understand regulations only where they’re absolutely necessary. The current government interferences are a profound negative and worsening. If we can somehow turn the long-standing trend toward excessive regulations around, then profit opportunities within the mining industry should improve dramatically.
I’m normally an optimist, but I have serious concerns about the world’s financial stability going forward. Europe in many places is a basket case. Japan is facing enormous problems, particularly demographic problems. Nobody knows for sure what China is doing. America is facing colossal budgetary problems. There’s a mess out there and it’s hard to see a really clear path to valid solutions to the litany of ongoing serious problems.
It’s not that I’m a pessimist. I love life, I love nature and hiking in the woods and mountains, but when it comes to discussing economic matters, I do try to be a realist and look reality straight in the face. Frankly, there have been pleasanter times.
TGR: Thank you, Leonard.
LM: My pleasure, indeed, Peter.
Leonard Melman, publisher of The Melman Report, has been writing about precious and base metals for more than two decades as monthly columnist for California-based ICMJ’s Prospecting and Mining Journal and Vancouver’s Resource World Magazine. He focuses on how political and financial considerations impact the world of mining and the prices of the metals.
To find undervalued energy stocks that offer upside and stability, look for utilities with undervalued energy assets. That’s Ray Saleeby’s preferred method, and the experienced value investor has shared his top picks in this Energy Report interview, along with some research pointers. Read on to find spin-off pearls missed by overspecialized market analysts.
The Energy Report: Ray, your firm, Saleeby & Associates Inc., focuses on identifying companies with turnaround potential—good firms that trade at a discount, but enjoy a solid customer base in hard-to-enter industries. Why?
Ray Saleeby: I buy stock in companies that are discounted to the intrinsic value of their operations. This differs from growth investing, which focuses on companies that outpace their peers for earnings. It differs from momentum investing, which attempts to time stocks on a short-term basis. My philosophy of value is more long term and contrarian. I buy companies when they are out of favor.
“I buy a lot of utilities because there are tremendous barriers to entry to that sector.”
I handle $220 million ($220M) plus, of which about $100M is in the utility and energy industry. I buy a lot of utilities because there are tremendous barriers to entry to that sector. One does not find a gas utility popping up every other week! For the same reason, I like the construction aggregate business. And I absolutely love the water business. It’s a resource that we’re going to need forever. I also invest in defense electronics and oil and gas. There are also barriers to entry in the drugs and medical device space.
TER: Tell us about your research process.
RS: I have a library of 60,000 different research articles going back 20 years. I subscribe to about 60 different periodicals that provide financial reports and different types of information about various companies. I look at annual reports and presentations by companies. But before I buy a stock, I call up the management and ask detailed questions.
TER: How do junior gas and oil companies fit into this model?
“I like companies that have a first-mover advantage in acquiring developable property.”
RS: With the juniors, I take a very hard look at management. Does it have a track record of success? Are the managers personally invested in the firm? Second, I like companies that have a first-mover advantage in acquiring developable property. Clusters of wells provide economies of scale where drilling rigs can easily be moved around. Energy is a commodity business and access to capital is very important. And being a low-cost provider is crucial when dealing with commodities, as we never know when the market will fall. And, last but not least, I want companies that have a good hedging strategy. And for tax reasons, I look toward MLPs (master limited partnerships).
TER: Let’s talk about discounted utilities with exploration and development arms. Where are the undervalued opportunities in that space?
“The typical oil and gas analyst does not generally understand how to analyze utility operations, whereas the typical utility analyst does not understand how to value oil and gas assets.”
RS: One of the positives about operationally diversified utilities is that they can spin off resource development divisions. Now, a utility analyst is completely different than an oil and gas exploration analyst. With a spin-off, suddenly there are two different types of analysts following two related companies, and the new firm can get double coverage. Secondly, the new managers may have more incentive to produce than they did when they were operating under the parent company’s top management. Also, utilities are heavily regulated; spin-offs are usually nonregulated.
The negative aspect of a divestment is that utilities are generally financially stable and can provide a cushion for commodity capital into its development divisions through boom and bust times. And the flip side of a spin-off in the analytical marketplace is that the typical oil and gas analyst does not generally understand how to analyze utility operations, whereas the typical utility analyst does not understand how to value oil and gas assets. So the double coverage can turn into a negative, a discount of real existing value.
TER: What are some promising names in this space?
RS: Questar Corp. (STR:NYSE) is a perfect example. Originally, Questar was a utility that also had a gas exploration business. About two years ago, it spun it off as QEP Resources Inc. (QEP:NYSE), and it’s been very successful and is leveraging the resource needs of its parent. Questar supplies natural gas to a lot of customers. It is very competitive with electric and it steals customers that have a choice between electric or gas meters. It is well diversified; its Wexpro division also develops and produces gas for the utility and it is very attractive on its own merits. Another factor to consider is that a lot of natural gas companies are not able to make a profit in the current price environment, unless they are hedged. Some are starting to shift their exploration dollars toward oil, rather than gas, because oil is holding up relatively well relative to gas prices. QEP Resources is well positioned in gas but has recently made a couple of acquisitions in the oil business to help balance things out. It’s even buying back its own stock.
An example of a well-diversified company that has not split is National Fuel Gas Co. (NFG:NYSE). It is a combination of utility, pipeline, storage and explorer and producer (E&P) company with, I believe, some of the best assets in the U.S. It has 800,000+ acres in the Marcellus fields close to the New York consumer markets. It’s been around for 100 years, it has a good balance sheet, and it has a history of paying increasing dividends. Looking deeper, it had some problems with executing on oil-producing land it owns in California. And it was not able to get a joint partner for its Marcellus field after natural gas prices went down. If gas prices start popping up again, National Fuel could be a takeover target. The Marcellus acreage is extremely valuable and it can be better exploited if natural gas goes higher. Mario Gabelli has a position in the company, as do I.
TER: How hard is it for an exploration company to switch over from natural gas to oil?
RS: Some fields are more attuned to gas, some to oil. It is hard to get out of leases to switch over from one to the other resource. And drilling crews have to be shifted around, which is expensive. But there’s a glut of gas right now in a lot of different markets. And that’s one of the reasons why the MLP sector is a very attractive sector going forward.
TER: How do MLPs work?
RS: Master limited partnerships are structured so that income flows directly to the investors. It is not double taxed at the corporate level. Investors receive K-1 forms versus 1099 forms for their IRS tax returns. However, it is advisable that you really know what you’re doing before diving into a complicated MLP arrangement. MLPs may not be suitable for all investors.
TER: What other utility-centric natural gas companies provide good value for investors?
RS: Enbridge Energy Partners L.P. (EEP:NYSE) is an MLP. It operates one of the largest pipelines and brings Canadian tar sands oil into the United States. It enjoys great access to capital. It is a very well managed company. It has I-units, which allow investors to reinvest dividends and receive a 1099. It’s a unique investment for the long term.
Energen Corp. (EGN:NYSE) is a small utility in Alabama that runs a large exploration company in the Permian Basin. It is currently out of favor in the market—discounted to its asset value. It is very conservative. It hedges a lot, and has 30 years of dividend growth. It uses the dividend income from the utility to grow the oil and gas exploration and development business. It’s a good value find.
TER: Why is Energen discounted?
RS: As a combined utility and oil and gas exploration company, it is subject to the kind of analyst misdiagnosis I explained earlier. But Energen’s cash flow and its EBITDA are cheap comparable to its peers. It has proven reserves. Management is competent, even though it just reported a disappointing quarter: gas prices plummeted and the firm was not as well hedged as it had been previously due to expirations.
TER: Is there a limit on the supply of natural gas?
“Some say that the U.S. is the Saudi Arabia of natural gas. But the real question is: Is the existing supply an economic supply?”
RS: Some say that the U.S. is the Saudi Arabia of natural gas. But the real question is: Is the existing supply an economic supply? Companies simply cannot make money exploring for gas at the current price. Capital is moving into oil. Sufficient cash is not spent on the necessary infrastructure, such as storage and transportation, to take the gas to the domestic consumer and to international ports for export. The other problem is that it takes a while for utilities to shift over from coal to natural gas. Facilities are being built, but it takes time. On the upside, there are transportation uses for gas, especially for heavy trucks and commercial vehicles and government vehicles. Incentives are needed to support that transformation. The more these gas-dependent industries develop, the higher the price of gas will rise, providing more capital for more infrastructure and development. But a lot of E&P firms are keeping the gas in the ground for now.
TER: Are there any energy holding companies that reflect your investment model?
RS: MFC Industrial Ltd. (MIL:NYSE) is a company that has done phenomenally well. A $1 investment in MFC a little over 10 years ago is worth $6.50 today. It’s averaging a 20% compounded return. MFC is a true value investor. It turns energy and resource companies around and monetizes them. It recently bought Compton Petroleum. The management is very shareholder oriented; executives own a large stake in the company. It is a small firm, but it sources and delivers commodities and resources throughout the world.
South Jersey Industries Inc. (SJI:NYSE) is a utility in New Jersey. But probably 30% of their business is nonregulated. An investment of $6,000 in 1985—with reinvesting the dividends—would now be worth $720,000. Management has just been top notch in creating shareholder value.
TER: To conclude, are any of these firms looking at renewable energy development?
RS: South Jersey is involved in solar. But with the revolution in cheap natural gas, a lot of the solar and wind ventures have been put aside. A few decades down the line, solar is going to be the solution. The world has an abundance of sun! There are, however, cost and efficiency problems with solar and wind due to storage and transmission of power. Alternatives have a role in the future, but we have an abundance of natural gas at this time.
TER: Thanks for speaking with us, Ray.
Ray Saleeby formed Saleeby & Associates Inc. in 2001 after 15 years working with brokerage firms such as R. Rowland Co. and Forsyth Securities. Saleeby published a newsletter between December 1987 and May 1996 that received national attention. Articles written about him and his recommendations have been published in USA Today, The Wall Street Journal, St. Louis Post-Dispatch, St. Louis Business Journal and other periodicals.
Byron King, editor of the Outstanding Investments and Energy & Scarcity Investor newsletters, is expecting surprises in the energy sector in 2013. In this interview with The Energy Report, King discusses his forecasts for fracking’s impact on oil and gas prices, a worldwide uranium shortage and a possible change in the economics of alternative energy sources.
The Energy Report: Let’s start with a recent takeover deal that’s been getting a lot of criticism in recent weeks. Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) made a $9 billion takeover offer for the oil and gas explorer McMoRan Exploration Co. (MMR:NYSE) and Houston-based Plains Exploration & Production (PXP:NYSE). Are you happy with this deal?
Byron King: It came as a surprise. I’ve held McMoRan Exploration in Energy & Scarcity for about two years. I like what McMoRan is working to do with deep gas in the Gulf of Mexico. Still, I recommended that readers take their money off the table with this deal. Sell the shares, take the cash and we’ll find other opportunities.
McMoRan Exploration nearly doubled after the Freeport announcement, going from $8 to $15 per share. You can’t walk away from that kind of potential gain. Take your money, pay your taxes at the lower 2012 rates and do something else with the money next year.
There’s another angle to this takeover. Freeport and Plains together already own about 36% of McMoRan. There are a lot of ties here, between key individuals. I think this deal was driven by the impending tax changes next year. Freeport, the copper play, is borrowing a lot of money to fund this whole process. Fortunately, interest rates are very low, so it’s borrowing cheap to do a big takeover, which will give a lot of people a really sweet payday, and they’ll get to pay capital gains taxes at much lower rates this year than if they wait until January 2013.
TER: James “Jim Bob” Moffett, who founded McMoRan, is also paying himself. He was a significant shareholder in McMoRan Exploration. He’s taking from his left pocket to put it in his right pocket.
BK: Wall Street hated this deal. Freeport’s share price dropped by about $6/share within a few minutes of the deal being announced.
TER: This whole deal really hinges on the Davy Jones well offshore of Louisiana and whether or not it can make that play. Can it turn this around? Can it make it a viable, producing well?
BK: Davy Jones is all about using new, deep-drilling and production technology to make this type of well work in the Gulf of Mexico, albeit in shallow water—20 feet or so. Sad to say, the Davy Jones well isn’t quite where it needs to be. But it’s coming, and likely sooner than most people believe.
“I’m forecasting that oil prices are going to rise.”
The components of the technology are all there, I’d say. I’ve seen super-strong well casing. I’ve seen advanced valve systems. I’ve seen blowout preventers that can handle the stresses. It’s just that I have seen these things in vendors’ offices and warehouses in Houston. Now the trick is to systematize it all, and make the Davy Jones concept work as a deep gas producer with economics that won’t break the bank.
The next question is what’s going to happen with natural gas prices in the U.S.? Whether it’s Davy Jones or a new well, companies are drilling wells that need $6, $8 and $10 per thousand cubic feet (Mcf) gas. Yet, on a good day, gas is selling at $3–3.50/Mcf. Are the economics going to work? That’s a whole other discussion.
TER: How does this change the landscape among the hard asset players? Are we returning to the 1970s, when mining companies and oil and gas companies were one and the same?
BK: Back in the 1970s, when oil prices went up and the economy realized that energy was a key component of everything, a lot of oil companies started to get into other resources. They did these types of rollups in the 1970s, and then they spent a big part of the 1980s divesting and spinning these things back out. Right now, in this era, McMoRan may be a one-off idea. It’s a unique play. It’s not quite time to break out your old 1970s leisure suits and hang the disco balls or anything.
TER: Let’s get to what you’re calling “taxageddon.” How will this affect investors?
BK: When the tax code changes dramatically on Jan. 1, a lot of people are going to feel the sting. We’ll get hit by that 2% increase in the FICA Social Security in every paycheck. The capital gains tax rates will effectively double on Jan. 1, including the Obamacare increase. The personal rates will go from 15% to the 30–35% range. It’s a big hit.
TER: Are you managing the Outstanding Investments portfolio differently than you were a year ago? Are there more yield-bearing stocks in that portfolio?
BK: In the last year, I’ve focused more on identifying yield-bearing stocks. I added one this fall called Linn Energy LLC (LINE:NASDAQ).
TER: In recent editions of Energy & Scarcity, you have discussed declining rates at fracking wells across the U.S. Do you believe this is an across-the-board problem or is it limited to certain plays or geology?
BK: It’s pretty much all of the shale gas wells. A fracked well that does not decline quickly is truly the exception. Last week, at a conference at the University of Texas, the overall decline rates that were tossed around were absolutely shocking. The decline rates on wells in their first year are in the range of 35–40%, and it is a similar number in the second year. By year two, a company will have produced perhaps 75% of the ultimate recoverable hydrocarbon out of a well.
It utterly wrecks the economics of a gas well to produce most of its output up front, during a low-price environment. These frack plays are astonishing wells, in a technical sense, but the economics are very problematic.
TER: If the production rates are rapidly declining and there is not as much natural gas as first thought, won’t that ultimately lead to higher natural gas prices?
BK: Natural gas prices are already starting to climb back up. About a year ago, the number of rigs devoted to drilling for gas fell off a cliff. I am bullish on natural gas in general. The natural gas price could double to the $7 range within the year.
TER: One of the companies in your Outstanding Investments portfolio is Royal Dutch Shell Plc (RDS.A:NYSE; RDS.B:NYSE), which is moving heavily into natural gas. Is that a smart move?
BK: Royal Dutch Shell is moving to gas. Exxon Mobil Corp. (XOM:NYSE) is moving to gas. Chevron Corp. (CVX:NYSE) bought Chief Oil and Gas LLC in western Pennsylvania to establish itself as a major player in the Marcellus region. However, the executives from these companies will tell you about the very tight economics of these projects. Actually, Rex Tillerson of Exxon said that up until now, Exxon has been losing its shirt on these things.
“I am bullish on natural gas in general.”
I’m not going to say that Royal Dutch Shell has done the wrong thing. It bears watching. These big companies have deep pockets, and will have to work their way through this storm the same as everyone else. The good news is that the big guys can afford to take risks that small companies, or even large independents, can’t take to drill gas plays and test new technology that might change those decline rates from being so steep.
TER: What are some other senior oil and gas producers in the Outstanding Investments portfolio?
BK: Over the years, I’ve focused more on international names. Statoil ASA (STO:NYSE; STL:OSE) of Norway is a large, well-run company. I like that the Norwegian government has a large stake because it seems to be mature enough to let Statoil operate as an oil company, collect the dividends and benefits, but not interfere in the day-to-day operations. Statoil has wonderful technical capabilities. It’s a nice dividend payer.
French company Total S.A. (TOT:NYSE) is also a large, global company that operates in a lot of jurisdictions that France has close ties with. It pays a nice dividend. Total has been good.
BP Plc (BP:NYSE; BP:LSE) has been in the portfolio for a while. I kept it through the Gulf of Mexico blowout. BP’s shares dropped terribly right after the blowout, although I told people to buy back in at $28/share, and it wound up going up to the $40s.
Yet BP has been a very frustrating company for a lot of reasons. Of course, there is the Gulf of Mexico disaster, but it has other issues related to people’s perception of its safety culture. Fair or not, people write books about it, like Drowning in Oil: BP and the Reckless Pursuit of Profit, by Loren Steffy of the Houston Chronicle. That hurts BP’s share value.
Plus, BP hasn’t done itself any favors with the confusion over its partnership with TNK-BP. I’m still thinking through what to do with BP. On the one hand, it has a lot of great people and assets. It has an aggressive aspect to its exploration and production in the future. On the other hand, there is informed speculation that BP could be worth more in a broken-up state. It’s going to be interesting to see how BP evolves over time.
TER: Most natural gas is used to heat homes and to create electricity at large utilities. Could declining output from fracked natural gas wells ultimately be a boon to green energy sectors like solar, geothermal or wind?
BK: Cheap natural gas has completely altered the economics of the electric utility system in North America. Natural gas base rates are now considered the number to beat, even when people are proposing nuclear power. That’s a very odd dichotomy because a natural gas well can be set up and generating electricity in a few years. With nuclear, it can be a 25-year process to acquire a site, get the permitting and navigate the maze of regulation and public acceptance for a reactor. What may be a temporary glut of natural gas is truly altering the long-term investment climate for nuclear power.
TER: Are you less bullish on uranium plays as a result?
BK: I’m bullish on uranium because there’s not going to be enough new uranium mined and milled to meet demand. China has an aggressive plant-building program. Every one of those plants needs to lock down a 20- to 30-year supply early in the development cycle. There are not enough new mining plays coming on to supply that.
An entire level of uranium supply is also going to go away in a year. Russia is not renewing its agreement with the Megatons to Megawatts program, which purchased nuclear reactor fuel that had been converted from enriched uranium in old nuclear weapons.
TER: Are there any particular uranium plays that you’re bullish on?
BK: Uranium Energy Corp. (UEC:NYSE.MKT) extracts uranium via in situ recovery, by washing the uranium out of sandstone using hydrogen peroxide in Texas. It is producing uranium yellowcake at an internal loaded cost of about $18–20/pound (lb), which sells into a spot market at $50/lb.
“These frack plays are astonishing wells, in a technical sense, but the economics are very problematic.”
UEC’s numbers are going up. It just had a brand new permitting approval at Goliad, Texas. It will be using a fairly simple technology, drilling wells that are less than 1,000 feet deep. It’s pumping the fairly benign substance hydrogen peroxide, along with a few other odds and ends, into the sandstones. It is pulling it out with resins and taking it to a fully licensed plant at Hobson, outside of San Antonio.
I’ve visited the facility. It’s all good: The people are good. The technology is good. The economics seem good. I like Uranium Energy as a long-term play. It will be very sensitive to rising uranium prices that I forecast in the next year or two.
TER: Any others?
BK: Over a longer time frame, there is a Canadian company operating in South America called U3O8 Corp. (UWE:TSX; OTCQX:UWEFF). U3O8 has very early-stage uranium deposits in Colombia, Guyana and Argentina. I’ve visited the Colombian play. It is polymetallic, which means that in the process of recovering the uranium, it is going to be able to pull out phosphate, silver and some intriguing quantities of rare earths. It’s very early stage. It is still doing the drilling out in the jungle. It is a speculative play for long-term investors who know how to ride these junior resource markets.
TER: The green energy sector is in the midst of hard times. It’s had more downs than ups during the past few years. How would you characterize alternative energies right now?
BK: The renewable energy space has been very frustrating for most investors. It’s not to say that you can’t produce energy using solar, wind or geothermal. Of course you can. But it gets back to that well-known critique about how, when the wind doesn’t blow, you have no power. When the sun doesn’t shine, you have no power. What’s the answer?
Europe has a lot of wind and solar power. It creates so much power during windy and sunny times that it actually disrupts the fossil fuel baseload within Europe. Yet, for every windmill and solar field, Europe still needs fossil fuel backups to kick on if the alternative source goes down. This kind of overdevelopment of so-called renewables may feel good to the green side, but it has completely disrupted the economics of a lot of utilities across Europe. Many European utilities have ceased being investment-grade assets.
“What may be a temporary glut of natural gas is truly altering the long-term investment climate for nuclear power.”
We haven’t built renewables to that scale in the U.S. If we do, we would have a similar problem. Rapid overbuilding of green power will degrade the investment quality of many public utilities, which are among the few things that pension funds and institutions can still count on. It’s something that investors need to keep an eye on. We blew up the stock market in 2008 with a housing meltdown. Do we want to risk blowing up the market again with a utility meltdown? We’re not there yet, but we could be on that track.
The Holy Grail for renewable energy is backup battery storage that charges up batteries for continued use after the wind or sun dies down. I’ve been focusing on American Vanadium Corp. (AVC:TSX.V), which is developing a vanadium redox battery that’s very intriguing and scalable. It’s capable of storing immense amounts of electricity.
TER: They’re only being used right now in Japan, right?
BK: The Japanese are leading the charge of commercializing it. The Chinese are close behind. In the U.S., it’s the typical story of caution and underinvestment, relating to the problem of industry working with public utility commissions (PUCs). Will the PUCs of America build this new tech into the rate base?
Nobody wants to be the first one to approve a vanadium redox battery system for a public utility. People don’t want to put their necks on the block. But I suspect that a lot of people would love to be the second players at bat. Unfortunately, we are very risk averse in the U.S., whereas Japan and China are charging ahead—if you’ll excuse the pun. Looking ahead, if we crack the code on reliable, large-scale storage, it could truly alter the economics of alternative energies.
TER: If you were to speculate on which one of those renewable energy sectors will be the first one to be commercially viable, where would your money be?
BK: Solar panels are becoming less costly, which is improving the economics for use on a much larger scale. It will be geography dependent. The sunny Southwest and West regions ought to see solar penetration the soonest and in the greatest degree. The idea that there could be a solar-powered Boston or Minneapolis is probably not as realistic.
TER: One issue with solar is the lack of baseload power. That’s a big advantage of geothermal over solar. However, if you want to talk about frustrated investors, look at geothermal energy.
BK: I started out Energy & Scarcity Investor with a number of geothermal ideas. I truly believed that these things were on the way up, but the technical problems and capital requirements have been absolutely overwhelming. The fact is that the largest geothermal power producer in the world is Chevron. It picked all that up when it bought Unocal. In 2005, Unocal had developed a lot of geothermal in Indonesia. A lot of green-power people hate it when I say that Chevron is the biggest geothermal player.
TER: Geothermal is working in Central America. Why isn’t it happening in the U.S.?
BK: It’s started to happen here in certain areas, such as Nevada. I drove by a geothermal facility on Interstate 80 when I was in Reno recently. Where it works, it works well. But it’s getting it to work that’s the hard part. The foremost reason is that there are few geologists and engineers who understand this space. It’s tough to build a technical team and keep the lights on long enough to make it all work. It’s been very frustrating.
“I’m bullish on uranium because there’s not going to be enough new uranium mined and milled to meet demand.”
Even more frustrating is that geothermal is struggling to spread in an environment that is supportive of renewable energy. California and Nevada state legislatures are telling the public utilities to have a certain percent of power coming from renewables by certain dates. The Obama administration and the Environmental Protection Agency are supportive at the regulatory level. There are tax benefits and low interest rates. Still, the geothermal space has not worked out.
TER: Have you stopped following geothermal companies?
BK: I haven’t stopped. I just don’t spend a lot of time on them. There are too many other ideas that offer a better return on investment.
TER: To conclude, what investable themes in energy should investors look for in 2013?
BK: In terms of oil and gas, people should look for surprises. I’m forecasting that oil prices are going to rise. There are conventional oil plays that still offer excellent returns to investors.
Natural gas prices are also going to drift up as the year goes on. The rapid depletion rates on fracked wells from the past two and three years are going to kick in, and probably with a vengeance.
There could be interesting breakthroughs in the alternative space. 2013 could be the year when investors start to better understand energy storage. This could be the year that the investing community is going to begin to realize it’s out there and that could lead to the beginning of a rebound in the solar and energy storage spaces.
TER: Will we see a dramatic rise in uranium prices in 2013?
BK: I think the spot price will start to drift up late in the year. People are going to have a lot more on their plates to worry about in the first six months of the year. For some strange reason, a lot of investors have allowed their investment horizons to shorten up. What people ought to be worried about now is that at the end of 2013, there is going to be a big uranium shortage worldwide. It will happen. I don’t think that it cannot happen.
Byron King writes for Agora Financial’s Daily Resource Hunter. He edits two newsletters: Energy & Scarcity Investor and Outstanding Investments. He studied geology and graduated with honors from Harvard University, and holds advanced degrees from the University of Pittsburgh School of Law and the U.S. Naval War College. He has advised the U.S. Department of Defense on national energy policy.