Some may have noticed the emerging marketing theme arguing that Pittsburgh is a place for investment because of… water. As in H2O. The veracity of that is a topic unto itself. I always find it curious how the argument can be made when much of the region is subject to what could be a fairly draconian consent decree if there is not a massive new investment in our water infrastructure. New investment that we have only made minimal preparations for as yet. We won’t even go into the sorry state of our locks and dams that are vital to our use of much of the local water supply. It is like the Pirates advertising what great ownership and management they have. Don’t get me wrong, I think these are big real issues and I have long had on the book wheel on the right a great semi-recent book: The Great Lakes Water Wars by Peter Annin. But hold all those thoughts.
What water wars are in the news of late? Up in Milwaukee they also have a fair bit of water as well. So much water that they also are arguing their water supply is a core part of their regional competitiveness… just like Pittsburgh. But there is the problem for Milwaukee. Pittsburgh: friend of foe؟ It turns out Milwaukee is renaming its “Pittsburgh Ave” to “Freshwater Way”. Really? You could have paid a consultant to come up with that. But why did they do it you ask? Supposedly because they also want to lure water technology firms and “Pittsburgh” did not mesh with their vision of themselves. OK then.
Here is the thing. I like Milwaukee. I have to admit it has been a decade since I’ve been there, but it had a real Pittsburgh ‘feel’ to it when I was there. A real cross-midwest civic sympatico. Or so I thought.
Apparently they have been working on this some time and I am not the first to take issue with the whole idea. What do we do now that they have gone through with it all? So I say take the high road. No need for a counterveiling campaign to rename our Milwaukee St. Maybe we need some confidence building measures to prevent a cross-midwest cold water war.
In a world of unlimited time I would write the book explaining all of our street names. Why do we have “Milwaukee St” anyway. And if anyone has specific history on why Milwaukee has a “Pittsburgh Ave” I would love to hear it.
Aaron Kennon, co-founder and CEO of Clear Harbor Asset Management, shares some of his company’s trade secrets in this exclusive interview with The Gold Report. Educating yourself is critical before investing, and Kennon suggests questions to ask, what specialized knowledge your adviser should know and why small-cap and junior resource equities are offering surprisingly thrilling returns.
The Gold Report: Clear Harbor Asset Management actively invests in resource equities, and it’s doing so during one of the most bearish periods ever for resource equities, particularly for small-cap resource equities. Some institutions are leaving the space altogether while others are reducing their exposure. What are your plans?
Aaron Kennon: While the resource benchmarks have all suffered significantly over the last several years, Clear Harbor’s natural resources strategy has returned more than 58% since inception 27 months ago. This compares to an approximately 4% return by our benchmark, which is the Standard & Poor’s Global Natural Resources Index. We’re thrilled with this performance and believe that our team is well positioned to take advantage of investment opportunities in a more proactive fashion while the vast majority of investors remain either defensive or rattled. So our plan is to stick to our disciplined, value-oriented approach to the sector and continue to perform well for our clients.
We have also constructed a strategy where the majority of our securities are listed and operated outside the U.S., with approximately 50% of the positions representing small-cap companies. This contrasts with most of our competitors, who are forced into the mid-cap and large-cap segment of the market due to the size and scalability of their investment strategies. Clear Harbor has no intention of backing away from this sector, which has long been a specialty for us. There are too many attractive investments and too many compelling macro tailwinds. From the rise of the global middle class to the future population expectations to the undeniable fact that the world is embarking upon the most expansive monetary experiment of all time, resources are an essential component for any investor’s portfolio.
TGR: You said most of the equities that you invest in are based outside the U.S. Do you have anything in China?
AK: Our position in Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) represents our only natural resources investment in China at the moment.
TGR: Are you employing new or different strategies to counteract or even take advantage of the risk-off sentiment in the resource space right now?
AK: Yes. Some companies in the sector possess more cyclical risk than others. The larger, more diversified resources companies capture the general cyclical trends in the market but do not have as much business-level risk imbedded in them, whereas many of the smaller-cap companies significantly outperform or underperform due to geological or operational success. We attempt to balance both of these risks in the portfolio and adjust our strategy based on shifts in company-level valuations and macro risks. Our strategy provides us with the flexibility to shift from resources equities into the actual commodity, which some other strategies do not have. In an environment where we believe that equities could experience significant stress, we have the ability to lighten up on our gold mining exposure and perhaps allocate that capital into bullion, or shift from the mining sector altogether to agriculture or oil and gas. Of course, we can also maintain cash when we deem appropriate.
TGR: Could you break down the asset allocation inside Clear Harbor’s Natural Resources Strategy?
AK: One third of the portfolio is in the metals and materials sector, just under two thirds is in the energy sector and the remaining piece represents agriculture.
TGR: Has that changed over the last year?
AK: The allocation has remained relatively steady.
TGR: Many analysts will tell investors that they need to do their due diligence before investing in junior resource plays, but that’s very easy to say and much harder to do.
AK: Due diligence is critical when analyzing the investment merits of a junior resource company. We always try to meet with management teams and determine their knowledge base and try to glean an understanding of their past successes and failures. We also seek to determine a company-level valuation based on existing and future resource potential. A drilling program at the junior exploration level can either kill a project or expand its resource potential and legitimize management’s vision for the company. This speaks to the geologic risk and, therefore, the investment risk that is inherent in a junior company.
TGR: Are there some rules of thumb that you apply to your due diligence?
AK: There are several. A few that immediately come to mind are: quality and flexibility of management, appreciation of the capital markets and valuation of the stated and prospective resource assets. The ownership structure is also of interest to our due diligence. Does management own equity? If so, how much?
TGR: Do you have a geology background? Do you like to look at the core?
AK: I’ve looked at lots of core. I do not have a geology background in an academic sense, but I spend a good deal of time on the ground with geologists. For example, when I was in Argentina recently, we had an opportunity to travel with a geologist from one mining company to the other, and he was extraordinarily helpful in connecting geology to an investment thesis.
TGR: These days, geologists can put numbers into computer models to build preliminary economic assessments and NI 43-101 technical reports. But these models often don’t take into account things like structural controls in terms of geology and other nuances of a deposit. As a result, are these mines not performing to the levels put out in prefeasibility and even feasibility studies?
AK: It varies. I make sure that there is a good deal of geology knowledge at the company level but also a respect for and an understanding that, at some point, an exploration program needs to go from being a science project to potentially a business model that can return value to shareholders. Part of my job as a portfolio manager is to find companies that have people at the top who can merge those critical components.
TGR: While you were in Argentina, the country’s government nationalized Repsol YPF SA (REP:BMAD), a division of a Spanish oil company. What was your reaction to the news?
AK: While this was a significant event for the country and the capital markets, my initial reaction was not one of shock but of disappointment. The government’s decision follows a pattern of contempt for foreign creditors. With that said, some of the largest companies in the world continue to wade into the country and accept the political risks. Apache Corp. (APA:NYSE) is increasing its capital expenditures in the country by 20% to $300 million (M). In my opinion, the Argentine government will find it challenging to seek out international partners to operate and expand the YPF resource in production. That will lead them to conclude that what occurred in this particular instance should not apply to other resources companies in the country in the future.
TGR: How does this compare to Venezuelan President Hugo Chávez seizing the assets of a number of oil contractors there as well as the Crystallex International Corp. (KRY:TSX) gold mine?
AK: Time will tell. YPF was once a publicly owned company, owned by the Argentine government before it was privatized and sold to Repsol in the 1990s, so the YPF nationalization was justified through several lenses: populism, colonial angst and national pride. The Argentine government recently aired a commercial that presented the history and identity of Argentina as firmly entwined with the history of YPF: former Argentine President Juan Perón, the Argentine flag, a crowd of children waving flags and a YPF gas station choreographed together in this television commercial. I’m not sure the government could pull off a similar ad displaying McEwen Mining Inc. (MUX:NYSE; MUX:TSX; MAQ:TSX) or Minera IRL Ltd. (IRL:TSX), for example.
TGR: While in Argentina, you spent time with Rob McEwen, the former CEO of Goldcorp Inc. (G:TSX; GG:NYSE). McEwen had remarkable success building Goldcorp into a top-tier gold producer, now the second largest gold company in the world. After he left Goldcorp, he started U.S. Gold Corp. (UXG:TSX; UXG:NYSE) and that performed remarkably well for shareholders as well. Then he took a large position in Minera Andes Inc. (MAI:TSX; MNEAF:OTCBB), and the two companies came together to form McEwen Mining. How did he react to the news of YPF being nationalized?
AK: He didn’t panic. He is a seasoned mining executive who has had to assess political, geological and execution risk on many occasions in the past. I’m sure he was disappointed, but he continues to believe there is good reason to maintain a significant presence in the highly prospective Santa Cruz province of Argentina.
TGR: Apache is there, and it is going to up its investment by 20%. On the gold side, Goldcorp is there. McEwen is there. AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) is there as is Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ). For silver, Coeur d’Alene Mines Corp. (CDM:TSX; CDE:NYSE) is there. Does the presence of these companies provide you with a measure of security in some of your Argentine investments?
AK: Certainly. These global players see the rewards in this region while also recognizing the risks. A junior investor should welcome their activity in the region. Juniors may seek partnerships with the larger players that have significant cash reserves and a desire to grow production in the coming years. Approximately 10 companies are actively exploring, developing or producing in this province. It remains a largely untapped opportunity, and that always attracts me as an investor.
TGR: This is a growing theme in this space that countries, especially in South America, continue to nationalize resource-based assets. It seems like it’s only going to get worse before it gets better. What makes it get better?
AK: We don’t see the core natural-resources countries in the region moving in this direction. Chile, Peru and Colombia are the other South American countries that remain on our radar screen. These three governments and their respective jurisdictions all function in their own unique way, but we do not see a thesis that what has occurred with YPF, for example, applies to the entire mining sector.
TGR: But Peru withdrew a mining permit from Bear Creek Mining Corp. (BCM:TSX.V). And there’s across-the-board resource nationalization via higher royalties and ownership stakes.
AK: Santa Cruz is a tundra, a desert-like environment with very few people and very little surface water. Peru has mountainous areas, ravines and the potential for mining activity to interfere in a negative way with the natural environment and local populations. We need to be careful not to confuse a removal of a permit for environmental purposes and local concerns with a true interference of government due to a desire to nationalize and retain capital within the country.
TGR: Apart from the Santa Cruz province being rather isolated and lightly populated, what else makes it a point of destination for mining companies seeking precious metals?
AK: Santa Cruz is vast but has significant infrastructure—roads, electricity—and also a meaningful level of collective mining knowledge on the ground there, both local and international. Most important, the geology appears exceptional by global standards. It was untouched by the mining industry until the mid-to-late 1990s. In other South American countries there are hundreds of years of artisanal mining. While San Juan has more history with mining and energy, Santa Cruz is in just the first years of what should be several decades of significant exploration and production success.
Larger producing mining companies with clean balance sheets and cash to put to work want to seek out mining companies in this capital markets environment that are on the verge of developing their mines, have already started to develop or are just in the process of producing. The geology is critical, but considering the stage of mine development may be an interesting strategy right now. A mid-stage or predevelopment-stage company is a multibillion-dollar company’s acquisitions sweet spot right now. In this challenging capital markets environment for the junior space, there may exist very interesting opportunities for the majors.
TGR: Are you buying companies, with that thesis in mind?
AK: Yes. The geology is exceptional, similar to Nevada in the mid-1800s: outcroppings, very little activity. This is a geologist’s and a gold miner’s paradise. And we’re not day traders in our strategy; we like to make investments, establish relationships with management and see a return on our capital over time.
TGR: You’re saying buy-and-hold can still work in this space.
TGR: What is the typical hold time?
AK: It’s significantly above the average holding period for a typical natural-resources strategy, particularly in the junior space. Greater than two years. Our strategy is only 27 months long, and many of the positions that were in the strategy on day one are still there today.
But we also look at every position objectively. We’re not beholden to the notion that every position needs to be a long-term holding. If the facts change, if management changes and we do not like the direction of the investment, we will change course as well.
TGR: What are some of your positions in precious-metals equities in Argentina?
AK: The positions that we own at the firm level that have exposure to Argentina are Minera IRL and Argentex Mining Corporation (ATX:TSX.V; AGXMF:OTCBB), but we have several names on the radar screen that we’re still doing work on: Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:FSE), Mariana Resources Ltd. (MRY:TSX; MARL:LSE) and McEwen Mining.
TGR: Why did you decide to take a position in Minera IRL, a small, precious metals–focused company?
AK: Minera IRL is an interesting company not only because it is a small cap that is under the radar screen of many investors, but it also represents the characteristics that an acquirer ought to look for in its business model: It has some existing production. It has a huge land resource. It has geographical diversification. It is active in Peru as well as in Argentina—it has production in Peru and is about to build an open-pit mine, Don Nicolas, in the Santa Cruz province. I am impressed with operational management, its geology knowledge base of the area and its willingness to be creative and nimble. The team is highly motivated and organized. It seems to communicate extraordinarily well and work well together across cultures, experiences and skill sets.
TGR: Argentex is developing its Pinguino silver-gold project in the Patagonia region of Santa Cruz province. What do you make of that deposit?
AK: The risk-reward profile of Argentex is different than that of Minera IRL, but I still think it’s a compelling profile. It has a resource estimate coming out this quarter, which should prove up the highly prospective nature of its resource, which is a silver resource. This is an asset that is trading at $0.10–0.12/ounce. The company has a bit of cash. It is drawing down about $200,000/month. It has probably $9.5M cash on its balance sheet. I am particularly impressed with the chief geologist over there, Diego Guido. He is also a professor at University of Buenos Aires and has access to other interesting perspectives within the geology space.
TGR: That stock is down about 20% this year. Does that make you nervous, when you see a company sliding 20–25% in less than half a year?
AK: We bought it about 30% lower than current prices. So it’s down on a year-to-date basis, but it’s a recent acquisition for us. So we’re actually quite pleased with where it is at this juncture. I think it speaks to who we are here at Clear Harbor Asset Management, which is a group of patient investors, and it also speaks to a little bit of luck.
TGR: Is that one of the things that you’re doing right now, seeing a lot of value out there and cherry picking some of the low-hanging fruit?
AK: Yes. There is some exceptional low-hanging fruit in the mining space at the moment. If you look at any sort of multiple across the space, cash-flowing gold mining companies are trading at historically extraordinarily cheap multiples. There are lots of reasons for that. One is the general nature of capital markets at the moment. Another one is disbelief that we’re going to see gold prices remain at current levels and perhaps go higher. Third is the historic transition of capital from the equity gold mining space to exchange-traded funds. There’s a significant opportunity to take advantage of these prices and carefully allocate capital across companies that you’ve done your work on and companies that represent different risks: country risk, perhaps geology risk to some extent and the risk of some being development stage, others being exploration stage and others being operational stage. Having a diversified portfolio is also important at this juncture.
TGR: Eldorado Gold, with an asset in Brazil, tried very hard to buy Andean Resources Ltd. (AND:TSX; AND:ASX), but Goldcorp ultimately won that auction. Do you believe that Eldorado will attempt at some point to reenter Argentina?
AK: Perhaps. It now is integrating the European Goldfields Ltd. (EGU:TSX; EGU:AIM) acquisition. This is a very talented management team. This is a group of people that has outperformed expectations over the last several years. To the extent that it integrates and moves the Turkey plans in the right direction, it wouldn’t surprise me if we see it dabbling in Argentina.
TGR: Are Argentex and Minera the only two in which you have positions in Argentina?
AK: Yes, but we are doing some additional work and believe that if someone is looking to allocate capital to the country based on the thesis that the YPF scare is overdone, you want to look not only at Minera IRL and Argentex but also look at Extorre, Mariana Resources, Mirasol Resources Ltd. (MRZ:TSX.V) and McEwen Mining.
TGR: Do you have some parting thoughts on the space at large?
AK: The capital markets are going to continue to challenge the juniors. This is an extraordinary time to be in the driver’s seat with capital and to allocate selectively to compelling investments, not just in Argentina but around the world.
TGR: Thanks for your time.
Aaron Kennon serves as chief executive officer of Clear Harbor Asset Management and is a member of the firm’s Investment Committee. Prior to co-founding Clear Harbor, he was a portfolio manager at Ingalls & Snyder LLC where he managed multi-asset class securities portfolios for institutions and high net worth individuals. Prior to joining Ingalls, Kennon worked at the Royal Bank of Canada and Citigroup Inc. Kennon is a graduate of Yale University.
Sagient Research Systems is known for its investor research in the drug and medical device field, but the firm has also tailored its scientific approach to market-moving catalysts in the precious metals industry. In this exclusive interview with The Gold Report, Senior Analyst Jocelyn August discusses looming events in a select group of natural resource stocks that are expected to move as information flows out.
The Gold Report: Jocelyn, you are following catalysts that affect resource stocks. Tell me about that.
Jocelyn August: We have started looking at catalysts in the natural resource sector. Originally, our CatalystTracker was designed to look at just medical devices and diagnostics as well as drugs and the catalysts involved in their development. But we did another impact study for the natural resource sector and identified some large-impact events in the minerals sector. Similar to drug and device development, you can follow a timeline for the development of a natural resource from the planning stages to exploration, and you can see similar catalysts in terms of the testing of the natural resources and results that might be announced. We think those types of events have large impacts for these companies.
TGR: And you publish on these events, right?
JA: We recently completed a Q212 Outlook Report for natural resources, and we discussed four upcoming gold catalysts for the second quarter.
TGR: Speaking generally for a moment to the differences between drug and resource development, I’m thinking that you have much shorter development times with mines than you do with drugs. Don’t you?
JA: It depends. I think there definitely are companies that have been developing a mine for a long time and have run into a lot of regulatory and permitting hurdles.
TGR: Can we talk about some of the impending events and companies?
JA: One that we highlighted in our report for gold was the General Metals Corp. (GNMT:OTCBB; GMQ:FSE). This is a very small company with a $5.8 million (M) market cap. It is working on the Independence mine project in Nevada. We expect it is going to announce a preliminary economic assessment (PEA), which is an important step in moving the mine toward production. It’s going to tell us if this mine is going to be economically viable in terms of development. So it’s a necessary step for moving on in the feasibility stage. It will be an important event for the company considering that that market cap is so small.
TGR: How important will this PEA be as a catalyst for General Metals?
JA: The company has announced that it does not have the additional funds to proceed with the plan of operation. So if the PEA is negative, then it’s going to be hard for it to come up with additional development funds. Because this is its only project in development right now, it might be forced to cut back or even cease operations if the PEA is negative. On the other hand, if it is a positive announcement, then this could be a major step for the company with pretty significant upside for that specific event. We think that that’s going to be happening in Q212 as well.
TGR: What else have you written about in your Q2 Outlook Report?
JA: We are looking at several different gold companies that have some updated resource estimates. There is a project in the Marban block in Quebec for Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.A). It has an option agreement with NioGold Mining Corp. (NOX:TSX.V; NOXGF:OTCPK) for this project. NioGold is currently the 100% operator of the project, but through its option agreement Aurizon can earn an additional 50% and then potentially up to 65% if it completes certain developmental milestones. So this updated mineral resource estimate for Marban would mean further fulfillment of the requirement for the option. It would mean that Aurizon would be at least a 50% operator here. That should work for both of them. That is also supposed to occur in Q212.
We also have an updated resource estimate projected for mid-2012 for Coeur d’Alene Mines Corp. (CDM:TSX; CDE:NYSE) for the Joaquin project, which is the gold and silver project in Argentina. It has already released some information on the estimate, and it is expecting to announce another update. That should give us a better indication of how much is actually present in that resource.
TGR: Coeur has a market cap of about $1.9 billion (B). How much can these catalysts mean?
JA: Coeur is a larger company with some other projects, but it should help give investors a better idea of where the company is going, how it’s continuing to develop its resources and continuing to make money. Obviously, all mines have a certain lifespan, and all these mining companies have to continue to find new areas to develop so they can make up for other mines’ production going down. It’s like a pipeline in drug development.
TGR: Is there one more you might mention?
JA: The only other one we have is North American Palladium Ltd. (PDL:TSX; PAL:NYSE). It’s a palladium company, obviously, but it is developing the Vezza mine, a gold mine in the Abitibi region of Quebec. The gold project is functioning as a diversification vehicle for the company, and we think that’s appealing. It is expecting to announce the start of commercial production in Q212.
TGR: Thank you very much.
JA: Thank you.
Jocelyn August is currently the senior analyst and product manager for CatalystTracker, a proprietary research product focused on identifying and analyzing the future events that will materially impact publicly traded companies. In her five years at Sagient, she has developed expertise in the highly event-driven medical device and diagnostic sector. In addition, she spearheaded the development of a new Natural Resource Industry product within the CatalystTracker product line with the publication of the Catalyst Impact Study: Natural Resources Sector. Outside of Sagient, August was named the director of communications for the San Diego Professional Chapter of MBA Women International. August received a Master of Business Administration from the Rady School of Management at the University of California, San Diego and graduated cum laude from the University of California, San Diego with a Bachelor of Arts degree in sociology.
Tom MacNeill doesn’t have to go far to find the most unique early-stage energy companies to invest in. The President and CEO of Saskatchewan-based investment firm 49 North Resources, MacNeill is bullish on his own backyard, and says of the province’s resources, “You name it, we’ve got it.” In this exclusive interview with The Energy Report, he explains why Saskatchewan resource plays trump their Alberta or Ontario counterparts.
The Energy Report: Even some of the most successful small-cap resource investors were schooled in 2011. What did you learn from last year’s ups and downs?
Tom MacNeill: We were definitely reminded of the nature of resource investments. Liquidity absolutely vanished in 2008, but by the time it reappeared in 2009 and 2010, investors had decided they wanted to keep their hands on their cash. Oil entered and exited 2011 at roughly the same price, but at times it had been much higher and much lower. That spooked investors. It became evident that most of the investors who were still comfortable with equity investments preferred dividend paying structures. It’s been a very edgy time.
We were reminded that investors were walking on thin ice. The companies that stepped up and started increasing distributions from their oil and gas production were well served. Those that did not, were not. There’s been a bifurcation in the market. The entire capped energy index is down relative to most of the broader indexes for the simple reason that investors were withdrawing money from the sector even though one barrel (bbl) of oil was about $100 throughout the year.
TER: Will the legacy of 2011 be the split between those companies that brought in dividends and those that didn’t?
TM: It’s one of the legacies. A lot of companies die in the aftermath of an event like the 2008 downturn. However, not enough undeserving companies died off because they had just completed financings and had millions of dollars in their treasuries that enabled them to weather the storm. We didn’t have enough of a rout.
Going into 2011, there were still a bunch of these Johnny-come-latelies and investors got wise. They started to watch the burn rate and what management was doing. It was a wakeup call. It was a really bad year in ‘08, it was OK in ‘09 and ‘10, and then ‘11 leveled as investors became objective. I believe that investors are more objective this year than they have been in five years.
TER: Your company doesn’t just invest in resource companies, it also instills management teams and brings in consultants with specific expertise. It’s an investor and a partner.
TM: We’ve had to be a little bit of everything within 49 North. We act as in-house management for developing companies. We provide seed capital and later-stage capital. We’ve got 25-plus of the best geoscientists in Saskatchewan on staff in one of our subsidiary companies, Northrim Exploration Ltd. That enterprise works with most of the senior players working in the province developing potash, oil and gas, and other sedimentary resources and is moving into hard rock mining consultation. We also have substantial connections within the junior resource capital market and investment banking community worldwide.
We had to develop it that way for the simple reason that we had no capital market in Saskatchewan. Where government used to hold business back, it is now very supportive. The resource business is now wide open. It’s a tremendous opportunity for us, and anybody who wants to invest in the province, because it’s like Alberta was in the ’40s and ’50s.
TER: Saskatchewan certainly shares some of the same commodities with Alberta.
TM: We view ourselves as much better off than Alberta from a geological perspective. The Western Canadian Sedimentary Basin overlays almost all of Alberta, meaning there’s really no hard rock mining with the exception of some coal mining and some other assets in the Rockies. Alberta is very much an “energy only” resource province.
Saskatchewan is the opposite. The sedimentary basin covers the southern half, but the northern half is exposed Precambrian shield. We’ve got all of the mining prospectivity and assets that you would find in Ontario and other hard rock jurisdictions, plus all of the oil and gas that you find in Alberta, and a sea of potash and other natural resources. You name it, we’ve got it. The neatest part is that it’s mostly still in the ground. There are 27 active mines in the province, but we should have a multiple of that given our resource base.
TER: How long do you think it will take you to get to that point?
TM: We have just begun, but it is moving fast. There is $15 billion (B) worth of capital committed already to expansion in the potash industry, not including capital commitments from BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), which is moving into the final feasibility stage of its 8 million tons (Mt) per annum potash mine at Jansen Lake. When mining is combined with our exponential growth in energy development I expect that $15B will double or triple in the next 5-10 years.
One new gold mine just came on-stream this past year. There are three others that are prospective in the Greenstone Belt in northern Saskatchewan. There’s a potential rare earth elements deposit that’s near development. In the next 10 years, at least 10–20 mining operations should reach feasibility in the province.
TER: One commodity that Saskatchewan is well known for is uranium. The Athabasca Basin is one of the richest areas for uranium in the world. In a 2010 interview with The Gold Report, you told us that you had mostly purged uranium from 49 North Resources’ portfolio and wouldn’t get back in until it was “time.” Is it time yet?
TM: The comments I made were based on a couple of observations. There was a physical price spike in 2006 due to uranium speculators. It created a parabolic price chart, so we knew that the price of uranium was going to come off. When that happens, all of the junior explorers get crucified. We took that time to exit our positions.
We’ve been diligently watching the uranium price chart and energy complex in general and view this year as the time to be taking positions. Uranium stocks have been beaten up. That’s the time when we get involved in projects and we’re actively pursuing more than what we have on the books right now.
We’ve got a significant investment in Unity Energy Corp. (UTY:CVE), which is an early-stage explorer in the same area as Hathor Exploration Ltd.’s (HAT:TSX.V) RoughRider deposit and the area were Fission Energy Corp. (FIS:TSX.V; FSSIF:OTCQX) is exploring. Also we have been accumulating a large position in Eagle Plains Resources. They have substantial landholdings in the Athabasca basin in Saskatchewan and recently announced a high-grade uranium discovery on their property near the Rabbit and Cigar lake mines.
TER: Tell us about Unity.
TM: It’s in the early stages of a promising exploration program having done the geophysical work necessary to advance their package of properties. We hold approximately 12% of Unity. Given that initial results have been very encouraging, we will likely be expanding our exposure shortly.
TER: What’s the earliest that Unity would have a resource estimate?
TM: They are at a very early stage in the exploration cycle so the earliest would likely be at least 2-3 years. Investors need to realize uranium exploration takes time, is expensive and if you want good science you can’t rush the process. This is a long-term investment, as all uranium exploration plays are.
TER: What macroeconomic trends are going to continue to drive energy commodities?
TM: Oil acts a lot like gold in that it’s a good parking lot for rampant money printing in the U.S. One thing that can quell inflation in the short term is a high oil price since it slops up many of the newly printed dollar bills in an asset that is used almost immediatly. This seems counter-intuitive, but it takes time for the inflationary effect of high oil prices to bleed into higher asset prices. So in the short term, it actually helps the money printers because all over the world, oil is traded in U.S. currency, thus distributing the new liquidity worldwide. The U.S. is the only country with this advantage, which creates some ironic economic activity that investors should pay attention to. As long as the U.S. keeps printing money, there’s going to be a high oil price. If the liquidity being added actually creates economic development, there will be rampant inflation. Usually that’s a tap that can’t be turned off, which could lead to much higher oil and gold prices. We view the coming five-year period as very interesting and probably very lucrative for resource investors, especially in gold and energy.
TER: What energy commodities are you most bullish on this year?
TM: We’re focusing on heavy oil and coal (for conversion to crude oil), but our backyard is unique. There are 20–40 billion barrels (Bbbl) of heavy oil in place in west central Saskatchewan. There are also staggering quantities of light oil as well in Saskatchewan, but I’m not as interested in that. Everyone knows about the Bakken shale and other tight light oil plays now being developed using modern multi-staged fracturing but very few follow heavy oil development.
My interest is tied to the recycle ratio, which is the net profit/bbl divided by acquisition and development costs/bbl. The ratio for light oil in Saskatchewan averages somewhere around two, meaning if a company puts $1 million (M) into acquiring and developing an average well, it will get $2M out of it. But heavy oil in Saskatchewan can have a recycle ratio as high as five.
That’s not true of everywhere in the world. We have two heavy oil upgraders in Saskatchewan that have been consistently adding capacity so we’ve got a real blessing here in that we can develop our heavy oil fields and achieve higher netbacks than elsewhere because of that very unique refining capacity in our backyard.
TER: What are some of the companies benefiting from that?
TM: Most of the companies that are developing these heavy oil assets that are in production are very large already and beyond our scope, such as Canadian Natural Resources LTD. (CNQ;TSX) and Baytex Energy Corp. (BTE.UN:TSX). We’re sponsoring private companies in this space. However, Baytex is coming up with ingeneous ways to drill multiple lateral wells from one drill pad and get enormous production out of thin-formation, heavy oil projects. They also pay a pretty decent dividend yield as well. That’s the kind of story we’re looking for, but we’re looking for it at a very early stage when a company has a prospective heavy oil development field and is investing its first $1–5M in the project.
TER: Are any of your private oil plays expected to go public?
TM: Probably. Allstar Energy Ltd., in west central Saskatchewan, is a light oil producer that is converting into a heavy oil producer as well. We’ve actually taken that one in-house and made it a subsidiary company. Had the capital markets been a little bit more buoyant over the last nine months, we might have entertained taking that company public sometime last year. At some point, given it’s growth potential, its capital needs will outstrip our ability to supply it and we’ll have to take the training wheels off and take it public. That could be in 2012 or 2013 depending on how development goes.
We also sponsor Admiralty Oil Ltd., a very early-stage light oil development in southeastern Saskatchewan. It will probably go public if it has some success this year.
TER: You said you are bullish on coal. What are some of your holdings in that space?
TM: There are two that we really like, which are both developing coal-to-liquid technology. We view coal as just another long carbon chain that can be converted into a shorter carbon chain to make heavy crude. These two enterprises are going about it in different ways.
NuCoal, a private company in southern Saskatchewan, will use full gasification to convert coal into transportation fuels at the mine site. It’s a multibillion-dollar project. The company has control of one of the largest coal resources in the world and it could possibly go public sometime in the next 12–18 months.
Westcore Energy Ltd. (WTR:TSX.V), which we have an approximate 25% stake in, has a significant thermal coal resource that it’s developing on the Saskatchewan-Manitoba border. It is working with Quantex Energy in Calgary, which has a proprietary technology developed at the University of West Virginia. Quantex tested some of Westcore’s coal and determined that it’s perfectly adequate for converting into heavy or light crude depending on the extent of processing.
Westcore is currently starting its winter drilling exploration program. It already has at least seven defined targets that have hit intersections as thick as 100 meters (m) of coal, which is absolutely enormous. It’s conservative to estimate that those intersections average 50Mt/coal, which could mean that the company has at least 300Mt/coal in one small area. That’s world class. It appears it will cost about $40-50/bbl of oil for the conversion technology. It will probably cost approximately $200M to build an initial 10,000 bbl/day conversion facility. Given that the process appears to convert coal to heavy crude at a ratio of 3-4 bbl crude from each ton of coal, there’s an almost endless potential supply of heavy crude oil for the refiners in Saskatchewan. Now that is an exciting energy story.
TER: It does sound exciting. Is the process by which they turn coal into heavy oil similar to what’s happening in the oil sands where they steam the bitumen to separate the oil from the sand and gravel?
TM: That’s a liberating technique using steam to get the bitumen. Then the bitumen is processed through hydrocracking, which involves heating up the bitumen under pressure with catalysts to separate it by strata into various elements. The lights float to the top of the column and the heavy stuff stays at the bottom, leaving five or six different strata. These synthetic crude products are then piped to refineries for further processing. The NuCoal project is similar to that in that it uses similar full-scale gasification technology but with the intention of the plant refining all the way to the transportation fuel level right on site.
The Westcore/Quantex route involves using a low-temperature direct liquefaction process. It adds some proprietary chemicals to the coal once it’s emulsified and converts it into heavy crude. The beauty is that the process does not leave much of a greenhouse gas footprint at the mine/processing site because most of the carbon dioxide and other problematic gases that would be emitted stay in the heavy crude and go to the refinery. The exciting part about low temperature conversion is its scale-ability with initial capital cost of probably one tenth that of full-scale gasification.
Both companies have viable approaches; they are simply on opposite ends of the development spectrum. One has low capital cost with smaller initial production while the other has large capital requirements at startup and therefore large initial output. At these energy prices we believe both approaches will be robustly economic.
TER: Once it’s converted it goes to the refineries. Where does the oil go from there?
TM: It is channeled into the North American distribution system running from northern Alberta into a hub center near Chicago. It goes directly into the pipeline system that bisects Saskatchewan diagonally. That’s the beauty. We’re infrastructure laden because we’re in between the consumptive market in the eastern U.S. and the production of western Canadian oil sands and conventional producers in the Western Canadian Sedimentary Basin.
TER: Do you have some parting thoughts on the energy space?
TM: I’m curious to see what prices are going to do. We’re comfortable that the price of uranium has bottomed and that it’s likely a very long-term bottom. We got our feet wet last year in some of the early-stage investments we’ve made. We’re going a lot harder this year and repatriating capital back into projects that we like. There are lots of good opportunities out there within companies that have done poorly in this twitchy market but have good projects.
The energy space should be an exciting one. If the governments keep adding liquidity, the resulting competitive devaluation of currencies will be inflationary and good for commodity prices. Or perhaps the world is going to get a little bit better—also good for commodity prices. It’s a bit of a win-win situation over the next five years if investors are patient.
Investors have to make sure that they stick to certain criteria. Look at management first, not the project, because the best project in the world can be screwed up by bad management. A marginal project can be made wonderful by good management.
TER: Thanks, Tom.
Read more of Tom MacNeill’s gold investing ideas.
Tom MacNeill is the founder, president and chief executive officer of 49 North Resources Inc., a Canadian resource investment company headquartered in Saskatchewan. As the first entity of its kind in the province’s history, 49 North is a pioneer in what is rapidly becoming one of the world’s most renowned resource jurisdictions. A graduate of the University of Saskatchewan (economics/geology), MacNeill is also a certified general accountant and holds a chartered financial analyst designation. MacNeill’s extensive knowledge of Canadian capital markets has been gained through experience as a management accountant within the mining industry, investment advisor with a major Canadian brokerage firm and chief financial officer of a Canadian trust corporation. He is a well-respected member of the resource industry and part of a worldwide network of exploration professionals and resource developers which enables him to source and structure projects.
A war-mongering U.S. government could be less than 18 months away from decimating the last 5% of value left in the dollar, says Richard Maybury, the author of the U.S. & World Early Warning Report. Until some new exchange-traded-fund-like basket of natural resources provides a store of value, this “juris naturalist” has some advice about how to protect your wealth during the coming collapse.
The Gold Report: Richard, last month, you made a presentation at the Casey Research/Sprott Inc. “When Money Dies” Summit entitled “The War that Will Kill the Dollar.” You explained that the corrupting influence of power had sent our country’s leaders shopping for war, disregarding Westphalian respect for sovereignty and hastening the collapse of society. What are the signs that we are reaching a critical point? And, is there any way we can change course?
Richard Maybury: You can see the signs very clearly in the Middle East and North Africa. The Federal government is involved in several wars there that have nothing to do with America. One of the best examples is Libya. U.S. officials are taking credit for Moammar Gadhafi’s death just a year after they were bragging about having tamed the threat. Now Libya is a mess. It will very likely be taken over by some sort of Islamic government that isn’t going to be very friendly to America.
TGR: Why do we, as a country, do this? If it’s not going to end well for us, what’s the economic or political reason to get involved?
RM: The U.S. government gets into wars in far corners of the world that have nothing to do with America because the leaders like getting into wars. That is how presidents achieve greatness in the history books. A president has no prayer of going down in history as great unless he has won a war. Look at Mount Rushmore. All four presidents featured there won wars. That seems to be the number one criteria historians use for deciding whether someone is a great president. It constitutes an automatic incentive to go out looking for wars.
TGR: What is the incentive for the American people to go war shopping?
RM: Nothing. It’s absurd. During the First Gulf War, people had a tremendous good feeling about going to war with Iraq. They would come home from work, order a pizza, sit in front of their TV sets and watch the war like it was a football game. War became a form of entertainment.
TGR: Is there anything we could do to incentivize our presidents to act peacefully?
RM: I doubt it very much. People go into politics because they seek political power. Once they get the power, they naturally want to use it on somebody. What is the point of having power if you can’t use it? So, no matter what kinds of controls you put on, future presidents will find a way around it.
The ideal situation would be one where war is used as a last resort. Westphalian sovereignty, a set of agreements dating back in the 1600s, established the precedent that the European powers would only go to war in self-defense. You had to have a clear and present danger before you could go to war. And, even then, it was supposed to be the last resort. That was the basis of international law up until this year. That isn’t to say that the Westphalia treaties weren’t violated a lot of times, but they helped. After Iraq, Serbia and now Libya, it is pretty clear that the policy is we can just go out and hit anybody we want for any reason we want as long as we believe the other guy is up to no good.
TGR: If this is the new reality, then let’s talk about some of the economics around it. War is expensive. You have pointed out that since the Federal Reserve was created in 1913, the dollar has lost 95% of its buying power. You said, “War destroys currencies.” It usually leads to governments printing more dollars to pay for guns and tanks. How much debt and overprinting can the country take before the velocity of economics, which is something that you also talked about in association with how quickly dollars are exchanged, catches up with reality and the dollar loses that last 5% of its value?
RM: Velocity refers to the speed at which money changes hands, and it is a measure of money demand. When people don’t really want the money, they start trading it away faster, trying to get their hands on things they do want, things that have value that they trust. The cost of this war in the Islamic world will continue going up. At some point, it’s going to be a major contributor to people losing what confidence is left in the dollar and people all over the world will start dumping it. This is a psychological thing. It’s about emotions, so it is hard to pinpoint when they will lose all confidence in the dollar.
TGR: What would it look like if that last 5% were gone? Are we talking about hyperinflation? Are we talking about banks collapsing? Are we talking about bartering? What would it look like?
RM: We are talking about all of that. It would be chaos. We saw it in Zimbabwe when the Zimbabwean dollar became worthless because the government printed so many that people wouldn’t accept them anymore. The country experienced enormous runaway inflation where prices were rising 50% a day before the Zimbabwe dollar collapsed.
It would probably start with someone somewhere in the world selling off his dollars and begin trading them for whatever it was he had confidence in. The foreign exchange value of the dollar would fall. Other people would notice; they would get scared and start selling their dollars. The foreign exchange value of the dollar would drop more. This process would continue until you have panic around the world to get out of dollars. Americans would be the last ones to get involved. We are always the last to know what is happening to America. Suddenly Americans would wake up one morning and find that a gallon of milk that cost $4 the day before costs $6 today. The next day they would find that it costs $12. And the next day they would find that it costs $36. That is when Americans would realize that they are in deep trouble; their dollars are about to become worthless.
TGR: Of course the Fed wants to avoid that scenario. You describe yourself as a follower of Austrian economics made famous by the Nobel laureates Friedrich Hayek and Ludwig von Mises. They describe financial systems as complex processes run by billions of constantly changing individuals rather than something that can be manipulated from a central point, which seems to be what is being attempted right now. If that is the case, what will be the outcome if the central government tries to force a more Keynesian control of the flow of money?
RM: They will mess it up even worse than they already have. The world has been living under Keynesian economics since 1971 when Nixon took the dollar off the gold standard. John Maynard Keynes was a semi-socialist. He believed that the way to fix the economy was to print a whole bunch of dollars and dump them out there. This has been standard procedure for the past 40 years. All currencies have been dropping in value during that time. Another round of quantitative easing (QE) could further speed the rate at which the money circulates, something that has the same effect as increasing the supply of dollars, creating a larger demand for goods and services and having an inflationary effect. I think Fed officials are dropping hints about the next QE because they are trying to cause velocity to rise, a secret QE if you will.
TGR: What if the stealth QE campaign doesn’t work? What form might a real QE3 take?
RM: It is hard to tell what they will do. One of the myths that everyone is taught is that the government has some sort of tremendous understanding of economics and the ability to make adjustments to economic activity. The term fine-tuning is used sometimes. Actually, we are talking about a group of human beings who don’t know much more about real economics than anybody else. They think they do, but they don’t. They just bounce around from one attempt to control things to the next, making a mess of the country. The economy is not a machine. It is people, human beings. It is a biological system, not a mechanical system. But, the government treats it like a mechanical system, so they are always making mistakes.
TGR: If war and hyperinflation are the inevitable future, how can investors survive or maybe even thrive during a time like this? What are the opportunities? Natural resources? Commodity equities? Where can we be safe other than putting that $100 bill under the bed?
RM: Well, I wouldn’t put $100 under the mattress, at least not for very long, because it will soon become worthless. But commodities, stocks of raw materials firms, gold and silver and platinum coins have value. Generally, I try to see the world in terms of two kinds of investments: dollars and non-dollars. You definitely want non-dollars, things that do not have their value tied to the value of the dollar. An example of a dollar asset is something like a bond or bank CD. Their values are tied directly to the value of the dollar. If the dollar falls, then their values fall.
Gold is a non-dollar asset. When the dollar falls, usually gold rises. The same is true with silver and oil. All of these things have values that are not tied to the dollar. My advice is to invest in non-dollar assets. Gold would be at the top of the list, silver and platinum and then oil.
TGR: In your Early Warning Report Newsletter, you predicted that gold will top $3,000/ounce (oz), silver will hit $50/oz and oil will exceed $300/barrel. Gasoline will go to $9/gallon. When will we see these rises? And what will be the catalysts that take them there?
RM: The next QE, which I expect to come along no later than March, could set off a flight from dollars. Then we could see those predictions realized within 18 months.
TGR: You said that once we have had this loss of the entire value of the dollar and people are looking for another way to trade, money could be based on some collection of metals with currency acting as a receipt for the tangible gold, silver, platinum and whatever else happens to be in that basket. What would that transition look like? How painful would that be? How would it be orchestrated?
RM: It doesn’t have to be painful. The markets are moving in that direction. People trade exchange-traded funds (ETFs) for practically everything now. I can envision a mutual fund or an ETF that is a collection of various things. It could be gold, silver and platinum. It could have oil in there. It might include Swiss francs. It could even have various patches of real estate. The ETF itself would then become a currency, not because anybody has it planned that way, but because the markets will see that there will be a demand for something that is a non-dollar asset that is easily tradable and seen as a store of value. There would probably be hundreds of these baskets of assets at the start. Some would work better than others would; the less workable ones would shake out. You might wind up with maybe a half dozen ETFs or mutual funds that are baskets of various assets circulating in the world. They would essentially become the currencies.
TGR: Would investing in ETFs now be a good way to prepare?
RM: No. I don’t know of any that are arranged that way. It may be a while until somebody catches the idea and decides to give it a try.
TGR: What about the precious metal equities? Would that be a good way to prepare?
RM: Yes. There are lots of good precious metal stocks. I own quite a few. That is another way to protect yourself. However, be sure to deal with a broker who really knows natural resources. You have to have some skill in picking those stocks. It’s not like going down and buying a gold coin where you just walk into the coin dealer and tell him I want a handful of American Eagles or Canadian Maple Leaves. You really have to know what you are doing when you are buying gold stocks.
TGR: Any final thoughts you want to leave with The Gold Report readers?
RM: The world has changed. When you look at the news and you say to yourself, “My God, America isn’t what it was; the world isn’t what it was,” have the confidence to know you are right. We are probably not going back to what America or the world was anytime in my lifetime. Therefore, you want to start learning everything you possibly can about this new condition and adapt to it.
TGR: Thank you for sharing your thoughts.
RM: Thank you, JT. I appreciate being here.
Richard Maybury, the author of the U.S. & World Early Warning Report, has written 22 books, including the Uncle Eric series, which focuses on economics, law and history. He has been interviewed on more than 250 radio and television shows. He is a Vietnam War veteran who served in the Air Force’s 605th Air Commando Squadron, a special operations unit involved in covert warfare in Central and South America. He has since lived and traveled the world, visiting 47 states and 45 countries. He considers himself a “juris naturalist” who believes in a natural law higher than any government’s law. You can visit his website at or phone 1-800-509-5400.
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Chen Lin stumbled into investing. While working on a doctorate at Princeton, he turned $5,411 in his wife’s retirement account into $1.5 million. In his newsletter, What is Chen Buying? What is Chen Selling?, Lin shares the fruits of his analytical aptitude. In this exclusive interview with The Gold Report, Lin reveals his latest finds in undervalued gold miners, and why he has high hopes for silver, too.
The Gold Report: With gold trading around $1,800+/ounce (oz.), famous precious metals investor Eric Sprott announced that he is selling 2 million units, or $30 million (M), of the Sprott Physical Gold Trust. Sprott then said he would take that cash and put it into silver, which he called “the investment of the next decade.” What do you think of his long-term silver strategy?
Chen Lin: Silver and gold are both precious metals, but they move at different times. Right now, the gold:silver ratio is a little bit over 40. Obviously, Sprott is more bullish on silver versus gold. I take a pretty even point of view. I like gold. I like silver. I know that historically the gold:silver ratio is much lower than it is right now. I checked Chinese history and it’s about 10:1. Even China has much less gold than the rest of the world and is richer in silver. We could have a much lower ratio, which means silver would outperform gold going forward, but personally I’m betting evenly on gold and silver.
TGR: Another interesting development is that Venezuelan President Hugo Chavez has announced that he will nationalize all of the remaining non-state-owned gold mining operations in the country. Is this announcement likely to affect the share prices of small-cap companies operating in other countries with leftist leaders, like Bolivia or Peru?
CL: I think it’s possible. What Chavez is doing will probably destroy the country’s gold mining industry because it needs the juniors to lay the groundwork so the majors can dig out the gold. If Chavez nationalizes, it will probably lower the gold production. I think one day he will regret that. It will increase concerns about the political risk in countries that have those close ties to Chavez.
TGR: Recently, we saw the Dow Jones Industrial Average drop a little over 400 points in a day. What’s your outlook for gold? Are we going to see $2,000/oz. gold before the end of 2011?
CL: It’s very possible. I personally do not want to see the parabolic move of gold. I hope gold doesn’t rise as fast as silver did in the second half of last year. But in the back of my mind, I think gold could do that. There is a dramatic difference between this year and 2008, however. In 2008, gold initially went down along with the stock market. This year gold went up as the market went down, which means investors believe gold is the place to put money. I read a report that some banks in China have low gold inventories because individual investors are buying gold like crazy. It’s very possible gold goes to $2,000/oz., but I hope it goes slower. I invest in gold. I have gold exchange-traded funds, gold futures, silver ETFs and silver futures on my recommendation list. But I hope they go up gradually.
TGR: Do you fear a correction?
CL: I hope we have some correction. I expect that the margin will increase another six times before gold has a real correction. That probably will push into early next year. Usually the gold season is strong from September into Chinese New Year. A severe correction could come in February.
TGR: You’ve said that you are seeing a decoupling of gold stocks versus stocks in the broader market. Can you explain that?
CL: Now, when the market takes a huge dive, gold goes up. Quite a few stocks, including Yamana Gold Inc. (TSX:YRI; NYSE:AUY; LSE:YAU) and Franco-Nevada Corp. (TSX:FNV) actually went up into the green. Many others, such as Pretium Resources Inc. (TSX:PVG), are up as well. Majors will start to stabilize and move up despite the stock market going down. As things stabilize, the juniors will likely catch up. As gold moves up, gold stocks are likely to outperform gold for the rest of the year.
TGR: Your investment success is somewhat legendary. You took about $5,000 in 2002 and turned it into about $1.56M by the end of 2010. Even as your portfolio regressed this year, it’s only by 10%. What’s changed in 2011 that is making it more difficult to find small-cap companies poised for big gains?
CL: This year has been difficult. The resource stocks got hit as investors took profits and ran. Fortunately, I have a pretty diverse portfolio. I have stocks, ETFs and futures. It is a very difficult year for small-cap companies, but I see some great opportunities. I’m ready to buy because investors are selling gold stocks indiscriminately. This is the time to buy. There are some great opportunities for investors that have a relatively long-term vision.
TGR: So then, what is Chen buying?
CL: Pretium, which I mentioned earlier, is run by Bob Quartermain, the founder of Silver Standard Resources Inc. (TSX:SSO; NASDAQ:SSRI). Management is really key at gold and silver companies. There are tons of companies that just go nowhere. The management raises money to pay themselves. With great management, like Bob Quartermain, there is a proven track record. He doesn’t just grant options to management. He buys them. He bought shares on the market like every other shareholder. He has a couple of projects that are becoming very promising in British Columbia, which I am visiting next week.
TGR: Is that the Snowfield Project?
CL: Yes. Pretium is in low-grade Snowfield and high-grade Brucejack. I think the Snowfield Project will likely do a deal with Seabridge Gold Inc. (TSX:SEA; NYSE.A:SA). Quartermain is more focused on the high-grade area with about 15 kilograms/ton of gold. Some people don’t believe it. They say it must be silver. It’s gold. That is what he is focused on. He is looking to do a very high-grade underground operation, which was permitted before. He just needs to reapply for a permit and get into production.
TGR: The company has a positive preliminary economic assessment, but it really hasn’t produced a dramatic rise in the stock price.
CL: That was based on previous results. In the new drilling tests, the company intersected a lot more gold. That will help them when people realize the valuation of the deposit. Another catalyst would be the deal with Seabridge and a major investing in the lower-grade area. The feasibility study is not very high, but the company used a conservative gold price. Eventually, people will catch up with it.
TGR: What are some other names on Chen’s radar screen?
CL: Barkerville Gold Mines Ltd. (TSX.V:BGM) has been on my list for a pretty long time. I like the company. I met the management. The stock has already gone up pretty significantly since my recommendation. However, it recently has been in consolidation, which could be an entry point. The company keeps making progress. It keeps producing gold, which means it can generate a lot of cash flow at the current gold price. That will fund its next move versus going into the market begging for money.
TGR: Barkerville is planning to mine about 50 thousand ounces (Koz.) from the QR Mine this year. Is it on target?
CL: I will be following that very closely. As long as the company is producing gold, it should be doing fairly well. As long as it can produce, even if it’s not 100% as planned, the higher gold price will compensate. If the company can make its target, that will be a great bonus.
TGR: Has Barkerville forward-sold any of its gold or is it fully exposed to the gold price?
CL: No, it is fully exposed to the gold price. You don’t want to invest in any company that has hedges in place. Then it would be selling gold at maybe $1,000/oz. when it could be getting $1,800/oz. or more.
TGR: Barkerville has about 937 Koz. outlined in all categories. That is still a pretty small operation. Do you believe that as the company produces gold and takes some of that money to further exploration, it will continue to discover more resources?
CL: The company is getting good drilling results. I’m sure when it updates its new resource, it will be much higher. Once the company starts to get into a good financial situation, it will do more exploration. Gold is prolific in that area—there is a lot to find.
TGR: What else is Chen buying?
CL: There is a very small company called Majescor Resources Inc. (TSX.V:MJX) that just announced fantastic drilling results. The stock is actually up about 89% right now. It’s a very tiny company with about a $20M market cap. It’s drilling next to Newmont Mining Corp.’s (NYSE:NEM) latest project in Haiti. Newmont’s chief executive said it is one of his most important projects. It’s had fantastic drilling results of 77 grams over 10 meters (m). It’s very shallow at about 100m deep. Plus, it has many other intersections with very high-grade gold and copper. For this market cap, it looks very promising.
TGR: It’s trading between $0.25 and $0.30. Is that a good entry point?
CL: I think the current price still looks very good.
TGR: How high could it go and still be a good entry point?
CL: There are heavy insider purchases at $0.20. I think anything between $0.20 and $0.30 is a great buy.
TGR: Majescor is effectively almost like an exploration arm for Newmont at this point. Does Newmont have a position in it?
CL: No, but Majescor has a mining license while Newmont is still applying for a mining license. That makes them a very good target for Newmont.
Haiti is on the same island as the Dominican Republic, which hosts one of the largest gold mines in the world. Since the earthquake, the U.N. is trying to help the country create jobs. One of the key areas it is looking at is mining. Haiti could be opening up and this could be a hot new mining area in the world.
TGR: What’s another name, Chen?
CL: I just visited Prophecy Platinum Corp. (TSX.V:NKL; OTCPink:PNIKD; Fkft:P94P). It’s in the Yukon, very close to the Alaska border and only about 10 miles from the Alaskan highway. It just announced a NI 43-101 for about 12 million ounces (Moz.) of platinum, gold and palladium. The key for the company is to have very high grades. Right now, it has consolidated a little bit as the company is probably going to raise money. Sprott just announced it bought about 10% in the open market. I would assume Sprott would probably participate in one of many raisings. Then we can potentially consolidate the stock and it could go higher.
TGR: It also has a producing coal mine in Mongolia, correct?
CL: That’s actually its parent company, Prophecy Resource Corp. (TSX.V:PCY). Prophecy Resource owns 45% of Prophecy Platinum, which is a spin-off. Prophecy Resource is also a very interesting story because Prophecy Platinum’s price almost covers the entire market cap. You’ve got a producing coal mine almost for free.
TGR: It just discovered a substantial coal seam in Mongolia about 20 kilometers away from its existing coal mine, which actually hasn’t had any effect on the stock to date. It certainly could be a promising find in the future.
CL: Exactly. There are bargains almost everywhere. Investors are just selling by emotions. There are a lot of opportunities and Prophecy is a perfect example. It owns 45% of Prophecy Platinum. You can calculate the market cap. It doesn’t make sense, but the market still treats it like this. I bet the market probably won’t treat it this way for too much longer.
Another is Romios Gold Resources Inc. (TSX.V:RG; NASDAQ:RMIOF; Fkft:D4R), which I am going to visit next week as well. It is drilling the Trek Property in northwestern British Columbia, right next to NovaGold Resources Inc. (TSX:NG; NYSE.A:NG) Galore Creek Project. It’s actually drilling on top of the company’s proposed mill site, so drilling results are pending. This stock could have a very explosive movement because its market cap is very small at about $70M.
NovaGold and Teck Resources Ltd. (NYSE:TCK; TSX:TCK.A, TSX:TCK.B) need to build a $1B tunnel to get ore from the other side of the mountain. But if the pair can find ore on the Romios side of the mountain, right on top of the mill, they could save $1B and take the company over. If there are good drill results, Romios will be an easy takeover target for NovaGold and Teck.
TGR: Romios recently found some massive sulfide mineralization at the Trek Property, which is known to host large gold and copper deposits. Can you tell us about those results?
CL: It has a lot more results coming. The assay is pending, but it looks very promising. If it has a grade similar to Tech and NovaGold’s Galore Creek, this is a very easy takeover target.
I want to mention another stock that is under the radar, Helio Resource Corp. (TSX.V:HRC), which is drilling in Africa and already has 1 Moz. of gold. Its market cap is very tiny, but it has some very important, pending results coming in the next few weeks. It is drilling to a mere 200m for open-pit gold. If it can upgrade its resource to a few Moz., that could make the company very cheap versus its market cap. It could see some major movement in the second half of the year.
TGR: That is the SMP Gold Project in Tanzania that has multiple zones of gold mineralization at shallow depths. Could that be a target for a company like African Barrick Gold plc (LSE:ABG)?
CL: It’s possible. Helio is an exploration company run by geologists. Its goal is to find a deposit and then sell it to the majors. If we use $100/oz. in its existing gold inventory that is already worth $100M and it is looking at a much higher stock price. It could expand dramatically with its recent drilling results. The company is well funded with $8M in the bank. It doesn’t have to raise money for a long time.
TGR: Helio is trading at just below $0.30 right now. At what point would you not get into Helio?
CL: I think it is dependent on its drill results and those are unknown. When the stock moves, it can move very fast. With its existing resource, around $0.30 is pretty good. But I don’t know what the drill results look like, so that will decide what the new valuation will be.
TGR: On the other side of the ledger, what are you divesting yourself of right now?
CL: I have been gradually selling some gold and silver ETFs. They have appreciated a lot, so I use them as buying power on the dip on the miners. Instead of following Sprott by selling gold and buying silver, I’m reducing a little bit to use that as capital to buy undervalued small-cap gold and silver miners.
TGR: You have had success in pulp, paper and oil and gas. What other sectors do you believe are poised for growth?
CL: I like the pulp sector, including the company Mercer International Inc. (NASDAQ:MERC). There are a lot of very undervalued energy stocks, as long as oil finds a floor somewhere in the $60–$70/barrel range. China does not have enough strategic oil reserves. If oil really dips, China would probably use the opportunity to build up more oil reserves. India has no strategic oil reserve. The pressure is on both countries to stock up if oil dips. In 2008, the worldwide oil demand only dipped like 1–2%. As long as investors stay with low-cost producers with good balance sheets, they will ride out the storm.
TGR: Any parting thoughts for us?
CL: I think this market correction will create a lot of opportunity for us. The market is putting a lot of pressure on the European leaders to get their acts together. There is a lot of pressure on Federal Reserve Chairman Ben Bernanke to do another round of quantitative easing. I hope the outcome will have some stabilizing effect on the market. In the meantime, when investors are selling everything, that’s a very good buying opportunity.
TGR: Excellent. Thanks, Chen.
Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc., publisher of J. Taylor’s Gold, Energy & Tech Stocks newsletter and Roger Wiegand’s Trader Tracks. Using his wife’s Roth IRA account, Lin invested $5,411 in December 2002, and by December 31, 2010, it was worth $1,188,993—with no cash added. You can see his portfolio chart here.
A doctoral candidate in aeronautical engineering at Princeton, Chen found his investment strategies were so profitable that he put his Ph.D. on the back burner. Chen worked in the Internet and computer area where he founded a few start-up companies. After the tech bubble burst of 2000, Chen was able to move his technology portfolio into the resource sector with considerable success. Chen employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis. To subscribe to Lin’s What Is Chen Buying? What Is Chen Selling? newsletter, click here or call Claudio Bassi at (718) 457-1426.
Growth is where you find it. Taylor Asset Management founder and CEO Stephen Taylor is an active global investor who loves Latin America, China and certain event-driven natural resource plays that he expects will provide big growth to investors who have made a bet on his Taylor International Fund. In this exclusive interview with The Gold Report, Stephen shares his best ideas—ideas that have multi-bagger potential.
The Gold Report: You had an interesting career that included being a floor trader on the CBOE when you were at Lakota Trading. You mastered skills there that could never have been developed in any other way aside from being on the floor of the Exchange. How does that inform what you do today, considering that so many of your current equity holdings are micro-cap, small cap or China-related and may not have derivatives attached to them?
Stephen Taylor: I started on the floor back in the days of floor trading, when it was open outcry and traders stood next to each other yelling and screaming. This was before the screen-based computerized trading of today, and it allowed you to see the emotional elements of markets up close and personal.
TGR: That’s actually what I was getting at.
ST: When you were going down to the trading floor, you could hear the roar of the crowd before you got there. Depending on that tone and the volume you could tell if the market was up, if it was down, how fast it was moving. In the trading pit itself you saw those periods when fear or greed would take over. There’s nothing like seeing it up close and personal and watching individuals or firms panic and make trades that maybe with the passage of time would not appear to be completely rational. So, in that sense it was an invaluable experience.
TGR: Your Taylor International Fund is heavily weighted in natural resources and emerging markets. Given that this space has seen a pullback and is generally soft at this point, how is your fund pacing so far in 2011?
ST: Well, we’ve taken our lumps. We’re not too far behind some of the resource-related averages, such as the TSX Venture. We’re down a little bit over 10% this year. But, you know, volatility is something that comes with this space. It’s something we’re comfortable with as long as we believe in the companies and the management teams that we’re investing in. We maintain a long-term perspective. We seek out and encourage our investors to maintain a long-term perspective. So, we’re not really rattled or shaken by these sorts of pullbacks. It just goes with the territory.
TGR: Do you think of the volatility as your friend?
ST: In many cases, absolutely. Not everybody likes volatility. Not all funds are able to deal with it. But it does present some opportunities. I think we’ve seen some overdone selloffs in the resource space. We’ve seen some extreme selloffs in the China space. And that’s presenting some good opportunities, in our opinion.
TGR: Your China positions represented about half of your portfolio when you last spoke to The Gold Report six months ago. Some of these were private equity. The due diligence would be daunting to most people. How do you research and verify these assets, liabilities and valuations in what I might refer to as esoteric investments?
ST: As you know, diligence is an ever-present issue, not just in this China space, but in the resource space as well. We are big believers in looking at management teams that have delivered in the past. We look at the partnerships that management teams and companies have, and the banking teams that they choose to deal with. We look at the strategic investors that they bring along, as well as the firms doing their auditing and legal counsel. We do site visits, and repeatedly meet with management teams. We try always to look at what companies do, and not what they say.
TGR: Is there any China counterpart to Sarbanes Oxley Section 404, requiring executives to be responsible for their financials?
ST: Well, I would point out that SarbOx has certainly not been a panacea in and of itself here in the U.S. A number of the high-profile blowups here in the U.S. were Sarbanes-Oxley-compliant, or at least testified that they were. Ultimately, whatever regulatory structure you have is only as good as people backing it up. With respect to China, clearly it’s a developing market. Their financial markets are not as mature as those in North America or Europe, and it’s an ongoing process. I think you’ll continue to see some progress being made in that area over the next year or two, especially with respect to allowing for broader SEC investigation and actions in China and harmonization of accounting standards.
TGR: When you founded the Taylor Fund in November 2008, you had $10 million under management, I believe. How much do you currently have under management?
ST: We’re a little under $50 million at this point.
TGR: So, you have almost five times the assets you started with two and one-half years ago. Has that growth occurred mostly without new investment?
ST: It’s been a combination of organic growth, some new investment and some follow-on investment from existing investors.
TGR: Have you reopened the fund to new investors?
ST: We haven’t formally reopened the fund. I suspect that we may do that sometime in the fourth quarter. That’ll be our three-year anniversary and an appropriate time to take a look at it.
TGR: That’s when the lockup will end for your initial investors?
ST: That’s correct, at least for a portion of them.
TGR: In a fund of this type, you really have to be as comfortable with the investor as the investor has to be with the portfolio manager.
ST: Oh, absolutely. In an ideal world, all funds would be that way. As a manager, it’s vital to know the risk tolerance and financial profile of your investors. I couldn’t operate nearly as well if I were concerned that some of my investors were taking inappropriate risks for themselves. It really has to be a good match.
TGR: You have to walk a narrow path, where you hold enough different positions that you’re not dangerously under-diversified, but where at the same time you can potentially achieve outstanding capital appreciation. Currently, how many different securities does your fund own? How are you weighted by country and sector?
ST: We have approximately 45 positions right now. In terms of weighting, we’re probably 20% in the energy space, 20% to 25% in the mining space, and we have probably about one-third in China-related investments. We currently have a 2% or 3% weighting in the financial space, but I suspect that will change to about 10% in the next few months. And we have roughly 5% or 6% in cash.
TGR: In part, you buy very small companies, some of which are in the micro-cap range. In many cases, they probably require some tinkering or restructuring. Do you think of yourself as an active investor or an activist investor? How do you see yourself?
ST: We like to look at ourselves as being positive, additive, collaborative shareholders. We like to think of ourselves as always having a good relationship with management teams. Depending on that relationship, CEOs will reach out and may ask for our input from time to time. We like to work on a collaborative basis in a win/win situation. Having said that, there are times when we have had to become active.
One case that I mentioned in the December interview was the Chapter 11 case of Meruelo Maddux Properties, Inc. (OTCPK:MMPIQ). It unfortunately required a lot of time and effort on our part, and it’s something that we’re happy we did. As part of the confirmed reorganization plan, which we believe will be effective this week, I will be taking a board slot there. So, I’m going to restrict my comments on that for now.
TGR: You invest in event-driven situations, and I assume distressed situations as well. Can you describe events and other situations where you might enter a position?
ST: By event-driven, we mean company-specific events that we believe will drive increased shareholder value. That could be a new project. It could be drill results. It could be a financial restructuring. In the case of Meruelo Maddux, it was bankruptcy reorganization. Another company that we were involved in early, of which I continue to be a big fan, is Red Eagle Mining Corp. (TSX.V:RD). I love Red Eagle Mining. We participated in this company as a private venture and knew it would ultimately move toward an IPO, and that it would bring in some very attractive additional properties in Colombia.
TGR: What’s your favorite region?
ST: Central and South America, because of its mining companies. We are big fans of Lumina Copper Corp. (TSX:LCC), which has its Taca Taca project in Argentina. The drill results just seem to get better and better. Its recent spinoff of the royalty company was very shrewd in our opinion.
Anfield Nickel Corporation (TSX.V:ANF) in Guatemala has the same management team as Lumina and is very good. Also, Silvermex Resources Ltd. (TSX:SLX) in Mexico is ramping up production now and is very good. We continue to like silver here. We think these are terrific names.
In New Zealand, we like energy companies, including Tag Oil Ltd. (TSX.V:TAO) and New Zealand Energy Corp., which should be having an IPO in the near term. We’ve been an investor in three rounds of private funding in the company, and think it’s really worth a look at the IPO.
We like Miranda Gold Corp. (TSX.V:MAD) in the U.S. We like Largo Resources Ltd. (TSX.V:LGO) in Brazil and in Canada. Largo has made some great progress since we last spoke. It’s completed the financing on its Maracas vanadium project, and the drill program is now underway in the Northern Dancer tungsten-molybdenum project up in the Yukon. This company continues to make great progress.
TGR: What’s the near-term catalyst with Largo?
ST: I think you could see some drill results out of the Northern Dancer project. The company began the drill program for a pre-feasibility study up there. They will begin construction on the Maracas project. I think vanadium is a metal that we’re going to hear a lot more about in the years ahead, and Largo arguably has the best undeveloped vanadium deposit in the world down in Brazil—one of the best markets. So, I think you’ll keep seeing good things about them.
TGR: Silvermex acquired the La Guitarra silver mine and put it back into production. Is that the principle growth driver here?
ST: Yes. You saw the first quarter production coming out, and it’s ramping nicely. The company has a shrewd, experienced team. It’s a bunch of ex-Hecla Mining (NYSE:HL) guys.
TGR: Going back to Miranda Gold for a moment. It’s a micro cap; about a $22 million market cap. Is there an exit strategy for the company?
ST: I’ve known Miranda Gold President and CEO Ken Cunningham for a lot of years. It just seems like people are finding more and more gold closer to his neck of the woods in Nevada, where Miranda has a great land package. And I like to say that Ken has a good nose for gold—I think over the next few months the company’s going to find some. It’s a dynamic company, and it has some great JV partners. It’s shown the ability to get into new jurisdictions such as Colombia and Alaska. I have a lot of respect for Ken and his team. I think they know how to find gold.
TGR: Miranda shares have been strong over the past month—up about 15%. I presume this is about the initial drill results from the Red Hill Project.
ST: That could be a lot of it. That stock is down 30% or so since the first of the year. I just think it’s a bargain. It’s been way oversold. I think there’s good potential news coming out of Nevada; don’t forget the joint venture with Red Eagle on a number of Red Eagle’s Colombian projects.
TGR: You also like energy.
ST: Yes, I like Saratoga Resources Inc. (OTCQB:SROE). It’s a Louisiana-based oil and gas company active along the Gulf Coast. It was in Chapter 11 a couple of years ago and management just refinanced some long-term debt. It’s completed two equity rounds this year and we participated in both. It’s our understanding that The Blackstone Group LP (NYSE:BX) is a big participant in the most recent round. Management owns a substantial stake in the company and is highly incentivized.
As the company has emerged from Chapter 11, it’s been able to spend on the necessary capex to bring back online a lot of the existing production that suffered during the Chapter 11 process. We see the company’s production and revenue growing very sharply over the next few quarters. Now that refinancing is out of the way, I think that stock has a lot further to go.
TGR: Do you see this a distressed situation or as a turnaround story?
ST: It’s a little of both. It had been a distressed situation, and like a lot of companies that have found themselves in the last few years with good operations and good managements but weak balance sheets, it got caught in a bind. Often it’s just a case of needing to find the right type of investor to step up and lead that first equity round or to bring in a few partners and demonstrate some confidence in these companies and their management teams, and be willing to be the first person in the water. We felt we played a little bit of that role with Saratoga. We’re playing that role with Pan Pacific Bank. It’s the type of role we don’t shy away from, and we think we could really earn some outsized returns for investors willing to take that risk.
TGR: You mentioned Anfield Nickel a bit ago. The stock is flat over the past six months, but it’s up about 49% over the past year. Do you feel there’s a lot more to go there?
ST: I think there could be. The recent preliminary economic assessment on its Guatemalan nickel zone was very decent. But it also is only based on a portion of that deposit. We think the company may be positioning for either a full or partial sale. The presence of Lumina guys [Lumina CEO] David Strang and [Chairman and Founder of Pan American Silver Corp. (TSX:PAA)] Ross Beaty as significant shareholders in Anfield is a very positive sign.
TGR: What about a China play?
ST: In China, I think LianDi Clean Technology Inc. (OTC:LNDT) continues to show terrific results. I mentioned it in December. The stock has been overly beaten down here, and I think it’s a real bargain at these levels.
On the China space in general, a lot of the good U.S.-listed Chinese companies will not tolerate these extremely depressed valuations for long. I believe you’ll see them move to delist from the U.S. and relist in places like Singapore or Hong Kong in order to receive fair and higher valuations. I think that’s a move that a lot of investors may not fully appreciate. Certainly the shorts may not be fully thinking about that yet.
LianDi is trading for two times next year’s earnings here, but in a place like Singapore or Hong Kong, it could probably be valued at 8 or 10 times earnings very easily. If you’re a short, you might have a problem there.
TGR: This has all been very exciting, Steve. Thank you.
ST: Thank you very much.
Stephen Taylor is chairman and CEO of Taylor Asset Management, a Chicago-based investment management firm focusing on small-cap domestic equities and emerging markets. He also serves as a portfolio manager for the Taylor International Fund, Ltd., a small-cap equity fund. In addition to emerging markets, Stephen’s area of expertise includes private equity, restructuring and turnaround situations and both small- and mid-cap companies. He has considerable experience in the natural resources and finance industries in Canada and China.
Marshall Berol and Craig Valdes are concentrating their focus on resource stocks in their Encompass Fund portfolio. In this exclusive interview with The Energy Report, they share their current thinking regarding the energy sector and give us the names of some stocks that are attractively priced now and that could do well as global energy demand grows. They remain very positive on the prospects for nuclear and see oil demand growing.
The Energy Report: Your Encompass Fund has had some pretty spectacular returns over the past three years. How have you been able to do this and what are your selection criteria?
Marshall Berol: Malcolm Gissen and I started Encompass Fund five years ago. We’ve been very ably assisted by Craig Valdes and Kevin Puil. Our concept was to invest globally in any market cap size company, utilizing both a top-down and bottom-up approach. That results in us looking at sectors we find to be attractive going forward, and then selecting companies within that segment that could experience long-term capital appreciation, which is the objective of the Encompass Fund. We also look at individual companies regardless of industry, where we like the company’s fundamentals.
We have liked resource companies for the past decade. When we started Encompass Fund in 2006, we had already been invested on behalf of individual private client accounts in various sectors of the resources industries, including energy, primarily oil and gas. We have continued to be invested in those industries because they have had some excellent growth and we expect that to continue in the future. So, that’s what led to the Encompass Fund performing very well in the last several years.
The end of 2008 is very painful to recall, as I’m sure it is for all of your readers. But, in late 2008 and the beginning of 2009, we eliminated some companies in the portfolio that we didn’t feel were as strong as some of the others and added to the companies that we thought were particularly strong, but suffering from the general stock market problems. That led to a 137% gain for Encompass Fund in 2009 and a further 60% gain in 2010. For the trailing one-year and three-year periods, Encompass Fund ranks as the top International Mutual Fund, according to Morningstar.
TER: In reviewing your portfolio, nine of the 10 largest holdings are resource companies. Is that the approach you’ll likely be following in the future?
MB: At this point, the outlook is bright for resource companies, including precious and base metals as well as oil, natural gas, coal and uranium. At some point in the future, one or more of these sectors will be less attractive for investment opportunities and we’ll adjust accordingly.
TER: What is your current thinking on where the various energy areas are headed now, in light of the changes since our last interview here in May 2010?
Craig Valdes: We like natural gas as a commodity and as an energy supply. But, because of advanced technologies such as “fracking” and horizontal drilling, you’ve seen an abundance of supply. And so, we might not be as positive on the direction of the price, meaning that it’s probably going to stay in the $4 to $5 Mcf. (thousand cubic feet) range in the near-term. But, as an energy component, we strongly believe that over the longer-term our energy policies will lean more toward natural gas.
Oil has backed off from its recent highs, but the oil price is really a function of how well the global economy is doing. As long as we have an environment with even slow to expanded growth in emerging economies, there’s going to be a continued demand for energy. So, we like oil for the near and long term.
TER: Do you expect any sort of a stabilized price range for oil, or are we going to see big moves up and down?
CV: I think that has a lot to do with energy policy. It also has to do with global growth and the emerging growth economies. We believe that prices on the low end may trade somewhere in the $70-$80/barrel (bbl.) range and at the high end it could be as much as $100-$120/bbl. I think oil stays in a reasonable trading range over the near-term and the next couple of years. The only thing that could easily change that are the Saudis and the Middle East geopolitics, which could affect pricing and supply. We believe that pricing is not going to change that much over the next couple of years.
MB: Certainly, geopolitical issues will have a large bearing in the short-term. We take a nine- to 12-month view in any of these industries. Short-term you get a lot more volatility. For example, when it was announced they were going to release 60 Mbbl. of oil from strategic reserves around the world, including 30 Mbbl. from the U.S. strategic reserve, the WTI oil price went down about 10% from around $100-$90/bbl. Now it’s back up to near $100/bbl. So, in the short-term it had some affect. In the long term it doesn’t. Overall demand continues and overall supplies are basically tight. Some particular situations could lead to a larger decline or, more likely, a larger spike.
TER: Can you tell us about some oil and gas situations you particularly like at this time?
MB: One company that is a major holding in Encompass Fund and has been for some time, is a smaller low-priced stock, GeoPetro Resources Company (NYSE.A:GPR). GeoPetro has five different projects, any one of which could be a real company maker. We have participated in private placements with the company, as well as buying the stock in the open market. The company has an operating natural gas plant and some natural gas wells in Texas. It has a very interesting project in the San Joaquin Basin area in south-central California. It sold a couple of large land positions it held in Alaska to Linc Energy Ltd. (ASX: LNC; OTCQX: LNCGY) of Australia and retained an attractive royalty interest. It is also one-third partner in a project in Canada with PetroBakken Energy Ltd. (TSX:PBN). That is less likely to be acted upon in the near future, but it’s got some very good promise.
GeoPetro has a minority interest in a project in Indonesia with the majority interest held by Chinese companies. The Chinese are actively doing seismic work and plan on drilling later this year. Any one of those projects with drilling success could be extremely beneficial for the company’s stock. GeoPetro has contracted to sell some excess equipment this September that will bring in more than $9M. That would be used to increase production from the Madisonville, Texas, wells and improve the natural gas processing. Those improvements should take the company to at least a positive cash-flow situation, which would be very attractive also. It’s a low-priced stock and there aren’t hundreds of millions of shares outstanding, as you sometimes see.
TER: What else do you like?
CV: We’re very bullish on the San Joaquin Basin in south-central California. NiMin Energy Corp. (TSX:NNN) is in the San Joaquin Basin. There are some big players down there like Occidental Petroleum Corp. (NYSE:OXY) with its huge find in 2009. NiMin is just a stone’s-throw away from some of that production. It’s heavy oil and NiMin has an enhanced oil recovery process called CMD, (Combustion Miscible Drive) on which they have applied for a patent. The company creates steam using a kind of soapy oxygen and injects this into the well reservoir. That heats up the heavy oil and it comes to the surface at a faster rate. The first well they demonstrated this on was producing about 30 bpd (barrels per day) of oil. Now it’s up to about 250 bpd. NiMin has identified a number of heavy oil opportunities in old existing wells in the U.S., which they can pursue. The company has a nice land package in the San Joaquin Basin (Santa Margarita Reservoir) and it is going to drill two additional wells in the second half of this year. Secondly, it may joint venture this enhanced oil recovery process with some larger oil companies. We think that’s a great opportunity, which only enhances the company’s other primary exploration and production focus in Wyoming.
Another company we like that has a large land package in the San Joaquin area is called Zodiac Exploration Inc. (TSX.V:ZEX). It is actually targeting light oil in the Kings County region, and drilling very deep wells. It just started drilling a horizontal well and we look for some updates on that in the next few weeks. When the company finished its first vertical test well to 14,000 feet a few months ago, it found between 500 and 1,000 feet of actual pay in about four different zones. We think Zodiac has a great opportunity long term in the Southern California oil sector.
MB: One of the things we look at in junior companies is the management, because it’s extremely important that management has been in the industry for a number of years and has achieved past successes. That’s the case with Zodiac, NiMin and GeoPetro. These smaller companies will often seek out a larger joint venture industry partner or partners with technical expertise, knowledge and the ability to handle financials. Then the junior will have an ongoing interest in any of the production that comes out of that well and any succeeding wells.
TER: A lot of oil and gas exploration is going on in South America these days. We don’t hear that much about it, but there have been some big finds down there. Can you bring us up to date on what’s going on?
CV: Obviously the interest has been spurred by the big find by Petrobras in Brazil (NYSE:PBR) in the last year or two. There’s oil and gas all over South America but we’ve focused on companies in Colombia because of the way it is regulated, much like the way the U.S. and Canadian governments operate. So, many of your Canadian and U.S. operators have gone to Colombia. We presently own three oil and gas companies in Colombia. One is actually a mid-tier company, Gran Tierra Energy Inc. (NYSE:GTE; TSX:GTE). It’s a larger company with current production of approximately 18,000 barrels of oil equivalent per day. One of the smaller exploration companies in our portfolio is PetroDorado Energy Ltd. (TSX.V:PDQ). PetroDorado, has working interests in a number of different blocks in Columbia and Peru. It has a 30% working interest in one block called CPO-5 that it would like to increase, but its partners are reluctant to sell any additional interest based on the recent seismic work completed. The company is going to be drilling that later this year. We’re looking for excellent results from this exploration region.
Another company that we like in the area is a service company called Estrella International Energy Services (TSX.V:EEN) working in Colombia, Peru and Argentina. Management was working for Schlumberger Ltd. (NYSE:SLB) and left a few years ago and formed Estrella. It’s a full-service oil and gas service company consolidating a fragmented industry in South America. Obviously the exploration companies and producing companies are looking for teams that have expertise and these guys have a great reputation. We think there’s a great opportunity just on the service side for Estrella. The company has demonstrated over the last couple of years that it is able to bid and win good contracts with top-tier companies, including some of the large ones such as Pacific Rubiales Energy Corp. (TSX:PRE; BVC:PREC), Petrobras (NYSE:PBR) and Canacol Energy Ltd. (TSX:CNE). That’s another company that we like on a long-term basis.
MB: Colombia has come a long way in the past decade. There is a lot of growth there and a lot of industry. A number of mining projects and energy-consuming industries are located there. With increased stability in the region, there has been far more activity. We think it has led to some significant oil and gas discoveries and a bright future for some companies.
TER: Moving on to uranium; it’s seen some turbulence since Fukushima. What are your thoughts on that market?
MB: There has been a lot of turbulence. But, long term we’re very bullish on uranium and the companies that are exploring for and producing uranium. Approximately 440 nuclear energy plants operate today around the world. Maybe half a dozen will be taken out of operation in Japan and another half dozen in Germany in the near future. The overwhelming majority of the 440 plants are continuing to operate.
As many as 50 new nuclear energy plants are still being built around the world. South Korea, France, Slovakia and even the United States, have said they intend to continue on the road to increased nuclear energy. There will be increased safety precautions. New designs have been developed for reactors over the last several decades and put in place subsequent to the reactors that were built at Fukushima. Nuclear energy provides 15% to 20% of the world’s growing electricity needs.
While 180 million pounds (Mlb.) of uranium is currently being used around the world to fuel nuclear energy plants, only about 110 Mlb. to 120 Mlb. is currently being produced. The balances come from inventories above ground and from the deactivation of the Soviet Nuclear Arms Agreement. This agreement ends in 2013 and Russia has stated it does not intend to renew it. So, somewhere between 25 Mlb. and 30 Mlb./year will need to be replaced. We think it’s going to cause an increase in the price of uranium in the years to come. The companies that are either producing it or exploring for it and will be producing it are very attractive and we remain very bullish.
Solar and wind are fine, but it’s a minuscule output now and probably for many years to come. Geothermal and hydro are also fine, but they’re extremely limited in production and location. Other difficulties emerge with increasing electricity generation from oil or gas or coal. So, nuclear energy plants have a definite long-term positive outlook.
It’s strange, but in the investment business, people don’t want to buy things that are on sale. The uranium companies are currently on sale. We were in uranium companies prior to Fukushima. We have increased some of those holdings and added new ones. People should pay attention to the uranium industry and what’s actually going on in the nuclear energy industry, rather than merely drawing conclusions from headlines.
TER: Can you tell us about some of the ones you like that are in your portfolio?
MB: One of the top holdings for some time has been Uranium Energy Corp (NYSE.A:UEC). The company’s primary projects are in South Texas. It started production in November 2010 using in-situ recovery (ISR). It’s a far less costly and far more environmentally friendly method than either open pit mining or underground mining. Uranium Energy Corp also has other projects they are bringing into production in South Texas. The company recently made an acquisition of a very large land package in Paraguay. It also owns additional exploration properties in Arizona, Colorado, Utah and Wyoming. It just recently signed its first long-term contract to sell some production.
Another current producer we find attractive is an Australian company, Paladin Energy Ltd. (TSX:PDN; ASX:PDN) with projects in Australia, Malawi and Namibia. It also acquired a project in Labrador and Newfoundland that looks very attractive.
A company that is near production is Ur-Energy Inc. (NYSE.A:URG; TSX:URE), which has some advanced projects in Wyoming and should be in production within the next year.
Tournigan Energy Ltd. (TSX.V:TVC, FSE:TGP), which is in Slovakia, is an interesting situation. More than 50% of Slovakia’s energy is generated from the four nuclear energy reactors currently operating in that country. The country is currently building two additional reactors. Tournigan is in advanced stages of exploration and prefeasibility on its Kuriskova project in Slovakia, which will be able to provide uranium for all the European Union countries.
A company we think is attractive and is earlier stage, is Crosshair Exploration & Mining Corp. (TSX:CXX). It has uranium projects in Wyoming, Labrador and Newfoundland along with some other commodities. Currently, the major uranium producer in the world is Cameco Corp. (TSX:CCO; NYSE:CCJ). BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF) and Rio Tinto (NYSE:RIO; ASX:RIO) are major multi-metal and multi-commodity miners that are also involved in uranium production.
TER: Do you have any thoughts on coal?
MB: We think coal is also attractive. While it has some environmental and safety problems depending on where the coal is being mined, 50% of the electricity in the United States comes from coal. It’s a higher percentage in China. That’s not going to change dramatically for quite some time. We are invested in several coal companies, one of which is operating in Mongolia, 20 miles from the Chinese border. Every bit of coal that is being produced by SouthGobi Energy Resources Ltd. (TSX:SGQ) in Mongolia is being purchased and used in China. SouthGobi has been in production for several years and is increasing production every year. We think it’s a very attractive company and very attractively priced because the price is down, for whatever reasons.
A large quality coal company is Peabody Energy Corp. (NYSE:BTU). We have holdings in Forbes Coal (TSX:FMC), which is in production in South Africa, and in L&L Energy Inc. (NASDAQ:LLEN). L&L is a U.S. company that has acquired several coal mines and coal washing projects in China and is producing and selling coal in China. We think coal is a very attractive industry now and going forward.
TER: Do you follow the potash industry? What are your thoughts there?
MB: We do and we like it because the growth of the population and economies in the emerging markets means that more people have more money and can afford, and want, better food. There’s a tremendous ongoing need for potash and the other types of fertilizers.
Over the years we’ve been in and out of PotashCorp (TSX:POT; NYSE:POT). While we are not traders, sometimes the price of a company gets bid up and we believe it’s time to either sell some or all of a position depending on valuation. That has been the case with PotashCorp.
The Mosaic Company (NYSE:MOS) is another very attractive large fertilizer company. A smaller one that we have invested in is Verde Potash (TSX.V:NPK), which is developing a large potash project in Brazil. There is enough demand from Brazilian agricultural industries that the company will probably sell the majority of its production in Brazil.
Passport Potash Inc. (TSX.V:PPI, OTCQX:PPRTF) is an early stage company with a very large land package in Arizona that likely will be brought into production. Another smaller company is Western Potash Corp. (TSX.V:WPX), which is using the ISR process in Canada’s Athabasca region.
TER: Can you to summarize your overall view of where the energy industry is going?
MB: As should be apparent, we are positive on the energy industry and the various components of it. Oil, coal and uranium are very attractive and there are a number of companies in those industries that we believe will do well. The Encompass Fund is focused on the long term and not day-to-day trading. When you look at the long-term factors involved in supply and demand for the various segments of the energy industry, they are very positive. Natural gas is in a somewhat different situation, but as evidenced by BHP’s proposed $12.1B acquisition of Petrohawk, natural gas is also valuable.
TER: We greatly appreciate your time today.
MB: We appreciate it. We’ve enjoyed it. And, if your readers are interested in more information about the Encompass Fund, we would refer them to the website, www.encompassfund.com. The ticker is ENCPX.
CV: Thank you.
Marshall Berol has been involved since 1982 as an investment manager in San Francisco, CA. He and Malcolm Gissen co-founded and co-manage the Encompass Fund, a no-load mutual fund. Also since 2000, he has been the chief investment officer of Malcolm H. Gissen & Associates, Inc. Mr. Berol did his undergraduate work at the University of California (Berkeley) and received a JD degree from the University of San Francisco School of Law.
Craig Valdes has been an investment manager in the San Francisco Bay Area since 1982. Since 2006, he has been the director of research and trading at Malcolm H. Gissen & Associates Inc. He previously was a partner and portfolio manager at Genesis Capital Management and Hutchinson Richardson Investment Management in San Francisco, CA.
Chen Lin is a successful resource investor who loves energy equities because he can uncover treasures still hidden from the very markets that will later recognize their value and bid them up. In this exclusive interview with The Energy Report, Chen shares names of some of his favorite positions currently boosting his portfolio.
The Energy Report: You spoke to The Energy Report approximately three months ago. We’ve been experiencing some weakness in natural resources since then. How has your portfolio performed since that time?
Chen Lin: It’s doing relatively OK. It’s down slightly, but not much. In the past few months, I’ve been telling my subscribers to be careful, to raise some cash and to be prepared and to buy on a dip. In the past couple of weeks, I have started to deploy some capital into buying those cheap, undervalued stocks. So far I’ve been doing OK, down slightly, I would say a few percent.
TER: Have these buys on dips been additions to existing positions? Or are these new stocks?
CL: Some of these stocks were already in my portfolio and some are new positions. I also want to say that I have sold some at a profit, including some of the stocks mentioned in my last interview with The Energy Report.
TER: You’ve told me that you focus on resources because the entire sector is under-researched, and you can find undiscovered jewels. How do you find an orphan stock? Do you discover these companies at conferences, seminars? What is the process?
CL: I find some companies at conferences. Some are already known and they come here to have private meetings, at which time I’m able to talk to the management. Also, I receive recommendations from people I know and trust who have already done some screening. So I can take a look see if a company’s really good.
TER: Typically, people won’t be talking to you about companies that they might buy next week or the week after. They’re talking to you about companies they already own. You have to make a judgment at that point on whether or not you’re throwing good money after bad, or whether it’s truly a great growth or value opportunity. Don’t you?
CL: Yes, absolutely. I should also add that some companies actually have business relationships with some of my friends who may already own the stock. So, they have some personal incentive to promote the company. But that’s fine. I only look at the valuation. When they bring companies to my attention, I do the research, and elect not to buy most of them. Many stocks have been thrown to me, but I only pick a few that I believe are the best.
TER: There is so much risk involved in a company that is not under the microscope. So much can fly under the radar. How much diligence do you do? How long does it take before you enter a position in a company that you’ve never known before?
CL: Usually it takes some time. Sometimes it takes days. Sometimes it takes weeks. Sometimes it takes months and then years. If I find a company of interest, I’m going to look at the back history. When did it do a private placement? When does a share become a free trade (expiration of lockup period)? Is it a flow-through share, or is it a regular share? Who are the shareholders? I want to see when it might be most likely that people will be selling the stock.
So even if I like a particular stock now, I might put it on my calendar to look at it six months from now. Perhaps at that time those private placements will be finished selling shares, and it could be a better time to enter the stock. So to answer your question, it really depends.
TER: So you want to see how much selling there is after a lockup expires.
CL: Exactly. As I told my subscribers, one stock I was recently buying is a flow through, and it will expire. You buy a little bit, and then when it drops, you buy more. When the stock dropped 30% in a couple of weeks, we bought more. Now it’s up 30%. If you followed those steps, you could have 30% gains in a week or two.
TER: You probably find it to be a good sign if insider ownership is increased from quarter to quarter.
CL: Absolutely. We’re in a period in which some energy stocks were hit really hard. And when an insider buys from the open market, that’s a very good sign.
TER: Out of the entire resource sector, in which industries are you currently overweight, and in which are you underweight?
CL: I’m currently overweighting energy because usually summer is a very good season for energy stocks. There are going to be heat waves and rolling blackouts, and oil demand is very high.
TER: Do you currently prefer oil to gas?
CL: Oh yes, I’m heavily in favor of oil. I would not want to look at a company producing gas in North America unless it’s an extremely compelling situation. Gas is very, very cheap here in the United States. If you calculate the gas-to-oil equivalent, the gas price is $25–$30/bbl right now, while WTI oil is $100/bbl. So, basically, if you use gas to run your car, it’s about $1 per gallon gasoline equivalent.
The United States is the world’s largest oil consumer, and it should be a no-brainer to switch to natural gas. In fact, most of the natural gas here is produced in North America, while oil is produced around the world, and by a lot of countries that are enemies of the United States. Even in China, where the price of imported natural gas is very high, people are still switching from gasoline to natural gas.
It’s very easy to switch. You just need to convert your engine, and it’s a very simple conversion. But it takes government will to do that because you need to build natural gas fueling stations nationwide. Once those are built, people will enjoy $1 per gallon natural gas that is sourced in North America. I do not understand why the government is not going for that. Government is run by a lot of supposedly intelligent people. One day they will wake up and say we should use natural gas, and so I’m very bullish on natural gas for the long run.
TER: During the month of May, Brent crude tested $110/bbl on the downside three times. It looks like a perfect triple bottom, and now oil has bounced. Was that what we needed for oil to continue its bull market?
CL: Goldman said before that it was bearish on oil, and that pushed oil down. Now Goldman is bullish on oil, and it goes up. I think maybe we’re in a trading range for the near future. But my energy companies are making extremely good cash flows at the current price. I’d like the price to go lower.
Although I invest in energy companies, I wish oil would go down to $80–$90/bbl. My oil companies are low-cost producers, and they can still make a lot of money at $80–$90/bbl. They don’t really need $110/bbl to make extra profits. So I actually hope energy prices will come down further, but I’m not counting on that. As for the technical side, $110/bbl seems to be the support level.
TER: What companies are you favoring right now?
CL: My current biggest position is Mart Resources Inc. (TSX.V:MMT). It’s a light sweet oil producer in Nigeria. The company has been ramping up production very nicely; current production is probably three times last year’s rate, and going higher. Well drilling continues, and production just keeps growing. The stock is trading at 1X pretax cash flow right now, and if production continues to progress, it will be trading below 1X cash flow. We know that most of the energy companies are trading at least 3–5X cash flow. Because it’s a Nigerian company, you have to give it a little discount, but it’s still extremely undervalued.
TER: You say it’s undervalued, but its share price performance has been stronger than most of its peers over the last year.
CL: Yes. I think that’s partly because it has such a strong cash flow supporting its stock. This company is generating $15–$20 million per month in pretax cash flow right now, and the market cap is only $200M; that’s a really compelling valuation, and I believe the stock will go much higher. [Editor's note: After the interview, Mart Resources published a new presentation stating that they were generating $13.5 million in monthly after-tax cash flow and around $20 million pretax.]
TER: I’m noting that Mart’s share of the Umusadege oil field play during Q410 produced 104,000 bbl of oil, compared to 317,000 bbl of oil in Q409. What happened there?
CL: There was a problem with a pipeline. What I heard was that the pipeline owner fired the security staff, and then there was some trouble and a significant pipeline disruption in Q410. But right now, everything has quieted down, and there has been almost no disruption since the beginning of the year.
TER: I also noted that the company announced that the total gross proved reserves in that field increased 56% year over year, to 9.6 MMbbl of oil on December 31, 2010, compared to 6.1 MMbbl at the previous year-end. Is that where you’re hanging your theory?
CL: Yes, but I think that’s just part of the picture. As the company continues to drill and develop, I believe that the net present value will continue to increase. So far, every well drilled has been a success. So the number will be much higher by the end of this year.
TER: You’re still very high on Mart Resources even though it’s up 153% over the past year, right?
CL: Yes, that’s correct.
CL: Another company is Porto Energy Corp. (TSX.V:PEC). It’s a new addition to my newsletter. It owns almost 100% of a big land package in Portugal, but the area has not had any modern exploration yet, and so it’s a virgin play. There are top-notch people on board from Devon Energy Corp. (NYSE:DVN), including Joe Ash, who ran the Devon International division, and that was a $10 billion business. He left to run the Porto Energy startup, and it already has a natural gas discovery.
I want to add that the natural gas price in Europe is much higher than in the United States. Porto has a natural gas discovery with a much higher value than the current stock price; also, there are going to be some very exciting oil wells drilled. You can look at Porto’s recent presentation to see how big it’s aiming. This is an elephant, and so the upside is very big.
TER: Chen, I noted that Porto raised $70 million with its IPO back on March 28th. Did you buy in at the IPO, or after the IPO?
CL: Oh, I didn’t participate in the IPO. I already participated in the placement earlier, about two years ago. But I bought from the open market recently, when the price dropped below the IPO.
TER: You said it was a virgin play. Will that $70 million take it to production?
CL: It will take the gas into production. My understanding is that Porto will start producing the gas already discovered in the first half of next year. The good thing about these small companies is that if they drill a well, and it’s successful, they can start pumping oil and then truck it out. There are two refineries in Portugal, and both are importing oil. So I think they’ll probably be more than happy to replace that with domestic oil, and as soon as the oil flow starts, cash flow will start.
TER: Will the gas production fund operations for oil?
CL: The $70 million will fund the drilling campaign this year and next; next year, the plan is to start selling gas. Joe Ash told me that if oil is found, it’s very unlikely that Porto will be an independent company a year from now.
TER: You have been watching insider ownership.
CL: Yes. There are three insider purchase companies I’ve been watching. One is Groundstar Resources Ltd. (TSX.V:GSA); I mentioned it last time I spoke with you. There has been insider buying, and recently the stock started to rebound. There’s one play in Kurdistan, one in South America and one in Egypt. The good thing is that Groundstar is not paying for the drilling, except in Kurdistan. All the others are currently in production.
There are two other companies. One is Harvest Natural Resources Inc. (NYSE:HNR). It’s pretty significant that one company vice-president spent a half million dollars to buy on the open market. This company has properties in Indonesia, in Africa (offshore) and in Venezuela. There’s an African well being drilled right now, in Gabon. I didn’t mention the company last time because it had a little too much debt on its balance sheet. But since then, it has sold its U.S. property for $4–$5/share cash, and the company today has a very clean balance sheet.
After paying down debt and all the other improvements, HNR probably has $3 or $4/share in cash, and this is a $12 stock. The Venezuela property is fully funded and paying dividends, and there is no need for funding. So it’s a very good value proposition, and the company is for sale. Management wants to maximize shareholder value. Then you can see the VP put a lot of money into this.
TER: OK, you said there was another insider play?
CL: Yes, another one with a pretty large insider purchase is actually a coal company called Prophecy Resource Corp. (TSX.V:PCY). The CEO has been buying the stock with significant amounts of money recently. Also, other members of management have been buying over the longer term. This company is starting two coal mines in Mongolia. One is already started, and one is in the process of getting the final permit. As we’ve seen, the price of coal has been rising dramatically. This summer, China is going to be experiencing the worst rolling blackouts in history. So I think there will be a lot of demand from China for its major power source: coal. The future looks very bright for coal. The insider purchases make Prophecy Resource look really good.
TER: Your three insider plays, Groundstar, Harvest Natural Resource and Prophecy, are very interesting stories. What else did you want to mention?
CL: Last time, I mentioned a few stocks I’m still holding: Vaalco Energy Inc. (NYSE:EGY), Pan Orient Energy Corp. (TSX.V:POE) and Vast Exploration Inc. (TSX.V:VST). VAALCO and Pan Orient both have some very significant drilling results coming in the next 6 to 12 months.
TER: You’ve sold your Leader Energy Services Ltd. (TSX.V:LEA), correct?
CL: That’s correct, yes. Leader Energy went up a lot, and I had a pretty good profit so I decided to take the profit on that. I was pretty lucky because I sold it when it was quite high—much higher than the current price.
TER: Leader is up 300% over the past 52 weeks.
CL: I just wanted to say QE2 (Quantitative Easing 2) is finishing at the end of June. The market could be volatile this summer, so it’s always nice to have some dry powder. That’s pretty much my message right now.
TER: Thank you, Chen.
CL: Thank you—likewise.
Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc., publisher of J. Taylor’s Gold, Energy & Technology Stocks newsletter and Roger Wiegand’s Trader Tracks. Using his wife’s Roth IRA account, Lin invested $5,411 in December 2002, and by December 31, 2010 it was worth $1,188,993—with no cash added. You can see his portfolio chart here.
Finding companies with growth potential is just the start for Windermere Capital, according to Managing Director Brian Ostroff. An active philosophy and deep technical expertise allow the firm to invest “anywhere along the spectrum” from exploration to production, all the way to operation. In this exclusive interview with The Gold Report, Brian delves into the gold-silver value proposition and names a couple of promising players in the Abitibi.
The Gold Report: Brian, let’s start with you telling us about Windermere Capital.
Brian Ostroff: Windermere is an investment manager. We currently oversee two hedge funds with a natural resource focus. The Breakaway Strategic Resource Fund and the Navigator Fund are both offshore hedge funds based in the Cayman Islands. They serve high net-worth individuals, family offices and institutional investors.
TGR: Do they have an open-ended structure or are investors committed to a cut-off investment?
BO: Both are open-ended. Navigator is a monthly. Breakaway is a quarterly.
TGR: So they’re corporations. Do they trade on an exchange?
BO: Yes, both funds trade on the Irish Stock Exchange, and they are quoted there. Subscriptions are done directly with the fund.
TGR: What is Windermere Capital’s investment philosophy?
BO: In terms of the basic investment theory behind both of our funds, we feel that we are quite different than most of the other funds in our space. For starters, we have strong technical expertise. Most of the people here have technical backgrounds as opposed to a financial or capital markets background.
We have two partners in our fund. One is a group called Ocean Partners, which is made up of the former ores and concentrate trading team at Pechiney. When Alcan bought Pechiney, these guys did a management buyout. They do business in roughly 35 countries and have a physical presence in 15. They are geologists, mining engineers and metallurgists, and their global footprint allows us to send someone to an opportunity quickly. Our other partner is Peter Hawley and his group. These guys have all been in the business for +30 years building and operating mines. Once again, this is an area where we think we have an advantage. We can look at various assets, not only as financial guys, but also with a deep understanding of the geology and the likelihood of it going into production.
The other area where we think differently from other funds is that a lot of funds do their due diligence and write their checks, make their investment. We find that our work really begins after we’ve written the check. We’re not activist investors, but we’re definitely active. We tend to take fair-sized stakes in companies, and then we try to help it going forward by making additions to its board, perhaps helping it operationally, assessing its assets and either helping the company divest or find other assets.
TGR: Active versus activist implies that you do everything but management—seed, assistance, banking, financing.
BO: We certainly assist in all those roles. We do not take board seats. What we do is find people in the industry with whom we have a relationship, people we think can help advance the company. With regards to our investment theory, we are extremely value oriented. Primarily, we invest in the micro- through mid-cap stages; but our alpha really comes from the micro-cap stuff. We tend to look at a company, assemble a peer group and try to understand why the company we’re looking at is considerably cheaper than its peer group. Once we understand that, we gather around the table with our partners to have an honest discussion as to what the issue may be and what we can do to fix it. Once we get to the point that we think we can help close that gap with the target’s peer group, we have a discussion with management to see that we’re all on the same page.
Once again, we are active—not activist. We have a meeting of the minds and when everyone is comfortable with the business plan, we tend to make our investment. Of course, that’s only in situations where we have large stakes. We use the mid-cap companies to move our positions around and get exposure to various metal groups. In the micro-cap space, we tend to take a position anywhere between 10% and 19.9%.
TGR: Micro cap is what, US$10–$75 million?
BO: Yes, actually, US$10–US$100M. If we’ve done a good job with that micro cap, hopefully, it really starts to grow from there.
TGR: The idea is to get it over US$100 million in market cap, so mutual funds can buy it?
TGR: Would you tell us about the differences between your two funds?
BO: The Breakaway Strategic Resource Fund is mining only. Due to the technical expertise to which I had alluded, it can make investments anywhere along the spectrum. The fund was first conceived in the dark days, just coming out of the global crisis. We felt there were a lot of good assets that were orphaned or had been lost and financial players had taken them over. We were looking to buy distressed assets, even outright buying the properties or mines. We do structured debt through our partners and offtake deals all the way through outright investment in the company’s equity. I like to describe Breakaway as a complete “rocks to stocks” Investment vehicle.
TGR: And what about Navigator?
BO: Navigator is all natural resources. Aside from mining, it also does energy and agriculture, paper and forest, etc. Its investments are primarily in publicly traded equities; however, we do have some room for near-public investments (i.e., those that we think can go public within about six months).
TGR: Does Breakaway Strategic also buy equity in private companies?
BO: Yes, Breakaway looks anywhere along the spectrum, and it’ll outright buy a mine if the opportunity presents itself.
TGR: So, does Breakaway Strategic own precious metals?
BO: Yes. Both funds have a fair-sized stake in some precious metals companies.
TGR: Where do you stand on precious metals? Are you bullish on gold, silver, platinum, palladium, whatever?
BO: Yes. I believe that we continue to be in a secular uptrend that will lead us significantly higher, but there will always be bumps along the way.
TGR: Why are you bullish on precious metals?
BO: I’ve always believed that gold is a currency. Ultimately, investors have a choice—put their money in dollars, yen, euros or pounds, as they choose or in gold. The one difference is that gold, unlike paper currencies, has to be found and mined. Last year, gold production was up about 3%. That compares with all the central banks around the world that are just printing money.
Now, I don’t put myself in the camp of being an absolute doomsayer, in terms of the fiat currencies or the U.S. dollar. What it really comes down to is—if the Americans print 20% more dollars, the Europeans print 20% more euros and the British print 20% more pounds, you can’t all of a sudden come up with 20% more gold. The relative valuation continues to favor gold.
TGR: What about silver?
BO: We love silver. It has definitely come into the forefront and has been a much better performer. Like many people who like silver, the physical market characteristics are very positive. Ultimately, we view silver as gold on steroids. When you’re in these uptrends and everyone’s looking at precious metals, silver tends to perform much better. We think that, as the whole precious metals bull market proliferates and more average investors start to look at it, silver at US$35–$40/oz. might be more appealing than gold at US$1,400–$1,500/oz.
As bullish as we are on precious metals, we’re even more bullish on precious metal stocks. We believe they are very cheap. If one was to go back 20 or 30 years on the XAU (the Philadelphia Gold and Silver Index) and do a relative valuation to the price of gold, one would see that it is still trading under the band at which it typically trades; so, we think there’s value there. Additionally, if one was to take a look at the TSX Venture Index as a benchmark (obviously, not all the stocks on the TSX Venture are just mining but it has a high percentage of them), that index is still considerably lower than where it was in May 2007.
TGR: Let’s stay with the XAU. You say it is trading at a discount to its traditional band. Could you tell me, to what is it trading at a discount?
BO: To physical gold. In other words, if you were to look at the valuations of gold stocks to physical gold, you would see that, historically, gold stocks are still trading well under their norm given where gold prices are. Of course, that can correct in one of two ways: Either the gold stocks relative to gold can appreciate or gold relative to the gold stocks can depreciate. Because we are still in a secular uptrend in precious metals, our feeling is that the stocks, ultimately, will catch up to the metal, as opposed to the metal catching up to the stocks.
TGR: So, you believe that the risk is greater to the upside than it is to the downside?
TGR: You mentioned that there was more value in silver due to the psychological perception of silver’s price per ounce versus that of gold. Does that imply greater volatility?
BO: It does; and in terms of value, I’m quick to say that value is a relative thing. So, is there value in silver? I’m not sure. Our feeling is that silver offers a better opportunity relative to gold—but make no mistake about it, silver is a lot more volatile. If we get a downturn in precious metals, silver will fall harder than gold.
TGR: Sticking to that value theme, could you say more about silver stocks offering value relative to the actual metal?
BO: There are very few producing silver names, and this is particularly valid for people who are looking for leverage in silver and don’t want to go into the bigger names, like Pan American Silver Corp. (TSX:PAA; NASDAQ:PAAS) or Silver Wheaton Corp. (TSX:SLW; NYSE:SLW). If their interest is in something a little more speculative, there aren’t many names that are already in production in the 2–5 million-ounce (Moz.) range. As more and more money comes into the sector with fewer names to invest in, those stocks should continue to get a disproportionate lift.
TGR: In effect, fewer opportunities mean greater demand?
TGR: To recap, you see gold and silver as a store of value. If you can’t print more gold, you have to find it. And if you do, it just adds value to the entire gold supply. If I’m not putting words in your mouth, isn’t this a currency devaluation play?
BO: Yes, that is the basis of our theme for investing in precious metals.
TGR: So, where do you find value?
BO: We think there are opportunities in niche stories—a company out there that the market hasn’t paid much attention to or, perhaps, a commodity that hasn’t received much attention. Those opportunities still exist and will always exist; they just get that much more difficult to find as a market matures.
TGR: Can you give me some specific places that an investor might look?
BO: Adventure Gold Inc. (TXS.V:AGE) is one of our large portfolio holdings. It’s a company led by a wonderful management team; Marco Gagnon is the CEO. His whole team comes from larger firms. In its three-year existence, the company has assembled a large portfolio of properties in the Abitibi. Its general philosophy is that the best place to find gold is right beside other gold mines that either are operating or will be in production soon. Adventure has accumulated close to 20 properties, which is quite a handful for a small company. But, it’s done a very good job of prioritizing.
It has what we would consider four flagship properties. The first one is the Meunier 144 property, which is in West Timmins. When Lake Shore Gold Corp. (TSX:LSG) bought over in West Timmins, it encircled Adventure’s property. As a result, Adventure made a deal that allowed Lake Shore Gold and RT Minerals Corp. (CNSX:RTM) to earn a stake in Adventure’s property by spending US$3 million in drilling. Adventure’s property is right beside Lake Shore’s Timmins and Thunder Creek zones, which are going into production. The theory is that the down-dip extension of those two deposits enters into Adventure Gold’s property, and it is currently being drilled to test that theory.
Adventure also joint ventured (JV’d) its Dubuisson property, which is right beside Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) Goldex Mine. A couple months ago Agnico, picked up 51% of Dubuisson through payments and drilling commitments. Agnico will continue to drill the property out, starting within the next month or so. What interests us about Adventure is that it’s almost a hybrid model. The company will option off some of its properties and keep others to work on itself.
Adventure recently put out drill results from its third flagship property, Pascalis-Colombière. This is the area surrounding and including the old L.C. Béliveau Mine, owned by Cambior. Cambior had mined it up until the early 1990s and, over a four-year period, it produced close to 170,000 ounces (Koz.) of gold. With gold prices coming down back then, Cambior closed the mine. Subsequently, IAMGOLD Corporation (TSX:IMG; NYSE:IAG) bought Cambior and viewed Pascalis as a non-core asset. Adventure picked up the property and has come out with very encouraging drill results. It’s important to note that production at that historic mine had been done only down to the 300-meter level, which, in Val-d’Or, is not very deep. But the company believes there’s still a lot of gold to be found beneath the existing and to the west of the mine.
The fourth flagship property that Adventure is working is the Granada Extension, which is next to Gold Bullion Development Corp. (TSX.V:GBB) Granada Property. Adventure picked this property up toward the end of 2010 and has received some encouraging sampling results. The belief is that the Granada Extension is similar to Osisko Mining Corp. (TSX:OSK) Malartic property. You’re looking at a large tonnage, low-grade type deposit. Gold Bullion has drilled aggressively and put out a non-compliant NI 43-101 block model, showing 2.5 Moz. in a relatively small area.
Adventure’s other properties also are in historic areas: Detour East, which is east of Detour Gold Corp. (TSX:DGC) property and Casa-Berardi, near the operating Aurizon Mines Ltd. (TSX:ARZ; NYSE.A:AZK) space.
These properties, coupled with the fact that the company has close to US$4M in cash and cash equivalents sets Adventure up very well. It has a lot of opportunities. With four properties now being worked, we think Adventure will generate a lot of news flow. We’re quite optimistic that, with a US$35M market cap, the market has not really given this company the attention it is due.
TGR: Could Lake Shore and Agnico, the two JVs Adventure is working with, act as something of a poison pill in hindering a takeout of Adventure?
BO: Our feeling would be that, if there were any interest in the company, it would probably be property by property. It is unlikely that one company would come in and take all those assets. Case in point, if drilling proves out the down-dip extension from Lake Shore’s property, Lake Shore might be interested in the Meunier property. If Agnico’s drilling proves out that there is more gold beside its Goldex mine, we would see Agnico having an interest in that property. Adventure’s assets are spread out within the Abitibi region, so we would see logical buyers on a property-by-property basis as opposed to an outright acquisition of the company itself. Particularly on its four flagship properties, we feel that any one of those could be a company-maker.
TGR: That is a great story, Brian. Do you have another one?
BO: Our funds are fair-sized holders of a company called Cartier Resources Inc. (TSX.V:ECR), which is a gold resource exploration company in the Abitibi. It is earlier stage than Adventure, in that its properties are more grassroots. There is some historic drilling, but we think the opportunity is more a combination of being in the right location and having an excellent management team that can move these properties along. Cartier owns a significant land position along the Cadillac Fault, an area that has seen significant interest by companies like Osisko and Aurizon. It also has assembled other very interesting properties within that area and has embarked on an aggressive drill campaign that we think should start to prove out some potential.
TGR: Brian, thank you for your time.
Brian Ostroff joined Windermere Capital, Inc. in 2009 and is a managing director. His area of focus is the junior and mid-tier mining sector. His previous experience includes a stint as a proprietary trader at a major Canadian bank and four years trading on his own. He also worked at the M&A advisory firm Goodrich Capital, where he was the Canadian managing partner overseeing mandates across a spectrum of industries with a focus on display technologies and mining. He worked at RBC Dominion Securities, where his focus was on smaller-cap special situations and alternative investments. Brian is a graduate of the University of Toronto. He can be reached at firstname.lastname@example.org, 514-908-4202.