Junior Mining Stocks Capital Destruction and Preservation
Commodities / Gold & Silver Stocks Nov 12, 2008 - 10:11 AMBy: The_Gold_Report
With feet planted on the ground and eyes trained on balance sheets, Brent Cook has earned a reputation for recognizing which juniors have the best chance of beating the odds and where rocks have the greatest potential for producing profit. An experienced professional geologist who has examined properties in more than 60 countries and learned the investment side of the business from master Rick Rule, Brent inherited investor/analyst editor Paul van Eeden's newsletter in February. He repurposed it into Exploration Insights, and in this exclusive interview, shares some of his insights with The Gold Report readers.
The Gold Report: You talk about capital preservation as a key tenet of Exploration Insights , and you focus on the juniors. With the markets having gone totally crazy and practically everyone experiencing depreciation rather than preservation or appreciation, what do you see on the horizon for juniors? And how far out is that horizon?
Brent Cook: It's really tough for the juniors right now, but let me talk about capital preservation because that is a really important aspect of what I try and do in Exploration Insights . I don't take a shotgun approach to investing. Rather I prefer to take careful and selective aim on targets. Right now we have about seven stocks in the portfolio and that's it. I don't ever anticipate having more than 20. I'm so selective because I've learned that is the best way not to lose money. That's Rule No. 1: Don't lose money. In this junior sector you can lose it awfully fast if you are not very selective on your purchases. More often than not in the junior sector it's what you don't buy that's more important than what you do. Although to be honest, over the past six months even our stocks have been hammered.
I'm very cautious in what I buy and I've been preaching or suggesting that people save their cash for the opportunities coming up. We're starting to see some of those now. That's what I mean by capital preservation—very, very selectively buying something that you are confident in the value of the assets and, that you're getting at less than net asset value. Also, and this is Rule No. 2: If your investment thesis is proven wrong, sell. Once you're investment thesis goes from certainty to hope, you've already lost your money.
TGR: But from certainty to hope in this market environment, you could lose money and still be invested in viable short- and long-term companies. How do you reconcile that?
BC: You don't lose until you sell. An example of a stock that is down considerably but we haven't sold is Altius Minerals Corp. (TSX.V:ALS) . They have about $180 million of cash, in the bank, which equates to about $6.40 per share and you can buy it for around $4.20 or $4.30. Altius is run by a very smart and committed group who will do smart things with the money. Selecting companies like that, to me, represents a means of long-term capital preservation.
TGR: But doesn't the cash-versus-cost comparison depend on the burn rate?
BC: Exactly right. Altius's burn rate is basically zero. With their revenue from a royalty stream on Voisey's Bay, a number of other smaller royalties and cash payments from other projects they have joint ventured out, it means they are hardly spending any of their cash at all—maybe a few million bucks a year at most when they have $180 million sitting in the bank.
But you're right. I see people coming out with recommendations that you should buy a company selling for less than cash in the bank just because it represents a discount. But if you look at what most of these companies are doing with their cash; next year they may be broke. Buying a company that is drilling a project that doesn't have or offer any value is not buying something for less than cash. Make sure the cash stays put and is used for something intelligent.
TGR: So basically Altius can survive a long time because it has a nice revenue stream. But why would we expect it to go up, given that the royalty stream is basically an annuity? Why would it go above the cash in the bank?
BC: At this point in the market, Altius has the opportunity to invest in projects and companies that are severely undervalued. They can do that at a real discount to NAV or some other metric and make money that way.
TGR: So you look at them as smart management. Is there a history of finding projects like this or investing in companies like this that we should know about?
BC: Yes. Their model is one in which they generate conceptual exploration and business ideas and venture them out to other companies with a lot more money or the ability to take on more risk and do the hard work. As you know, most exploration projects go bust, so these guys generate the ideas and vend them out. Somebody else spends the money and, by and large, they go bust. That costs Altius hardly anything and they maintain their business of generating ideas and turning them out until one works. One transaction that worked very well was a uranium project they ventured out to Aurora Energy in Labrador. Aurora found a uranium deposit, spent tens of millions proving it up, and it looked like a very legitimate deposit. Altius was able to make $130 million or so out of an initial investment of about $600,000 by selling shares of Aurora, which represented their interest in the project.
TGR: That's nice.
BC: Yeah. That's the type of guys they are, just taking advantage of whatever the market offers. So you've got a lot of cash, you've got low burn, you've got a small income stream, and you've got smart guys at a discount to cash. That's pretty good.
TGR: That's a nice blend. As you look at your other juniors, either in your portfolios or ones you know about in general, are these viable if gold sticks in the $700 to $800 range?
BC: Most of the juniors don't have any gold; they have the hope of finding gold. Rationally speaking, it doesn't make any difference to them what the gold price is if they don't have any gold. Of course, they're hoping to find something that has gold, and obviously, a higher gold price would be better for them if they do.
But there are companies out there now who have gold resources in the ground and they are selling for less than the net asset value of their deposits. Likewise, there are a number of companies that, although they don't have a compliant gold resource, they have released enough data that I can work up my own resource estimate, then what it will cost to build it, mine it, etc. and show they are selling for considerably less than that value. You can buy those sorts of companies right now really cheap, assuming a $700 or $800 gold price of course.
The juniors that don't have a lot of cash in their pockets and no discoveries on the horizon are in serious trouble. I see this going on for a couple of years, to be honest. I see a serious shakeout coming. The first question you want to ask any company is “How much money do you have and how long is it going to last?” If they don't have two years' worth of cash and something seriously legitimate to work on, they have problems.
TGR: If gold sticks to $700, how difficult will it be to get projects joint ventured out?
BC: To a major mining company, $700 is not a bad price. A Barrick or Goldcorp that makes decent money at $700 gold can afford to do a joint venture with a company that has—and this is really key, Rule No. 3 if you will—a large target. So the project or concept being joint ventured has to offer a major discovery. It can't be something small and I'm afraid from my experience most companies are really peddling small targets.
It also has to offer good margins with cash production costs of maybe $350 or $400 an ounce or less. That's what the majors are looking for. Also, when evaluating the project you always have to view the economics using the gold price in local currency. Plus, I think we're going to see capital and labor costs start coming down. In fact I am seeing it now virtually across the board.
TGR: Are such large targets out there?
BC: Oh, yes. One I like a lot is MAG Silver Corp. (TSX:MAG) (NYSE:MVG) . They've made a major discovery in Mexico adjacent to the world's richest silver deposit, Fresnillo. It was owned by Peñoles, and spun it out into a public company, Fresnillo LLC, which is now MAG Silver's joint venture partner. The asset is probably the highest-grade silver discovery in decades. It averages over a kilo a ton, it has some 240 million ounces of silver, and it's open to further discoveries. Plus there's gold and base metals.
I figure that MAG Silver's 44% is worth on the order of $15 a share to MAG Silver if silver is $10. MAG Silver is selling for about $5 a share. Fresnillo has been creeping up their holdings of MAG Silver; they own about 19% now; and MAG Silver's 44% is worth a lot more than $5 to Fresnillo. So I see that as a takeover scenario coming at some price appreciably in excess of $5. That's one instance of a high-grade deposit that a major is definitely coveting.
TGR: Is there a 43-101 on this deposit?
BC: It was put out in December. It comes in at about 240 million ounces of silver grading a bit over one kilogram per ton silver, about 2.2 grams per ton gold, plus base metals. MAG has 44% of that. Once you take out recovery and dilution, it's about $350 a ton rock in the ground. It's going to cost on the order of $60 a ton to mine and mill it, so there's a lot of money to be made there. It's adjacent to Fresnillo's operating mine, they've got plans to go in and bring this into production. Everything's set up. No political issues, no technical issues.
TGR: It seems a little bit too easy.
BC: It does. Those deals are few and far between, but you don't need many of those.
TGR: We're hearing a lot of money on the sideline is going to start coming back into the market selectively. As it does, will it go into the precious metals with the less-than-optimistic returns experienced over the last two years?
BC: I hear that as well, but I don't know how much money there really is on the sidelines. I work with a number of funds in North America and Europe that really don't have much cash to invest, particularly in illiquid juniors. About $400 billion has come into the resource sector since 2003, much of it in commodities. The $30 billion that came in to the Toronto Stock Exchange through private placements, which mostly came from funds, has been wiped out—and these guys are looking at redemptions coming again at the end of the year. So there's not much money there that I see.
In terms of individuals, it's tough. Net worth for most people I know has been halved or worse. I don't see a lot of money on the sidelines. There's some, certainly, and I suspect we're going to see the first thing people migrate into is the large gold companies because they're liquid. They've been decimated as well and that's the intelligent thing to do. But on the junior side, it's a long time before we see much come in. You see people putting out fantastic drill results with no effect. Take a company like Hathor Exploration Ltd. (TSX.V:HAT) , which has a uranium discovery in the Athabasca Basin. They're trading about where they were when they first made this discovery, and since then they've drilled 30-odd holes with grades of something like 46 meters grading 3.1% uranium. That's incredible. That's $3,000 rock, I think. Yet the stock has backed off from $4.50 to $1.50 despite that news.
TGR: But is it that news or is it the price of uranium? It's gone down so dramatically in the past year.
BC: That's hurt it, but a deposit like this is one-of-a-kind. Cameco's and Areva's mills are desperate for ore, and this deposit sits within trucking distance of both. And a key point with Hathor's deposit, as well as MAG's and others I am looking at, is that the deposits offer the possibility of very high margin mines. Regardless of the metal prices or global economy we are still using metals and profitable mines will always be coveted.
TGR: So this a situation in which they have permits, no political issues and infrastructure available nearby.
BC: There are always political and permit issues with uranium deposits, but less so here. This deposit's being drilled out right now. There's no 43-101 resource yet, but it certainly is a discovery that could be significant in an area where people are mining uranium—and the world's two largest uranium producers have underutilized mills next door. This is another instance where people who have the money could buy this asset. This could be a serious discovery.
TGR: When is the quantification—the 43-101—expected?
BC: The discovery is under a lake to some degree, so they need to come in this winter and drill through the ice to really prove it up. Whenever it freezes, they'll start drilling. I'm guessing we'll see a resource estimate probably by early summer.
TGR: Can they drill only in the winter?
BC: They drilled this summer, but once the lake freezes, they can get on top of it and get a better handle of what the deposit looks like and come up with a resource estimate. It's not a deep lake, 10 or 15 meters deep, so it's easy enough to drain and start the mine. It won't be an issue in that respect; it's just a matter of proving it up first.
TGR: You suggested that when individual investor money comes back into the market, it probably will come back in to the large gold producing companies. Not long ago Kerry Smith, an analyst at Haywood Securities, basically recommended investing in large gold producers over the juniors because the seniors are trading at such low multiples. What's your advice to our individual investors?
BC: I don't see any problem buying majors and waiting for the market to turn and then moving down into the smaller companies. That's a smart way to go about it. It's not what I'm doing, because I believe I can select the few juniors' stocks that have real assets that a major is going to buy. Right now it's a matter of picking the few assets that are high enough quality that a major will want to buy—that will give me a lot more leverage than waiting for Barrick to go up 20% or 30%.
TGR: Then the thrust of your investment portfolio advice for the next several years is acquisitions.
BC: Yes. I've been following three investment scenarios. One is buying a few companies like Altius that are significantly capitalized, smart guys, trading less than cash value. The second is going for the acquisitions, the people drilling out or with deposits that are high enough margin and quality that a major would want to buy. And the third is going after a couple of very speculative companies that are pure exploration plays, but the risk-to-reward is huge if they're successful.
For these very high-risk plays everything I've seen in the geology and results so far tells me they have a decent shot—a long shot but a decent long shot—at hitting. If they hit, we're looking at a tenfold increase. So those are the three things I focus on. I'm not buying small companies selling for less than cash or that sort of thing. And definitely not any companies with what I perceive to be small targets. There are a lot of those out there and they're very good at getting rid of that cash.
TGR: But if it's less than cash and either an acquisition target or a high risk-reward given its geology and location, you'll look at it?
BC: That's right.
TGR: Does your view of the juniors change if the U.S. and then the world go into a recession?
BC: No. I'm assuming that happens anyway.
TGR: So you expect the resources sector to still be in demand.
BC: Selectively. I do believe we're heading into a global recession and it's going to be a damper on commodity prices. The credit crisis or liquidity crisis right now is going to severely limit money coming into the sector as well as money coming in to build new mines. At the same time, the major companies have to replace the resources we're depleting—and they have to replace them with high-grade resources—regardless of what the metal prices do.
I'll give you an example. We're producing 15 million tons of copper a year; which is about the amount of copper ever mined from the Bingham copper deposit in Utah. This is one of the biggest in the world. So on a yearly basis we're depleting one major copper deposit. Same with gold. We're running through about 80 million ounces of gold a year. That's all the gold ever produced from the Carlin Trend in Nevada. That's the dichotomy here: Nobody wants resources but everybody wants them.
TGR: Would you comment on any specific companies? How about Miranda Gold Corp. (TSX.V:MAD) ?
BC: Great company. Great management. Great geologists. Selling for cash just about. Actually, I was just on their project in Nevada in mid-October. They've got a number of joint ventures with major and junior companies. I don't know that they have a discovery in their hands, but they're smart. This is one of these joint venture companies that come up with the ideas and then bring in the major companies to test them.
TGR: So they fit into your first investment scenario, selling for less than cash with the potential of a find?
BC: I would say so. I think they have about $11.5 million in the bank and their market cap's about that too. They have Newcrest just finishing a drill program on Horse Mountain. Who knows what's going to come out of it, but if they discover what they're looking for, it's huge.
TGR: That's true of everybody, though.
BC: Not necessarily. Most people I run into are not really looking for big deposits. They may claim they are, but the geology isn't right.
TGR: How about Virginia Mines Inc. (TSX:VGQ) ?
BC: Another great company. André Gaumond is one of the most honest, ethical guys in the business and he's followed the joint venture model as well. He's had a bit of problem because the discovery he has with Breakwater is a base metal deposit and base metals haven't done too well. But in terms of a company, that's a great one. You can definitely trust your money with them.
TGR: Rimfire Minerals Corp. (TSX.V:RFM) .
BC: Another great company. They're selling for almost cash too. Same thing. Joint venture model. Very, very smart guys who understand not just geology, but the business of exploration. They're involved in Western Canada and Australia and a bit in Nevada as well. Actually, I own all three of those you just mentioned—Miranda Gold, Virginia Gold and Rimfire.
TGR: How about AuEx Ventures Inc. (TSX:XAU) ?
BC: I was just on their project in Nevada as well. Long Canyon, which they joint-ventured out to Fronteer, is an interesting property. They may actually be on to a new legitimate gold discovery in Nevada. It's in the eastern part of the state, off of the main Carlin and Cortez Trends, but similar style and mineralization to Carlin type deposits. Fronteer has done an excellent job of figuring out the geology. They have four drill rigs plugging away and they hope to have a resource estimate out by early next year. And AuEx, again, smart guys and another company that follows this joint venture model.
TGR: When you say legitimate new gold discovery, what makes it special?
BC: So I guess by “legitimate” I mean real. A lot of people claim to find a major discovery, but usually that's not the case. This is really what I think could be a new gold trend.
TGR: Earlier you talked about the key being to find the companies that are about to find or announce a discovery, and as you pointed out, by no stretch of the imagination do all of the juniors have that potential.
BC: Right. I've been doing this for a long time and I look at most of these projects and see the ultimate potential—if they're successful in drilling out what they think they've got—is not worth much. It doesn't make any difference if you find something nobody cares about, which most of the several thousand junior companies are doing. There's no point investing in any junior exploration company if you don't see the chance for a 10-for-1 increase in your stock price.
TGR: The tenfold increase in the stock price is a little bit easier today than it was a year ago.
BC: Yeah, 20-to-1 is even better at this point. But let's talk about 10-for-1 potential for a moment. Diamonds North Resources (TSX.V:DDN) raised money at $1.08 and is now trading at about 30 cents. Very, very smart group. Intelligently explored up in Nunavut. Early analysis of the kimberlites showed a good diamond count, good quality diamonds, and now they've gone back in and taken some bulk samples. The results should be out within a month or so. If they show large diamonds, this is potentially a 10-bagger.
TGR: So there's real potential here to be the 10-bagger; in fact they may find large diamonds.
BC: They need to find the whole spectrum of diamonds. So far the samples they've taken have been mostly micro diamonds. It wasn't a big enough sample to evaluate the diamond size distribution. Now they've taken large enough samples that if they have indications that the diamond size range goes up into the larger sizes, this is potentially a diamond mine. This is the sort of thing that BHP or DeBeers would be looking at.
TGR: Tell us a little bit about Exploration Insights .
BC: I'd been working with a number of the newsletter writers—Doug Casey, Brien Lundin, Bob Bishop, Paul van Eeden—and started contributing more and more to Paul's newsletter. Over the previous two years I generally followed specific stocks while Paul covered the macroeconomic scenario. When he shut down his newsletter in February, I took it over. So it has changed to my newsletter and I basically talk about geology and stocks with an emphasis on what they are actually worth.
There is a Stock Talk section and a Rant section to the letter. In the stock talk section I specifically talk about stocks we own or are following. Most of my subscribers are fairly involved in doing their own analysis as well so I try to provide numbers, costs and geological interpretations from which they can draw their own conclusions. I also comment on stocks in the news or ones that I get a lot of emails from subscribers asking about. If a stock doesn't make it into the Exploration Insights portfolio I am not afraid to say why. Generally, in the rant section I give people useful insights into what is happening in the mining and exploration sector as a whole. Also what to look for, how to value properties, mines, deposits, that sort of thing. And we sometimes cover some politics, economics and everything else, too.
TGR: This is a weekly letter?
BC: It comes out pretty much weekly. I'm on the road at least half the year but I still manage to get it out most weeks.
TGR: Your site visits. You get out there and kick the tires, meet management, the whole thing.
BC: That's key. I've been doing this for 25-plus years and the only edge I've got over anyone is that I've seen so much that I can recognize a good versus a not-so-good project. The only way to do that is to really go on the ground. Things always look different on the ground, sometimes better but most often worse.
TGR: And you're a trained geologist?
BC: Yes. It helps when you're looking at geology.
TGR: Rick Rule speaks pretty highly of you. He says you are a “no nonsense ‘boots on the ground' geo, not one of the ‘desk explorers' who cost the investment community so many millions.”
BC: Yes, I worked with Rick for six years and made him a lot of money, I did OK too. He is probably the smartest investor I've come across. I learned a lot from him. I knew geology before I got into this, but I learned about investing from him and how to make money.
TGR: Rick says easily 80% of the juniors are not worth investing in. And with the other 20% you still have to look at the balance sheets and that will be the real key. He's a big resource bug; in order for the world to keep going, you need the resources. He's saying it's going to be ugly here for the short term, but then the opportunities will start showing themselves.
BC: I believe he's right. It seems to me there are a lot of problems to work out of the global financial system still and we could go way past ugly. But further out, the quality mineral deposits and exploration companies you can and will be able to buy now will certainly look like bargains in the rear view mirror.
Brent Cook, who launched his Exploration Insights newsletter in February 2008, brings more than 25 years of experience to his role as geologist, consultant and investment adviser. His knowledge spans all areas of the mining business from the conceptual stage through to detailed technical and financial modeling related to mine development and production. His hallmarks include applying rigorous factual analysis to the projects and companies he examines, and augmenting his analysis with on-site field evaluations.
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