Brent Cook on Junior Minors Upside Potential
Commodities / Metals & Mining Jan 27, 2009 - 05:10 PM GMTBy: The_Gold_Report
Turning Rocks Into Money - Geologist Brent Cook, editor of Exploration Insights newsletter, 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. In this exclusive interview The Gold Report, Brent shares some of his insights about which juniors have upside potential in this volatile market. Brent has examined properties in more than 60 countries and learned the investment side of the business from master Rick Rule.
The Gold Report: Brent, as we look at the various programs that Barack and the Congress are going to put in place, what's your feeling for Mr. Obama's first 100 days and how will that impact the markets?
Brent Cook: I've probably got a bit of different view on Obama than lot of the hard money crowd. I'm not as jaundiced about him—I think he's very intelligent, insightful and, in the overall picture of things, I see him bringing a lot more credibility to the United States. I believe The Rule of Law, transparency, shutting down Guantanamo etc. are very important to setting America in the right direction on the international scene. This is positive and more in line with America's core values.
In terms of the economy, I don't know that anyone really has a chance of fixing that in 100 days or a year or two years. We've got serious problems out there. We're looking at a $6 trillion public deficit, and up to another $2 trillion more in various bailout packages and stimulus packages someone has to loan us the money for. That's a 30% increase in debt this year. The massive increase is happening as tax revenue, which was about $2.5 trillion in '07, is headed south. The U.S. deficit was $168 billion in 2007, a prosperous year, and this year it's projected to be $400 and something billion. So expecting any sort of fix in 100 days—it just ain't going to happen and I think he realizes that and he's going to prepare the rest of us for the reality of this. My plan, if elected, would have been to give every individual taxpayer one year of no taxes. Anyway, neither he nor anyone is going to fix this quickly.
TGR: If that's true, what would be the impact on the market?
BC: I think people are still under the impression that the government, Ben, Hank and whatever new guys or gals who show up, can save us, which is ironic given they're the same folks—and Greenspan—who essentially drove us into this ditch. They were completely blind driving into it and now we're expecting them to drive us out? Give me a break. The public still doesn't realizing how bad the situation is or how long it is likely to last.
I think short term we may get a rally here, but six months from now, nine months from now, a year from now, I think it's not going to look better and the market's going to reflect that.
TGR: So with that said, there's still demand for certain materials such as base and precious metals. Will certain sectors come out of this with some type of buoyancy?
BC: Looking at the metals market, which is what I know best, we've had—just by my count—on the order of 125 base metal mines shut down, suspended and put on hold over the past six months. On top of that, we've got dozens of companies that are in the process of proving up resources, converting the resources to reserves or in the permitting stage, but are now completely halted. I don't see base metal prices increasing much over the next few years, at least. Basically, all the discoveries for the next bull market are sitting idle right now. As base metal prices slowly increase as the global economy rights itself, all the pent-up supply will act as a cap to rapid price increases—barring another speculative binge. So I don't see much hope for base metal prices, certainly on an inflation-adjusted basis. In terms of exploration, the world doesn't need another porphyry copper or VMS deposit.
TGR: So you're saying once the base metals price comes back, those projects will come back on line. So until then, that's not a sector to look at investing in.
BC: No. If someone's positive on base metals—and I think it's more important to act on your read of the data than mine—now would be a great time to buy the producers with the lowest production costs and low debt. Those are the companies that will survive and buy the assets they feel offer value. But I am not focusing there.
TGR: What about precious metals?
BC: That's a different story. I think precious metals will be entering a new era of respect over the next few years at least. Gold is going to do quite well over the long run and silver, which to some degree mirrors the gold price, will also do well.
Gold is real money. Silver is often lumped into that category as well by investors. I do think the fundamentals for silver are going to improve just because 70% of silver production comes out of base metal deposits. With these base metal deposits being shut down, the silver supply or production is going to drop off and that should be positive for the silver price.
TGR: But if silver goes up high enough, wouldn't that justify keeping those projects going?
BC: It's on a case-by-case basis. Let's look at what people call silver mines, the silver companies. There are very few pure silver companies. Almost every silver company is really a lead, zinc, and silver production company and they need this lead and zinc credit to make these things profitable. I look at a lot of the mines and companies operating in Mexico and Peru. By and large the so-called silver companies are underground mining silver grades in, say, the 150 to 275 grams per tonne range with decent zinc and lead credits. That's not a very good deposit, really. It's marginal at best and these things don't make money, especially if you add in exploration and forward development costs.
These mines generally produce a lead-zinc-silver concentrate that then gets shipped to a smelter and the smelter pays you X amount for the lead, zinc, and silver in that concentrate. When zinc was $1.50 to $2.00, you made good money. Now at 50 cents, you can see what the problem is.
Plus, because there's such a low demand for base metals, the smelters are paying even less for the zinc in concentrate. It used to be they'd pay, let's say, 70% of the spot zinc price back to the mining company. Now I've seen them only getting about 50% of the value of zinc in their concentrate. If zinc's 50 cents, which is low, they're only getting 25 cents once the smelter takes their cut.
TGR: So regarding silver, you're saying because the base metal mines are shutting down, the production of silver is decreasing, at the same time the demand will increase because of the financial situation worldwide?
BC: I think so.
TGR: And gold is a slightly different story, though. Is gold production increasing?
BC: No. This is interesting. Since about 2001, gold production has been declining slightly. Yet, starting in 2001, the gold price up till now has increased about $600. That's counter intuitive. You would think that as gold price rose, gold production would rise. That hasn't happened.
The reasons behind that are that it's getting harder and harder to find good deposits. We've got mining companies decreasing their reserves by 78 million ounces a year coupled with dearth of new gold discoveries coming online. We've got mining companies trying to increase their production and unable to do so, so their production profile is falling off.
TGR: So if the lack of new discoveries and the current projects don't have the capability of scaling up, we are facing almost a finite amount of gold right now.
BC: Yes, finite amount of economically viable gold deposits. There is not shortage of uneconomic gold deposits out there. Trust me, I have looked. Here are some interesting statistics. Historical world gold production comes to about 4.4 billion ounces. That's worth about $3.5 trillion today. Interesting number, given the deficits the U.S. is looking at of $8 trillion.
Over the past 100 and some odd years, the gold inflation rate, which is essentially the amount of new gold that's been produced and brought into the market, has averaged around 2.2%. That's across that whole time frame. So we've got gold inflation of about 2.2%, which now is only in the order of 1.5%, due to the declining production. Compare that with the global monetary inflation, which averages—depending on the country and such—considerably more than that. So right now we're looking at a declining gold production or a declining inflation rate of gold, and rapidly increasing monetary inflation. Those two things alone are going to be very positive for the gold price.
TGR: This has been true for the last five months. Why hasn't gold taken off?
BC: My suspicion is that what we've got is a massive global deleveraging and what that means is people are selling everything they possibly can to get liquid. Gold is one of the most liquid instruments out there, so I think we're seeing people, or more likely funds and countries, selling gold to raise cash. And, on top of that, the most liquid currency is the U.S. dollar, so people have been buying U.S. dollars because it's perceived as safe.
TGR: So as we look at gold increasing in value—and I think that's pretty much what everyone's saying—there are basically three ways to be buying gold. One is to buy physical and hold it, to buy an ETF, or to buy the production companies. What's your thought on those?
BC: I personally don't own any physical gold to speak of. I guess because everything else in my net worth is so linked to the gold price—my newsletter, investments and life, I don't need it sitting in my basement, too. The gold ETFs and leveraged instruments on top of that make a lot of sense to me. I have done some of that and I will do more.
I personally believe we're going to see gold get whacked again in the near future as the realization of what's happening to the banks in Europe and across the world starts to take effect and people grasp that things are not going to get better very quickly and that we've got serious problems. I think that'll drop the gold price for the very reason I gave you before, that people need to get liquid and they run to the dollar. That's what I'm looking for to jump in a lot harder into the gold ETFs and the leveraged instruments.
Gold mining companies have not performed as well as they should have and I think it's because of the deleveraging that's been happening, as well as they really haven't provided much shareholder value. As the gold price has gone up, the production costs have gone up. Just late last year the CFO of Barrick Gold Corporation (NYSE:ABX) stated something to the effect that their break-even cost was about $700 gold when you throw in exploration and all the different costs. So your margins aren't increasing that much, even though the gold price is going up.
So I would selectively be buying some gold mining companies, very selectively, and make sure those companies are not big base metal producers. Actually, that's something that the large companies have done in order to keep their production up. They bought or brought base metal deposits like porphyry copper-gold systems into production because of the gold credits. When copper was at $3 to $4, it lowered their perceived gold production costs and increased their profitability. With copper at $1.50 or less, their profitability is down a lot. So make sure it's a pure gold company with decent margins.
TGR: So what gold price do you think would make these stocks turn?
BC: Until we see a real sustained increase in the gold price, it's hard for me to see big investors—the big funds and generalist funds—come into the gold market. These guys need to see profit margins or at least a sustained trend. That said, there is a fair bit of money just waiting for a five day gold rally to jump in feet first. How quickly people forget.
TGR: But gold prices could still go up and the stock could still go down.
BC: Yes, definitely.
TGR: Do you think the real big investors are waiting to see the stock prices stabilize or are they watching the gold prices?
BC: I think they're watching the gold prices and the margins. They need to see that these companies can actually make money as a business. Most of the usual investors in the gold sector don't really look at it as a business that you're supposed to make money in. I think they look at it more in terms of what they think the gold price is going to do.
I think that you need to look at these gold companies as a business. What are the margins they're going to make on producing their gold going forward?
TGR: On top of being a geologist, I believe you also look at the financial health of the companies that you're recommending and look at.
BC: Yes. Mining and exploration are very capital-intensive businesses.
TGR: Do you have any companies that are both the pure gold plays and also have margins?
BC: I don't spend a lot of time on the big cap mining companies. There's too much to really understand to get an edge over the competition. You need an edge in this business and for me that is understanding the fine geologic details that will either show up a fatal flaw or indicate a true discovery. So I stick pretty much to the smaller cap gold companies and, in fact, mostly the exploration-stage companies. Not many people put the time in to figure these early stage companies out.
I was very, very cautious last year and I will be again this year. I think it's going to be very tough out there. The problem we've got is that it's no longer a market where someone's going to buy your mistake. You're going to live with your mistakes. There's a lot I'm following, a lot of things I look at and keep on my radar screen and watch, but there's not that many companies I actually buy. Over the whole of last year, we purchased 13 stocks in the portfolio and right now we own 10. Just to plug myself here, I was down 12% on the year.
One company that I have recommended in the newsletter is Sangold Corporation (TSX.V:SGR) . This is a small company in Manitoba. They've got a small reserve that doesn't justify the market cap, and a good resource in the order of 1.2 million ounces. But most importantly from my perspective, a new discovery called the Hinge Zone #4 that is adjacent to the current operations—well, a kilometer away—and readily accessible. And this thing will run probably two to three times the average grade of the mine they're currently working on. So we've got a small mining company that's moving towards production with a lot of upside in terms of future discoveries. So I like that one.
TGR: If they're moving towards production, do they have the capital to bring it into production or are they anticipating selling this?
BC: It's in production right now but not up to speed. They've got the capital to improve production —I think they're targeting 900 to 1,200 tons a day as things get going over the next few years. So it's a small operation. These are underground veins. You can't mine that much anyway without a lot more buildup of infrastructure.
The advantage is that they're permitted, they're in production, they've got a work force, they're in Canada, and they've got fantastic potential to discover new higher grade bodies. If I'm a mid-tier to large producer, this is the sort of property I would want to buy. I think someone will look at this as an acquisition to add on to their current production because it'll be high margin with lots of exploration upside.
TGR: How about a company like AuEx Ventures Inc. (TSX:XAU) ?
BC: That's a pure exploration company. I visited their project a couple of months ago and, actually, I recommended buying that one subsequent to the visit. These are very, very smart guys with something like 10 to 12 projects ventured out to other people. That tells me the projects they turned up were good enough for someone else to spend their money on. So AuEx gets carried in the exploration without having to spend a dime.
Now the best property I looked at was Long Canyon in Eastern Nevada. This is a new discovery. It's a Carlin-style deposit or system that they are now 49% participating partners on with Frontier Explorations. Frontier's managing the project; they're doing a fantastic job and, so far, they've delineated a northeasterly trend that covers over 1.5 kilometers and is up to 300 meters wide.
They do not have a resource estimate on this yet. They've got a lot of drill holes into it and hope to have one out by sometime in February and this'll just be an initial resource in what could develop into a real gold system of merit. The mineralization is oxidized, near surface. It's in a great location, permittable, eight miles off the freeway. There's power, water, everything, so this looks like a low cost high margin deposit. I like this quite a bit but have not come to terms with the structural controls so am not willing to "guesstimate" a resource figure now.
TGR: How does that compare to the other projects they have? You mentioned they have 10 to 12 joint venture projects going right now.
BC: The others are much more early stage explorations. For example the West Pequop project, they've got in a joint venture with Agnico-Eagle Mines (TSX:AEM) . Agnico's going ahead and earning 70%, and AuEx, I believe, is 30% carried through a feasibility study. They've had a lot of success drilling good mineralized holes. To my mind, they have not yet put it together so that they've got enough to claim or prove up a significant resource. But it's an intriguing system; it's a Carlin-style system, and Agnico's going full steam ahead on that, trying to find where the deposit is if one exists. The other projects are more early stage exploration, where a partner is drilling a few holes or doing some work. They've got a strategic alliance with Agnico in Argentina and they're also doing some work in Spain.
TGR: As a geologist, when you look at their projects in Argentina and Spain, is there a high probability they will produce high-yielding gold projects?
BC: Argentina, certainly. They're down in the Patagonia area, which is a Jurassic-aged volcanic plateau, not too dissimilar from Nevada today. So there's known deposits down there, some good ones and it's relatively unexplored. They're using good exploration techniques they developed in Nevada. So, certainly, Argentina is a good place to be exploring and politically I think it's okay if you're in the right province and they're in the right province. Spain has some historical productions and I don't know enough about their exploration to comment on what exactly they're chasing over there.
TGR: You also follow Miranda Gold Corp. (TSX.V:MAD) , correct?
BC: Right. They're a Nevada-focused group similar to AuEx. They follow the joint venture model, where they generate ideas and then get someone with money to come in and spend money on it while they're carried through the high-risk exploration. Smart, smart business model, particularly in Nevada, where you're usually drilling hundreds of meters blind looking for a deposit. These guys are intelligent enough to know that the only deposits of interest are mega deposits, so they focus their explorations on the major gold trends in Nevada that produce deposits of 2, 5, 10, 20 million ounces. Technically they're amongst the best, if not the best in Nevada. I like what they're doing. I own the stock.
TGR: You say technically they're amongst the best. Are you talking about their geology team?
BC: Yes. For sure.
TGR: And they're looking for mega deposits?
BC: Yes, they're looking for mega deposits that someone will buy or at least carry their costs through based on the joint venture arrangement. Just as an aside, in my opinion, I have no interest in anyone looking for small deposits or developing a small deposit. Everyone says they're looking for something big. In reality, the geologic setting or environment that most companies are working is not conducive to mega deposits.
TGR: Are there other gold companies that you're following that you can share with us?
BC: MAG Silver Corp. (TSX:MAG) (NYSE:MVG) . This is one of the few companies that has a silver deposit that is not reliant on base metal credits. This is a very high grade silver deposit. Their Valdecañas Vein on the Jaunicipio project, Zacatecas, Mexico, is probably the best silver discovery in quite some time.
They and their partner have drilled out current resources of 231 million ounces of silver, about 500,000 ounces of gold with lead and zinc as well. It averages over 1,000 grams of silver per ton. If you just look at the gross metal value per ton, it's nearly $500 a ton. So this is a fantastic deposit that they've found and within the property package they've got serious potential for additional discoveries. So I like MAG Silver and their partner, Fresnillo, is a Mexican silver company, probably the best silver company in the world. They're 56% owners and they operate. They've made an offer to purchase MAG Silver for the equivalent of $4.54 U.S. MAG's currently trading at $5.70, I believe, something in that order. From the beginning I expected a takeout offer from Fresnillo. I did not expect it to be lower than the actual price the stock was trading at, so I was half right.
I've got a model on the vein and I've used costs from the Fresnillo operations, which should be about the same—and I can come up with in the order of a discounted after tax net present value of a minimum $440 million up to $1.3 billion just for MAG's 44% of the deposit. The offer from Fresnillo values the company at about $230 million.
TGR: Why such a low-ball bid?
BC: The markets were collapsing at the time and I think Fresnillo felt that they could pull it off. I don't think they're going to. I know most of the major shareholders and none of them has indicated they're willing to sell the stock for that price. My subscribers, I think, if they believe what I say, are not going to sell it for that price either. Again, going back to who else might like it, Silver Wheaton should certainly take an interest in this. If I was Pan American Silver, I would be looking at it. If I was any major silver company, I'd be looking at this. This is a fantastic deposit that's going to generate a higher profit margin than any other deposit they own and you've got Fresnillo as the operator.
If Fresnillo had offered something above the current price, they may have pulled it off, but I don't think they're going to pull it off. Now legally MAG Silver has to produce an independent valuation to give to give to their shareholders so the shareholders can make a considered opinion on whether to tender their shares or not, so this is going to be a fairly long process. I bet it takes two months. And what's going to happen is an independent engineering firm and a financial group are going to go down and review all the data for this deposit plus all their other operations and come up with some sort of fair value for the deposit. And I suspect it's going to be considerably more than $4.54 a share.
TGR: That'd be good for your investment then.
BC: Yes.
TGR: You have Sprott Resource Corp. (TSX:SCP) on your list. That seems like it's completely different than most of your other investments.
BC: Yes and no; it's all about value. Sprott is run by a very financial savvy group of people. They understand markets, they understand market trends, and they're able to do intelligent deals because of who they are. They currently have about $260 million in the bank and I come to that number based on my understanding of the tax treatment of the profits they made off a coal company they sold. So this is not for sure, but it's close. I'm not a tax man. So they've got $260 million in the bank, which equates to about $3.15 a share vs. the current share price of $2.40 a share.
To me this is an intelligent actual real investment in a proven company at a discount to net asset value. I love those. There are a lot of junior companies out there that are trading at or below cash value. Most of those I wouldn't throw into the league of this because they've got $5, $10, $20 million, maybe. Problem is they're very capable of spending that money in no time at all on projects that don't stand a chance of making any money. So just because a company is selling for less than cash in the bank doesn't mean it's a good buy. That money will go. I've seen it.
TGR: Why are they focusing in on the precious metals area?
BC: They're wide open to anything; although I do notice that late last year they purchased a bunch of gold bullion and silver bullion, so I know they're favorably disposed towards precious metals.
TGR: Brent, are there any other companies you're following that have some interesting stories that you can share with our readers?
BC: Hathor Exploration Ltd. (TSX.V:HAT) is interesting. I've been following Hathor for quite a while. That's a company with a uranium discovery up in the Athabasca Basin of Canada. This is the richest uranium province in the world and last year they pulled some incredible drill holes at this little project called the Roughrider Zone. So I'm following that, have been for a while, and I'm favorably disposed towards it, although the stock has come up in price.
They certainly have some sort of deposit there. These deposits are very small and complex, so it's difficult to put together a resource, but I suspect there is one there. And right now they have four rigs on the property drilling off, infilling drilling, and drilling some extensions and geophysical anomalies. If they hit the geophysical anomalies, this is very significant. We've got two companies up there with uranium mills, AREVA (CEI:FP) and Cameco Corp. (TSX:CCO) . Both of them are desperate for ore.
TGR: What can you tell me about Cardero Resources Corp. (TSX:CDU) (NYSE.A:CDY) (Frankfurt:CR5) ?
BC: That's another one of these situations—and this is something I'm looking for a lot—where we have resources and a buyer sitting there. Cardero has a large iron deposit in Peru, great infrastructure, great location. A preliminary scoping study came out with a discounted NPV of about $4 billion. Iron prices have come off substantially since then but you can see it is a major asset. The company's market cap is about US$65 million and there's a non-binding offer on the table from a Chinese group to buy this for US$200 million. What that means in share price is C$1.30 vs. the offer price of C$4.50. The deal hasn't been clinched, the money hasn't exchanged hands, but that, to me, is another one of these good risk-reward situations that you only get in these sorts of markets.
TGR: Let's say the Chinese group doesn't go through. What does Cardero look like on its own?
BC: Well, then we've got a company with less than $5 million in the bank, another few million in shares of other companies—not bad shares—a large iron deposit that's got valuation of $4 billion, another iron sand deposit that looks like it could make decent money, although the iron market's tanked. They also have number of prospects scattered around Peru, Mexico and one in Michigan. So your downside is not that much; your upside's quite a bit, I think.
TGR: That's interesting. It's great little find.
BC: I like that one. Just hope the Chinese come through.
TGR: Brent, thank you so much for your time.
Brent Cook inherited investor/analyst editor Paul van Eeden's newsletter in February '08, which he then repurposed into Exploration Insights . Brent 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. The website is www.explorationinsights.com
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