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Why Goldman Sachs Is Wrong About Commodity Prices

Commodities / Resources Investing Mar 18, 2015 - 10:30 AM GMT

By: Metals_Report


Goldman Sachs delivered a dire commodities outlook earlier this year, but RAB Capital Founder Philip Richards still sees compelling buying opportunities. In this interview with The Mining Report, Richards discusses his outlook for oil, gold, vanadium, zinc and nickel, and profiles companies with projects that will see the light of day even in harsh price environments. A few of these names have doubled in stock value in recent months, and still others look poised to deliver multiple returns on investment.

The Mining Report: Goldman Sachs cut its price outlook for almost all commodities, including oil, which it said could go as low as in the high $30 per barrel ($30/bbl) range. Do you see that as realistic?

Philip Richards: I think that oil has now made a bottom. I look at Brent crude more than West Texas Intermediate. Brent bottomed at around $46/bbl and has since rallied around 30%. The reason for thinking that oil could go lower is that oil is a relatively price-inelastic commodity. That means if you have a big move in the price, you don't necessarily get a big response on the demand side. Nevertheless, demand is picking up at these lower levels. In fact, even in the U.S., which is a material market, there has been a notable uptick in the growth of oil use at these lower prices, so oil is responding a bit on the demand side.

The other question is whether supply can move dramatically in one direction or the other. Now, Iraq is beginning to pump more oil, and may add another 1–2 million barrels per day (1–2 MMb/d) within the next two years. On the other hand, the whole Middle East is becoming increasingly traumatized, by the Islamic State in particular. There is ongoing unrest across the region, such as Shi'ite Houthi militia taking over strategic sites in Yemen. That could destabilize Saudi oil provinces, which have Shi'a Muslims, who are disaffected with the Saudi regime.

Also, about 5% of oil production drops out of the equation every year simply because reserves run out. This is a commodity with production running at around 92 MMb/d, so about 5 MMb/d must be replaced every year. With the lower oil price, a lot of investment has been curtailed, and consequently, that will slow the pace of new supply coming on-line.

Generally speaking, my prognosis would be that we are looking at oil prices slowly increasing over time.

TMR: In this range of oil prices, what oil companies could be successful?

PR: A number of oil companies had their share prices come down quite a lot. I think you have to look at the mid caps or juniors for real bargain prices. The blue chips, the big-cap stocks, didn't come down as much.

Falkland Oil and Gas Ltd. (FOGL:AIM) has been a long-time favorite. It is just commencing a major five-well drilling program. The stock should show some upside, particularly if the oil price rises.

In the U.S., a company like Noble Energy Inc. (NBL:NYSE), which is a partner of Falkland Oil and Gas in the South Falklands Basin, is well positioned, and also has some decent production elsewhere in the world. Noble is a good example of a fairly large mid-cap stock that could do well in this range of oil prices.

If you looked into something a little bit smaller in, say, the United Kingdom, you might consider Premier Oil Plc (PMO:LSE), which has production. The share price has come off very considerably from its high. In September, the stock was at about 350 pence/share (350p/share). It's now at only 120p. So I would think that's a good example of a bargain stock.

TMR: One thing that Goldman did see increasing was gold. It raised its forecast to $1,262/ounce ($1,262/oz) from $1,200/oz, saying that the downward trend was short of its expectations. What are your expectations for gold?

PR: Gold should be a beneficiary of all the money printing that's been going on in the world. Central banks everywhere have been doing quantitative easing. The European Central Bank is now printing large volumes of euros. Gold should benefit from that. Likewise, just as with oil, the gold price has come down a lot from its peak of nearly $2,000/oz in 2011. So it's about 40% down from its peak. However, that drop has resulted in curtailed production, which should begin to cause a tightness in supply.

Gold obviously is very much a financial commodity that is used speculatively; nevertheless, our view is that a money printing environment with very low interest rates should be good for gold. Also, we believe that the Chinese would like to increase their central bank holdings of gold, and they're not alone. There are some other Asian central banks that would like to increase their holdings of gold. We think the demand side should improve.

TMR: What numbers are you using for your valuation estimates?

PR: We tend to use around $1,200/oz gold to be conservative. We would also look at projects at $1,000/oz gold, just to make sure companies can survive a more severe price pullback. I also would look at a scenario where gold gets back to, say, $1,600/oz. Typically, we would look at a minimum of three different scenarios so as to see what the leverage could be.

TMR: What are some of those gold companies you're following that could do well in any of those three scenarios?

PR: Victoria Gold Corp. (VIT:TSX.V) has done well since we last spoke. It's up nearly 100%. However, the company is still trading at a very deep discount to its net present value, which is three or four times the current share price, depending on what gold price you use. It has a decent project in the Yukon, which is obviously a safe political jurisdiction. I think this is one stock that could double again from here.

TMR: Victoria has announced that it is waiting until the market turns to go into production on its Eagle gold project, and it's focusing more on mergers and acquisitions. What are some of the opportunities you see for Victoria? There are a lot of deals out there right now.

PR: Yes. I hope that Victoria doesn't buy anything that is too big. In the Eagle deposit, it has a very big deposit already. I guess if it's actually going to try and put something into production, it's better if it's smaller, quite frankly, unless it buys another very big sleeper project and waits for the gold price to increase. I think the Eagle project will get into production at some point over the next couple of years. It's not a project that requires a very high gold price to be economic.

TMR: What are some other gold projects you're watching?

PR: I quite like the Russian producers. Kinross Gold Corp. (K:TSX; KGC:NYSE) has big production in Russia. That's a major blue chip stock, of course. With the ruble having fallen dramatically, the company's local costs of production have come right down. Kinross is a good company that is in production and has strong cash flow.

TMR: Let's go to some of the other commodities. What about vanadium?

PR: Vanadium pricing has been a little bit soft. I guess that's due to softness in stainless steel. Largo Resources Ltd. (LGO:TSX.V) has come into production. That's had actually quite an adverse price movement since we last spoke. Actually, the main worry there isn't its cash-flow generation, which, even at these vanadium prices, remains reasonably strong. Most of the worry has been due to the fact that Largo has some debt that has to be rescheduled in the next month. Hopefully, over the next couple of months, Largo will have quite a major improvement in share price due to the successful debt restructuring.

TMR: Is Largo still on track to produce 17+ million pounds of vanadium this year?

PR: Yes, more or less. It is certainly in production. Whenever you are in the first year of production, things can come in a little bit lower, but I think, broadly speaking, Largo is on track.

TMR: A number of people we have interviewed are quite excited about the prospects for zinc. Do you share that excitement?

PR: Yes. Trevali Mining Corp. (TV:TSX; TV:BVL; TREVF:OTCQX) has started to do well. I think Trevali has a lot more upside from here. I would hope that by the time we next speak, it will be up 50–60% from here. Its cash flows are starting to come through. It has production in Peru. It is just coming into production in New Brunswick in Canada, and it has some other assets to exploit. So I'm positive on Trevali and on zinc.

A large-cap zinc stock would be something like HudBay Minerals Inc. (HBM:TSX; HBM:NYSE).

TMR: Is HudBay looking to acquire more production as it runs out?

PR: Yes, I would figure so.

TMR: Are there any companies you're watching that could be acquisition targets for HudBay?

PR: Actually, Trevali would be a prime candidate. Selwyn Resources Ltd. (SWN:TSX.V) still has the ScoZinc deposit in Nova Scotia. That would be quite a good one for HudBay to buy as well. I remember when HudBay bought out OntZinc Corp., which operated in Ontario. I think HudBay is likely to go for North American assets. Trevali and Selwyn's ScoZinc are two pretty easy targets. Neither company is very expensive and either company would be quite an easy takeout target.

TMR: What about nickel?

PR: Nickel has been a big disappointment. The price was really looking to firm up, and it's come all the way back down to the bottom. So I'm very disappointed in nickel.

TMR: Are you following nickel companies?

PR: Yes, we're still following Royal Nickel Corp. (RNX:TSX). I think the Dumont project is great, with an NPV clearly in excess of $1 billion, depending on nickel prices, but frankly, we do need a higher nickel price for that project to fly. Royal Nickel is going to be a major beneficiary of any nickel rally. My own view of nickel is demand growth remains quite good. The supply situation obviously improved dramatically when the Indonesians imposed their export ban on nickel pig iron. But there has been leakage of nickel pig iron from the Philippines, and possibly some leakage out of Indonesia. We are very disappointed by how low the nickel price has been, and we are hoping for and expecting an improvement in the next few months. But that has been an unexpected setback.

TMR: What about the Abitibi itself? Are you positive on that region?

PR: It depends on the project. Typically, people are positive on a region when it just looks geologically prospective and they're not sure what opportunities are there. In the case of Royal Nickel, we don't need any encouragement: we have clearly defined resources. We know what's there, and we have a mine plan. It's really quite advanced in that respect. We just need a better nickel market to bring this into production.

TMR: What about iron ore?

PR: Iron ore has been completely disastrous. However, Sable Mining Africa Ltd. (SBLM:LSE) is one company we would still consider buying at these levels. It's very, very cheap. Sable has one of the best iron ore resources in Africa. I think even at these iron ore prices, it's one of the few African iron ore projects that could be economically viable.

TMR: Investors seem to agree with you. The stock price has been perking up a bit lately.

PR: It perked up a bit because Sable confirmed it now has an ocean access railway route through Liberia. So it now has an improved train route that has been approved by the government to get access to the sea. Sable has a very, very good product—high grade, low impurities. I'm pretty confident that this is a project that will see the light of day and possibly reward shareholders with multiple returns on their investments.

Another early-stage iron ore stock I would mention is Royal Resources Ltd. (ROY:ASX). Royal Resources has a several-billion-ton resource in Australia, which should have quite a low production cost because it's near the sea. This project should be competitive. It will take longer to build Royal Resource's project than that of Sable Mining, which could probably build its mine within a couple of years. Nevertheless, Royal is in a good, safe jurisdiction, and it's a world-class asset. On a five-year view, iron ore prices could be picking up strongly.

TMR: What is the one thing natural resource investors need to do this year to take advantage of the opportunity?

PR: I think they have to get involved in decent projects that can see the light of day. The bottom of the market was December/January. From the bottom, we've seen a few stocks move over 100%. Falkland Oil and Gas, which we discussed, bottomed at 18p/share. Recently, it was trading at 36p/share, so that's a 100% move. Sable Mining bottomed at around 0.65p/share, and it's actually been as high as 3p/share, so that was a nearly fivefold move. It has come back down, but it's still well off the bottom. Even though these names have been very risky and have been very painful to hold for quite some time, I think there is an opportunity there. People should grasp that.

TMR: Thanks for your insights.

Philip Richards is the Founder and President of RAB Capital Limited, having cofounded the company with Michael Alen-Buckley in 1999. He is the investment manager for the RAB Special Situations Fund. Prior to joining RAB, Richards was a Managing Director of European research and later Managing Director of investment banking at Merrill Lynch. Richards holds a Bachelor of Arts Honours from Oxford University (Corpus Christi College) in Philosophy, Politics and Economics.

Want to read more Mining Report articles like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see recent interviews with industry analysts and commentators, visit our Mining Report home page.


1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Victoria Gold Corp., Largo Resources Ltd. and Trevali Mining Corp. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Philip Richards: I own, or my family owns, shares of the following companies mentioned in this interview: All. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
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