The Gold Report: Your presentation "How to Navigate Junior Mining Right Now" uses the image of a giant intake hole in a lake to illustrate the condition of high-risk explorers. However, your price chart of the TSX Venture Exchange's performance shows the exchange to be in better shape than it was in 2000 or 2009. Why is everyone scrambling now?
Matt Badiali: The price chart does not tell the whole story.
Using 2004 as a base, there were 995 mining companies listed on the TSX Venture Exchange (TSX.V) then. Today, there are 1,309. In 2004, the total market value was about $12.3 billion ($12.3B). Today, it is about $19.25B. Additionally, the distribution in 2004 was more even. In 2004, the small caps made up about 7%, and the top 10% of those issuers represented 50% of the market value. Today, the average market cap is about $14 million ($14M) and the top 25% of the issuers are 84% of the exchange. That means 327 companies account for $16B of the $19B in market cap, leaving 75% of the companies comprising a tiny fraction of the total market cap. There is a big divide between the haves and the have nots.
Another ugly trend is the growth in the number of shares outstanding. In 2004 the average company had about 27M shares outstanding. A typical company today has an average of 72.8M shares out—almost three times as many. It may look as if things have gotten better, but the pie has been cut in much smaller slices.The average share price in 2004 was $0.46; today it is $0.20—a more than 50% loss.
TGR: Is there much mobility between the haves and have nots? Are small companies growing up into bigger companies?
MB: Most of the companies are in decline. There has been erosion in the market since 2011, especially in the ability of mining companies to get financing. These companies have no earnings. They cannot generate cash. What they can do is sell new shares in the hope of putting the money generated into the ground and making a discovery that will increase the company's value so they can raise money again at a higher share price. That is a miserable business model for most investors.
"Fund redemption is pushing down share prices of companies with real discoveries."
The number of financings fell from 3,000 in 2007 to 1,450 in 2012. Debt financing, on the other hand, has grown. Going to the bank to raise money is dangerous for small mining companies because they lack the ability to repay the debt. Debt financing is a great way to lose your asset.
Fund redemption is another mechanism pushing down share prices of companies with real discoveries. When the shareholders of funds that have bought new mining stocks want their money back, the fund has to sell whatever it can. With the bulk of the value in the top 10% of the TSX.V, that is what the funds sell off first.
As a result, some good companies have been sold off unfairly. For example, Bob Quartermain's company, Pretium Resources Inc. (PVG:TSX; PVG:NYSE), has a great discovery in British Columbia. It has gold intersections in its drill holes on the order of 1 kilogram per ton. It is a fantastic deposit run by one of the most successful explorers out there. And the share price fell 57%.
ATAC Resources Ltd. (ATC:TSX.V) has one of two potentially viable gold discoveries in the Yukon. It has fallen by the wayside. ATAC's share price fell 87%. Kaminak Gold Corp. (KAM:TSX.V), which owns the other, saw its share price fall 73%. Because these companies have viable discoveries, a lot of people got in quick and then got out just as quick.
"I do not think the TSX.V is done falling, but there are opportunities out there."
It is mind-boggling that a company like Mirasol Resources Ltd. (MRZ:TSX.V) is so far down. It made a couple of great discoveries in Argentina and sold one to Coeur d'Alene Mines Corp. (CDM:TSX; CDE:NYSE), which was its partner on it, for $30M in cash and $30M in Coeur d'Alene shares. Mirasol's share price is down 77%.
Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE) is down 56% from its recent high. It has an ongoing discovery in Mexico and a ton of cash. It is run by a father and son, proven ore finders, a team I respect.
Overall, I do not think the TSX.V is done falling, but there are opportunities out there.
TGR: Why are share prices for juniors going down after they release positive news?
MB: People with large positions in these companies decide they want to sell, but not on the open market, which would destroy the stock. Instead, they look for liquidity events, occasions when people have eyes on the stock. They then put blocks of shares up for sale and hope the news is good enough to allow them to sell some of their position. The same is true for the funds, to a lesser extent.
TGR: Last year you predicted gold equities would catch up with the commodity price. Since then, the Composite Index has sunk from 1,750 to 1,100, and the price of gold has dropped from $1,700/ounce ($1,700/oz) to $1,600/oz. Are they both in that drain where equities are sinking faster than gold or are there other forces at work?
MB: You have just proven that I am a better analyst than I am a forecaster.
Folks do not trust mining equities right now. Any form of risk has sent them running, and we have had a series of contrived financial apocalypses: the purported death of the European Union, the fiscal cliff, austerity. Every time there is a new threat, investors run away screaming from gold equities.
TGR: I would like to return to that top 25% you mentioned. Which companies in that group fit your investing rules?
MB: First the rules, then the companies. Following the rules will help you sort through the companies, finding reasons to buy or walk away.
"I believe the companies that fit my criteria will turn ahead of the market."
First rule: Cash is king right now. Companies must have enough money to keep the lights on, the doors open and get business done. A company with $3M in the bank and plans to spend $10M on its project needs to be worried, because financing is not easy. The financiers willing to do those deals are going to require a full warrant. Investors cannot afford to fall in love with a project in this market. This is all about the business.
Second rule: Buy management. Look for serially successful entrepreneurs. We use Pretium's Bob Quartermain as our example there.
Third rule: Buy the business model. I like the prospect-generation business model because it preserves cash. The company is spending someone else's money. These companies tend to be run by smart, experienced exploration geologists who have no interest in building a mine. They just want to find stuff. For example, Mirasol had Coeur d'Alene pay for its exploration, and at a certain point, Coeur d'Alene bought the project from Mirasol for $60M. That was a lot of money for a tiny company like Mirasol.
Companies like Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE), Vale S.A. (VALE:NYSE), Antofagasta Plc (ANTO:LSE) and Newmont Mining Corp. (NEM:NYSE) are partnering with tiny prospect generators for exploration.
Fourth rule: You want high-quality deposits in safe places. Too many investors forget that a mine has to be a business. A lot of companies have marginal deposits. I look for high-grade, economic projects in good jurisdictions. Finding a good jurisdiction is more difficult now. You want places where the tax burden is not too high and your chances of the government taking your deposit are low.
TGR: Now that we know the rules, let's talk about companies, starting with one you already mentioned, Pretium. Its feasibility study for a high-grade underground mine in the Brucejack area is expected soon. What do you want to see in that document?
MB: I want to see how much it will cost to build and get an idea of the profitability. I also will look hard at the timeline. A feasibility study is about the last piece of good news once a company starts construction.
There is a lot less expectation built into Pretium's shares now than when it was an $18 stock.
The development period is a good time to acquire companies and then hold them through production. Once they go into production and start making money, the stock gets picked up by the indices and attracts the large funds.
TGR: What other companies meet your rules?
MB: ATAC, Mirasol, Kaminak and Almaden. All have cash. They all have active projects, and I consider them to be undervalued right now.
A few small prospect generators meet the rules. Evrim Resources Corp. (EVM:TSX.V) is tiny, but it is run by smart folks doing good things. It has plenty of money and some strong partners.
Miranda Gold Corp. (MAD:TSX.V), another prospect generator, is run by Ken Cunningham. He is looking for elephants in Nevada.
TGR: There is lots of talk about Nevada. Do you consider it a friendly jurisdiction?
MB: I do. Nevada is a great place to look for gold, for two reasons. One, the state understands that gold mining pays its bills. Two, it has an enormous gold endowment.
Gold mines tend to cluster, and that is the case in Nevada. The Carlin and Cortez trends are fantastic. Miranda does not have an ongoing discovery right now, but it has a lot of shots on goal.
To me, the epitome of the prospect generator business model right now is Eurasian Minerals Inc. (EMX:TSX.V). It has projects all over the world and I have visited several. It has a project in Haiti with Newmont Mining. In Turkey its partner on the Balya project is a Turkish mining company called Dedeman Mining Group. Eurasian will get a 4% uncapped royalty on Balya. That project was slated to go into production, but Dedeman kept intersecting high-grade zinc, so much so that development stopped and the companies are rethinking the exploration plans.
Eurasian has another gold project in Turkey called Akarca. It had a partner on it, and the partner gave it back after spending several million dollars on exploration. I expect that to be a great discovery.
Eurasian has income and a great technical team. It has major partners like Freeport and Vale. I have a lot of respect for the business acumen of Eurasian's CEO, Dave Cole. He has a great, long-range plan for the company. He was acquiring royalties before it was cool. It fits all of my rules.
TGR: You mentioned Almaden as a company that meets the rules. Can you tell us more about that company?
MB: I think of Almaden as a prospect generator, but the company also does development, at Ixtaca, in Mexico.
I have enormous respect for Duane Poliquin, Almaden's founder, and his son Morgan, who has a doctorate in geology. They are smart, polite folks who can speak intelligently on an enormous range of subjects, not just geology.
Ixtaca is high on my list. It is an ongoing discovery. The company has plenty of money in the bank.
TGR: Almaden just announced a resource estimate. The stock price has been a bit down. Is the resource estimate enough to pull it up?
MB: In a good market, it would have given the share price a nice boost, but not in the current market. Investors are still looking for reasons to sell, rather than buy.
I would like to see an uptrend. Despite a series of manufactured cliffhangers, I do not see an impending crisis. Look at the growth in China. The Dow Jones Industrial Average is hitting new highs. Investors are putting their money to work. The malls here in Florida are packed. You need a reservation to go out to dinner. People are feeling a little more wealthy.
Investors have not yet returned to the junior resource sector, but I believe the companies that fit my criteria will turn ahead of the market. The turning point will be when investor sentiment changes for the blue chips of the junior mining sector.
TGR: Any final advice for investors trying to keep their head above water?
MB: My general rule of thumb now is to keep your powder dry. Keep half of the money you want to invest in junior mining in cash for now. Look for opportunities and nibble. Maybe take a small position in a few companies with the idea that, when the uptrend comes, you can take a bigger position.
TGR: Matt, thank you for your advice and your insights.
Matt Badiali is the editor of the S&A Resource Report, a monthly investment advisory that focuses on natural resources, including silver, uranium, copper, natural gas, oil, water and gold. He is a regular contributor to Growth Stock Wire, a free pre-market briefing on the day's most profitable trading opportunities. Badiali has experience as a hydrologist, geologist and consultant to the oil industry. He holds a master's degree in geology from Florida Atlantic University.
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1) JT Long conducted this interview for The Gold Report and provides services to The Gold Report as an employee. She or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Pretium Resources Inc. and Almaden Minerals Ltd. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
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