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-- Latest Stock Selection Update: 11th February 2009
Stock Selection Update #56 - Feb-11 2009
Over
the past two months we have mentioned that investors could obtain
exposure to a portfolio of junior resource stocks by purchasing Sprott
Resource Corp. (TSX: SCP) or Endeavour Financial (TSX: EDV). We added
SCP to the TSI Stocks List in mid December and continue to like it as
an under-valued, well-managed long-term play on the junior resource
sector. Today's email, however, is about EDV.
EDV recently completed a very large equity financing that
re-capitalised the company. This financing raised C$115M at C$1.77 per
share, in the process tripling the company's share count and putting
downward pressure on its share price. Also, the large increases in cash
and shares outstanding reduced EDV's short-term leverage to the junior
resource sector, as well as its risk.
Despite the 200% increase in share count EDV is still trading at a
sizeable discount to its net asset value. Specifically, based on the
market value of the company's investments as at 31st December 2008 (the
current value should be about the same as it was then) and
incorporating the effects of the recent financing, we calculate that
EDV presently has cash and investments with a combined value of
US$163M. This equates to about C$2.00 per EDV share, which compares
favourably with Tuesday's closing share price of C$1.58. However, EDV
also operates an investment banking business with a book value of
US$55M. Adding the book value of the investment banking business to the
market value of the cash and investments results in a net asset value
of C$2.77 per share.
Assuming that EDV's management invests its cash prudently in junior
gold and other resource companies over the year ahead, the company's
net asset value should increase markedly. One reason is that there is a
huge amount of value to be found in this area of the stock market.
Another reason is that EDV, due to its connections and status, gets
presented with a lot of good investment opportunities that are not
available to the average person. In the short-term, however, the stock
may not be a stellar performer due to the effects of the recent
financing (higher share supply and watered-down leverage).
For risk-tolerant speculators, the reduced-leverage issue can be
overcome by purchasing the new EDV warrants rather than EDV shares. The
warrants, which trade on the TSX under the symbol EDV.WT.A (the Yahoo
Finance symbol is EDV-WTA.TO), have an exercise price of C$2.50 and an
expiry date of February-2014, so as long as there's a bull market in
junior resource shares at some point over the next 5 years there should
be an opportunity to realise large gains on these warrants.
Furthermore, there seems to be reasonable liquidity in the market for
these warrants at around C$0.50 (950K warrants traded between C$0.49
and C$0.52 on Tuesday).
We are going to add the above-mentioned EDV warrants to the TSI Stocks
List at Tuesday's closing price of C$0.49. With the stock at around
C$1.60 we calculate fair value for the warrants to be C$0.48-C$0.52.
Stock Selection Update #55 - Nov-21 2008
The
US stock market plunged again on Thursday, which, as usual, boosted the
US$. Not so usual was that gold also gained some ground and achieved
the first decisive daily close above its 18-day moving average since
early October. This could mean that the de-leveraging has run its
course in the gold market.
The HUI has now fallen for 5 days in a row while remaining above its
13th November intra-day spike low on a daily closing basis. Perhaps
there will be 1-2 more days of pain before the gold sector begins to
rally, but whether it begins today (Friday) or early next week we
suspect that the coming rally will be explosive.
It would be safer to wait for evidence of an upward reversal before
establishing any new trading positions, and for non-gold/silver stocks
we would certainly do that (we would wait for the S&P500 Index to
close back above 850). However, we think the gold sector's short-term
upside potential is large enough to warrant foregoing some safety. We
are therefore going to add three new gold/silver trading positions to
the TSI List as discussed below. This reflects the actions we are
taking in our own account, but risk-averse speculators could reasonably
decide to wait for the HUI to close above 200 before adding any new
long-side exposure.
The TSI Stocks List presently contains a GDX January-2009 call option,
a Yamana Gold (AUY) January-2009 call option and a Silver Wheaton (SLW)
December-2008 call option. The AUY and SLW call options are a long way
out of the money and will almost certainly expire worthless, although
there is still an outside chance that AUY will strengthen enough over
the next two months to inject some value into our call option. In any
case, the AUY and SLW options are too far out of the money to provide
meaningful leverage to the coming rally, so we have decided to add
trading positions in the underlying stocks at Thursday's closing prices
of US$3.60 (AUY) and US$2.57 (SLW). These stocks should outperform IF
there is a strong sector-wide rebound over the coming months.
The third new trading position is in New Gold (AMEX: NGD), which closed
at US$0.85 on Thursday. There is already a longer-term NGD position in
the TSI List, but we want a separate trading position on which profits
can be taken within the next few months.
We will set initial protective stops on each of the three new positions
at 15% below Thursday's closing prices. Also, to avoid confusion --
especially since there will now be two NGD entries -- we will create a
separate section in the TSI Stocks List for trading positions. This new
section will initially contain the three stocks mentioned herewith plus
our existing Hecla Mining (HL) trading position.
On a different matter, we are downgrading our short-term bond market
outlook to "bearish". The December T-Bond closed at around 122 on
Wednesday, rocketed up to 126 on Thursday, and traded as high as 128.5
earlier today. As we write it is trading just above 127. All the gains
achieved by bonds during this panic phase are likely to quickly
disappear.
Stock Selection Update #54 - Jul-25 2008
A
quick note that we are adding Precision Drilling Trust (NYSE: PDS, TSX:
PD.UN) to the TSI Stocks List at Thursday's closing price of US$21.32.
PDS provides drilling services to natural gas producers in Canada and
the US. At its current price it has a market cap of about US$2.7B,
yields about 7.5%, and has a P/E ratio of around 10. As was the case
with Chesapeake Energy a couple of days ago, PDS's sharp downward
correction has just reached the 200-day moving average.
More info on PDS will be provided in the Weekly Update.
Stock Selection Update #53 - Jun-25 2008
In
the 14th May Interim Update we said we would add ATW Ventures (TSXV:
ATW) to the TSI Stocks List if it traded at C$0.68. It reached this
price on Tuesday and has accordingly been added to the List.
Hecla Mining (NYSE: HL) is another stock mentioned over the past couple
of months as a potential future addition to the TSI Stocks List. We
have decided to add HL to the List at Tuesday's closing price of
US$7.52.
ATW is a small development-stage gold miner with operations in Western
Australia. HL is a mid-tier silver producer with operations in the US.
Write-ups on both stocks will be included in Thursday's Interim Update.
We are apprehensive about adding these stocks to the TSI List ahead of
Wednesday's Federal Reserve monetary policy statement because this
statement will probably move the markets sharply in one direction or
the other. In our opinion, the smartest thing for the Fed to do at this
time would be to shock the markets with a 50 basis-point rate hike. We
expect that such an action would give the US$ a hefty boost, push oil
and other commodity prices sharply lower, and, following an initial
knee-jerk decline, boost the stock market. Because it would quell
inflation fears such a move by the Fed would also probably reduce
long-term interest rates and thus help the housing market. However, the
most likely thing for the Fed to do would be to leave the official
interest rate target unchanged and include some inflation-fighting
words in the policy statement.
Due to the potential for Wednesday's Fed news to prompt a sharp move in
an unknown direction, a reasonable approach for those interested in
buying one or both of the aforementioned stocks would be to take an
initial position immediately with the aim of adding to the position at
a later date (after the dust has well and truly settled).
Stock Selection Update #52 - Jun-20 2008
We are
going to 'bite the bullet' and make a complete exit from Patriot Coal
(NYSE: PCX). The profit, based on Thursday's closing price of US$151.40
and our December-2007 entry at US$35.14, was 330%.
We've agonised over this decision because we don't think the coal bull
market is close to being over and because the stock may never pull back
enough to provide us with an attractive re-entry opportunity. In other
words, by losing our position now we run the risk of never being able
to get back in at what we would consider a reasonable price. However,
this is a risk we are willing to take in order to avoid the risk
presented by a stock price that has risen so quickly that it is now
almost triple its 200-day moving average.
Our decision to make a full exit from PCX has also been influenced by
the possibility that Thursday was an important reversal day in the
energy sector.
On a different matter, there was a new development in Australian
trading today (Friday) in the LST-IRN-Xstrata tussle. Specifically, a
fourth party has entered the fray by announcing a higher bid for IRN.
Due to LST's 25.4% stake in IRN, the new (A$1.28/share) bid for IRN
increases LST's net asset value by about A$0.14/share.
Xstrata now has until 10.00am on Sunday 22nd June to match or exceed
this new bid. If Xstrata does not raise its offer to at least match the
competing offer then LST will no doubt opt to sell its IRN shares to
the new bidder and return more money than previously expected to LST
shareholders.
Stock Selection Update #51 - May-16 2008
In
yesterday's Interim Update we noted that the HUI needed to soon resume
its advance to avoid negating the bullish signal that was generated
last week. Thursday's rally in the gold sector was therefore 'just what
the doctor ordered'. A daily close above 430 by the HUI would be
additional evidence that a correction low was put in place at the
beginning of this month.
Everything may look bullish right now as far as the broad stock market
is concerned, but further evidence of a gold sector bottom would be a
"red flag". Specifically, a daily close above 430 by the HUI would be
evidence that the S&P500 Index was within a few weeks and a few
percent of an important peak.
Anyhow, the main reason for this brief message is to advise changes to the "Options" section of the TSI Stocks List.
First, we are exiting the Intel call-option position (the INTC
January-2009 $25 calls) that was added to the Stocks List in January.
Based on Thursday's closing price of US$2.49 and our January entry at
US$1.30, the profit on the trade was 91.5%. (By the way, in our own
account we exited half of the INTC calls on Thursday and plan to exit
the remainder within the next 4 weeks).
Second, we are going to add a position in Mitsubishi Financial Group
(NYSE: MTU) January-2009 US$12.50 call options (ZHRAV) at Thursday's
closing price of US$0.60.
Our most recent mention of MTU was in the 7th May Interim Update, when
we suggested that traders with a 6-12 month timeframe take a position
in the stock following a pullback to the low-$10 area. The stock traded
as low as $10.11 on Wednesday and may well have reached a short-term
bottom at that time.
Traders who are 'long' the stock should place a protective stop at
around $9.50, thus limiting the potential loss to less than 10%.
However, traders who buy the above-mentioned MTU call options should be
prepared to lose up to 100% of their money. With out-of-the-money
options there is usually no middle ground -- they either work extremely
well or not at all.
Stock Selection Update #50 - May-06 2008
Oil's
surge back to $120 on Monday has created a good short-term
profit-taking opportunity in non-uranium energy stocks, which for us
means natural gas and coal stocks.
In general, the most likely candidates for selling at this time are
those energy stocks that are a long way above their 50-day moving
averages. As far as our 'gassy' Canadian trusts are concerned, this
means Trilogy Energy (TSX: TET.UN). At Monday's closing price of
C$12.92, TET.UN was 28% above its 50-day moving average. On the other
hand, our other 'gassy' energy trusts are not yet close to being
overbought. In fact, PEY.UN is still completing a multi-month basing
pattern and is actually suitable for new buying near Monday's closing
price of C$20.50.
Additional natural gas exposure within the TSI Stocks List is provided
by mid-tier Canadian E&P company Fairborne Energy (TSX: FEL). In
the 16th April Interim Update we said that we would grab the
opportunity to make at least a partial exit from FEL if it moved up to
resistance in the C$10-$11 range within the coming month (it was
trading at C$8.47 at the time). It has just risen into this resistance
range, prompting us to cut our own exposure to the stock by half on
Monday. However, we have decided to keep FEL in the TSI Stocks List
because: a) it is not yet close to being over-valued despite the recent
doubling of its price (it is trading at only 5-times cash flow), b) it
offers good leverage to the spot natural gas price (only about
one-quarter of this year's production is hedged), and c) it is likely
to achieve strong growth over the next 12 months.
As far as our coal exposure is concerned, at Monday's closing price of
US$73.60 Patriot Coal (NYSE: PCX) was 34% above its 50-day moving
average and certainly at a level where PARTIAL profit-taking would be
appropriate. We capitalised the word "partial" in the preceding
sentence because it will be important to maintain sizeable core
exposure to both coal and natural gas until the stocks become
over-valued. Like TET and FEL, PCX is currently overbought on a
short-term basis, but it is not remotely close to being over-valued.
The bottom line is that the current euphoria engulfing non-uranium
energy stocks is, in our opinion, presenting an opportunity to reduce
exposure to these stocks. A reasonable approach would be to do some
selling now with the aim of buying back later this year -- following
pullbacks to 50-day moving averages. The risk, of course, is that the
stocks move much higher before pulling back, but even if this risk
materialises it shouldn't create a big problem for someone who
maintains a core position.
The uranium sector is a totally different 'kettle of fish' and has been
mired in depression. We will re-visit this sector in one of the next
two TSI commentaries (most likely Thursday's Interim Update).
Lastly, there continues to be a reasonable chance of the AMEX Gold BUGS
Index (HUI) making a final plunge to new lows before its correction
comes to an end. However, some of the junior gold stocks we follow have
almost certainly bottomed already and others appear to be very close to
bottoming out. One junior that appears to be very close to
bottoming-out -- if it hasn't bottomed already -- is Gold-Ore Resources
(TSXV: GOZ). GOZ has drifted back to a price area (the low-C$0.70s)
where it should find good support and where it offers very good value.
How much value does it offer at Monday's closing price of C$0.71? Well,
the company is currently producing gold at the annualised rate of 28K
ounces and is on track to reach its 70K oz/yr target. A profitable 70K
oz/yr gold mining operation with a 10+ year mine life in a
politically-secure location (Sweden) should be worth at least US$175M.
GOZ's current market cap is less than US$60M.
Stock Selection Update #49 - Feb-27 2008
With
things heating up in the precious metals world we thought we'd send out
this quick note with some ideas that could work well in the short-term
as well as the longer-term.
Silver Stocks
Silver is probably within 6 weeks of an important peak (we'll explain
why in Thursday's Interim Update) so this is not the time to be moving
aggressively into silver-related speculations, but those who currently
have minimal exposure to "poor man's gold" can still find some
reasonable buying opportunities at the junior end of the silver-stock
universe. For example: as a junior with a substantial in-ground
resource, about 4.5M ounces/year of unhedged current production and a
market capitalisation of only C$330M (70M shares at C$4.70/share),
First Majestic Silver (TSX: FR) should benefit greatly IF silver
continues its surge over the next few weeks. This is because the
company would experience a sharp increase in its profit margin and
because the stock market would be forced to assign a much higher
valuation to FR's 175M ounces of in-ground resources under such a
circumstance. We think that Sabina Silver (TSXV: SBB), a tiny
exploration-stage company with a massive in-ground resource in a
politically secure location, would also fare extremely well if the
degree of speculation were to increase over the coming weeks.
A small silver producer that looks interesting at this time, but is not
a current member of the TSI Stocks List, is US Silver (TSXV: USA). USA
is expected to ramp-up its production to around 3.5M ounces/year over
the next 2-3 quarters and has a market capitalisation of only C$160M
(206M shares at C$0.74/share).
Due to insufficient liquidity the above-mentioned juniors -- and junior
resource stocks in general -- aren't well suited for short-term
trading, but someone who buys now with the aim of holding for 1-2 years
could end up with significant short-term gains.
Gold-Stock Warrants
This far into a gold rally the junior gold stocks would normally be
running hard to the upside and the warrants on these types of stocks
would be going berserk, but, as we've discussed many times in TSI
commentaries, the current gold-stock situation is not normal. As a
result, most junior gold stocks are still in consolidation patterns and
some of the warrants on these stocks are still reasonably priced. Here
are two examples of warrants that are candidates for new buying near
current prices:
1) European Minerals April-2010 C$1.20 warrants (TSX: EPM.WT.A).
With EPM at Tuesday's closing price of C$1.40 we calculate fair value
for EPM.WT.A to be around C$0.50, but paying anything up to the
high-0.50s would be OK.
2) Great Basin Gold April-2009 C$3.50 warrants (TSX: GBG.WT).
With GBG at Tuesday's closing price of C$3.37 we calculate fair value
for GBG.WT to be around C$0.65, but anything up to around C$0.70 would
be OK.
The above-mentioned warrants are a lot more risky than the underlying
stocks. For example, if GBG were to trade sideways over the coming 14
months then someone who owned the stock wouldn't lose any money, but
someone who held the warrants over this period would lose 100% of their
investment (the warrants will expire worthless if the stock price is
below C$3.50 at the April-2009 expiry date). The EPM warrants are less
risky because they are 'in the money' (their exercise price is below
the current stock price) and because they have an extra 12 months of
time prior to expiry, but there is still a significantly greater risk
of loss with the warrants than with the stock.
Despite the additional risk, warrants are sometimes worth considering
due to the leverage -- and the associated additional upside potential
-- that they offer. For example, a rise in GBG's stock price to around
C$5.50 over the next few months would result in a rise to more than
C$2.00 in the fair value of GBG.WT; that is, a 60% increase in the
stock price over the next few months would lead to an increase of at
least 180% in the warrant price.
Stock Selection Update #48 - Nov-27 2007
Before the
start of trading on Monday, NovaGold Resources (TSX and AMEX: NG)
announced that it and its 50/50 JV partner (Teck) were suspending
construction at the Galore Creek copper/gold project due to a massive
increase in the project's estimated capital cost. Specifically, the
estimated capital cost has jumped from around $2.2B to around $5B,
making the project uneconomic. This news meant that NG was, at best,
worth about half of what the market was valuing it at when trading
ended last week, so the stock's 53% decline on Monday was probably
reasonable.
What wasn't reasonable, in our opinion, was the knock-on effect of the
NG news on the share price of our Copper Fox Metals (TSXV: CUU). CUU
was caught in NG's blast radius because it owns a similar type of
project (a large porphyry-style copper/gold project) in the same part
of the world (British Columbia).
Our expectation is that CUU's Schaft Creek project will be shown to
have much better economics than NG's Galore Creek project, but at this
time the economics are unknown because Schaft Creek is at an earlier
stage of development. On Monday, however, 'investors' weren't in the
mood to calmly assess CUU's underlying value and took its stock price
down by 45% on the off-chance that the Galore Creek news had important
implications for Schaft Creek's economics.
It is common for greed to drive share prices far above their fair
values and for fear to take them far below their fair values. This is
the nature of the stock market. It is the reason for the vastly greater
swings in stock prices than in the underlying businesses and is the
generator of great buying/selling opportunities. The stock market
appears to have just generated a great opportunity to buy CUU.
CUU had a market capitalisation of around $40M at Monday's closing
price of C$0.46. At the same time, it controls a project in a
politically secure location that contains 7.7B pounds of copper and
8.1M ounces of gold (about $30B of in-ground metal at current prices)
in the measured-and-indicated category. If long-term bull markets are
in progress in the copper and gold markets then at some point over the
next few years the stock market will surely value this project at many
times the current level.
NovaGold (NG) could also be a worthwhile speculation at around $9 based
on the value of its non-Galore assets and allowing for the fact that
Galore still has significant option value. Bear in mind, though, that
when a stock gets pummelled in response to unexpected news the initial
high-volume sell-off is normally followed by a rebound and then a
decline to new lows before a sustained recovery begins.
Interestingly, NG had been a relatively strong stock prior to Monday's
debacle thanks to the touting of Jim Cramer and a good resolution of
the Donlin Creek dispute with Barrick Gold. This was despite Teck
Cominco's warnings a few weeks ago that costs for Galore Creek would
exceed estimates by a significant amount.
Stock Selection Update #47 - May-22 2007
First
things first: Late last week we added QID, a leveraged inverse index
fund, to the TSI Stocks List with a 'tight stop' (we said we'd exit if
the NASDAQ100 closed above 1915). The NASDAQ100 Index closed at 1916 on
Tuesday, so we are out with a small loss of around 3%. We won't be at
all surprised if the NASDAQ100 reverses downward on Wednesday, but one
of the main reasons for entering this trade was the NDX's failure to
confirm the new multi-year highs achieved by other indices. This,
combined with the break to new lows by the NDX/Dow ratio, had created
an interesting similarity with the days leading up to the stock market
correction that occurred during May-June of last year. However, the
price action of the past two days has eliminated this similarity.
We are maintaining our short-term bearish view on the US stock market,
but with the NDX having just closed at a new multi-year high the basis
for our bearish trade is no longer in place (opinions/views can be
maintained in the face of uncooperative price action, but traders need
to set rigid limits).
Secondly, in the 9th May Interim Update we said we'd add Golden Phoenix
Minerals (OTC: GPXM), a molybdenum play with some gold assets, to the
TSI Stocks List if it became available at US$0.42. The stock traded at
0.42 on Tuesday and has therefore been added to the List.
Thirdly, continue to look for opportunities to accumulate the Canadian
'gassy' energy trusts. These could to do well in the short-term if the
natural gas price is able to break above resistance in the $8.00-$8.20
range, but we are more interested in the 1-2 year bullish outlook for
the commodity and the trusts.
Stock Selection Update #46 - May-18 2007
A very quick
note to say that we have added UltraShort QQQ ProShares (AMEX: QID) to
the TSI Stocks List at Thursday's closing price of US$48.37. QID is
designed such that the daily percentage change in its price will be
roughly equal to twice the INVERSE of the daily percentage change in
the QQQQ (the NASDAQ100 Trust). For example, QID would gain 2% on a day
when the NASDAQ100 fell by 1% and lose 2% on a day when the NASDAQ100
rose by 1%.
In this highly liquid environment we don't want to take many chances
with bearish positions so we'll immediately exit if the NASDAQ100 moves
only a small distance above the highs of the past few weeks.
Specifically, we'll exit if the NDX closes above 1915 (versus
Thursday's close of 1885). This should allow us to limit our loss to
around 4% in case things don't go according to plan.
Stock Selection Update #45 - May-01 2007
The
performance of the gold sector on Monday was obviously bearish in that
the HUI closed below last week's low and gold stocks were weak relative
to gold bullion. However, we don't know if it means a great deal. The
major gold stocks look oversold in dollar terms and relative to the
metal, and the decline from the mid-April high still looks more like a
consolidation than the first phase of a new multi-month downtrend.
In any case, we've learnt over the years that when a stock we like for
the long-term drops to an attractive price level we should do some
buying even if we think the broad market is headed lower in the
short-term; and that when a stock we own moves up to a level where
profit-taking makes sense based on individual company considerations
then we should take some money off the table even if we think the broad
market is headed higher in the short-term. We manage risk on a
portfolio-wide basis by adjusting the size of our cash reserve in
response to our assessment of the overall market's risk/reward balance,
but while our desire to maintain a certain cash percentage imposes
constraints on our overall sector exposure we try not to let it prevent
us from grabbing stock-specific opportunities when they present
themselves.
Due to recent price action an opportunity to buy one of our long-term
favourites in the gold/silver sector is now presenting itself. The
stock in question is First Majestic Resource (TSXV: FR).
FR is in the process of arranging an equity financing of between 4M and
8.8M shares. This financing has put the stock under pressure, but note
that at yesterday's closing price of C$4.51 it is now trading more than
10% below the C$5.00 price at which the new shares will be issued.
From a technical perspective, FR is now oversold due to having been in
a downward drift for more than two months and having fallen for the
past six days in succession. Furthermore, the pullback of the past two
months has retraced 50% of the rally that commenced last September.
From a fundamental perspective, at the current silver price we think
the stock's fair value lies in the C$4.50-C$5.50 range. FR is therefore
right at the bottom of this range and close to being under-valued.
Silver stocks rarely become under-valued by normal valuation metrics,
so FR won't necessarily get much cheaper than it is right now unless
the silver price moves significantly lower.
Over the years FR has been an excellent example of how our preferred
approach of trading around a core position -- scaling-up during the
purges and then scaling back to the "core" during the subsequent surges
-- can work to good effect. Last September, for instance, we
highlighted FR as a buy three times at prices ranging from C$2.55 to
C$3.41, and then in February we suggested it was time to take partial
profits after the stock had moved up to around C$6.
We've now come back to the point where buying is again beginning to make sense.
Stock Selection Update #44 - Feb-20 2007
Sabina Silver
(TSXV: SBB) has gained 33% over the past 4 trading days and at Monday's
close (C$3.25) was up by 225% from the price at which it was added to
the TSI Stocks List last June. For money management reasons it would
probably make sense to take PARTIAL profits at this time, but we think
it would be a mistake to make a complete exit from the stock.
The catalyst for SBB's most recent surge was last week's news that
Agnico Eagle was buying Cumberland Resources. We doubt that SBB will be
the target of a takeover in the near future, but Agnico's willingness
to pay-up for Cumberland's Meadowbank project highlighted the value of
SBB's Hackett River project.
SBB has also just been given a boost by the conditional C$3.90/share
offer for Wolfden Resources (TSX: WLF) from Australia's Zinifex (ASX:
ZFX). SBB owns 4M Wolfden shares, so if ZFX's bid goes ahead it will
result in the injection of another C$15.6M into SBB. By our
calculations this would leave SBB with a cash reserve of around C$38M
(C$0.70/share), which would, in turn, mean that the company was fully
financed for at least the next 12 months.
Stock Selection Update #43 - Feb-14 2007
Copper Fox (TSXV: CUU) came onto our radar screen last October due to an article at http://www.resourceinvestor.com/pebble.asp?relid=25170
that compared the company's Schaft Creek copper/gold deposit with the
neighbouring Galore Creek deposit owned by NovaGold Resources (TSX:
NG). At that time we didn't want to increase our exposure to large
undeveloped porphyry-style copper deposits because we were
intermediate-term bearish on copper and because we already had
significant exposure to such deposits via NovaGold, Metallica (AMEX:
MRB) and Northern Orion (AMEX: NTO).
Since then the copper price has dropped sharply, but the shares of
companies that own large undeveloped copper projects have generally not
fared badly. The shares are out of synch with the metal, with many of
them getting hit hard while the copper price was still within 10% of
its all-time high and then stabilising, or in some cases even firming,
after the copper price broke down. We remain intermediate-term bearish
on copper -- we expect that the copper price will drop to new 52-week
lows following a rebound over the coming 1-2 months -- but thanks to
the price decline that has already occurred the downside risk is a lot
less now than it was three months ago. This, combined with the recent
interest being shown by other mining companies in large undeveloped
porphyry-style projects* and the fact that we exited our long-term
NovaGold position late last year, prompts us to add a (potentially)
long-term position in Copper Fox to the TSI Stocks List at Tuesday's
closing price of C$0.71.
The investment case for CUU can be summed up as follows: The Schaft
Creek deposit is roughly equivalent in size to the Galore Creek
deposit** owned by NovaGold, but CUU has a total market cap of only
US$47M whereas the stock market appears to be assigning a value of
around US$700M to Galore Creek (US$700M is about 40% of NG's total
market cap).
There are, as always, some good reasons for Schaft Creek's large discount, including:
1. Galore Creek already has a completed Feasibility Study (FS) whereas CUU's FS won't be complete until the end of 2008.
2. NovaGold's senior managers have a lot of credibility/experience and
are excellent stock promoters. CUU's CEO also has a lot of
credibility/experience, but appears to be lacking in promotional skills.
3. Barrick Gold's unsuccessful takeover bid for NovaGold brought the
potential value of Galore Creek to the attention of the investment
community and gave the project's economic viability a boost in the
minds of many investors.
However, we think CUU's discount will prove to be unreasonably large
because preliminary indications are that the economics of Schaft Creek
will be superior to those of Galore Creek due primarily to a
substantially lower capital cost.
Something else worth noting is that the Schaft Creek project is a joint
venture between major mining company Teck Cominco (TCK) and CUU whereby
CUU can earn 100% of TCK's 93.4% interest by completing a bankable FS.
Furthermore, under this JV arrangement TCK can earn back 75% (of 93.4%)
by matching 4-times CUU's total expenditure on the project and
arranging production financing. Therefore, if the metals bull market
continues and the FS is as positive as we think it will be then it is
reasonable to assume that CUU will end up with only 23.35% of Schaft
Creek. NovaGold, on the other hand, will probably end up with around
50% of Galore Creek after doing its own deal with a major mining
company, which, in very rough terms, means that CUU's current market
cap would be around US$330M if the stock market were assigning similar
values to Schaft Creek and Galore Creek (if 50% of Galore Creek is
worth US$700M then 23.35% is worth $330M).
One of the main risks with CUU is that it will almost certainly have to
issue a lot of new shares over the coming 18 months in order to fund
the Feasibility Study because the FS is expected to cost around C$40M
but the company only has about C$4M in the bank at this time.
Obviously, the number of new shares issued will depend on CUU's stock
price, which will, in turn, be strongly influenced by market-wide
interest in junior resource companies. In any case, equity financings
along the way will likely create multiple buying opportunities, so
anyone interested in the stock could consider taking an initial
position now (in the low-0.70s) with the aim of scaling-in over the
coming year or so. Also, bear in mind that whatever CUU spends will be
returned four-fold if TCK decides to exercise its back-in right.
We'll include a chart of CUU in tomorrow's Interim Update.
*Rio Tinto has just bought a stake in Northern
Dynasty's Pebble project and a takeover battle for BcMetals -- a
company that owns 25% of the Red Chris copper/gold deposit in the same
neck of the woods as Galore Creek and Schaft Creek -- has recently been
fought between Taseko Mines and Imperial Metals.
**Schaft Creek has a measured-and-indicated resource
comprising 8.33B pounds of copper and 8.6M ounces of gold. This
compares with Galore Creek's 8.5B pounds of copper and 7.4M ounces of
gold. Both NovaGold and Copper Fox are expected to provide updated
resource estimates within the next couple of months.
Stock Selection Update #42 - Nov-27 2006
Monday's action
was a clear sign that a long-overdue correction has begun in the US
stock market. This correction has the potential to extend into year-end
so we are now downgrading our short-term stock market view from
"neutral" to "bearish".
It was encouraging that the gold sector held up very well in the face
of the sharp downturn in the broad market, especially considering the
fact that the gold price only gained $2 on the day. In any case the
main purpose of this e-mail is not to discuss the latest market-wide
developments, but, instead, to cover the latest development with one of
our stocks: Gryphon Gold (TSX: GGN).
We highlighted GGN as a buy in Sunday's Weekly Market Update.
Unfortunately, the company announced on Monday morning that it would
have to revise the feasibility study (FS) for its Nevada-based Borealis
gold project due to an over-estimation of the resource (the FS was done
by Samuel Engineering, an independent consulting firm). At this stage
the effects on the project's economics have not been quantified, but an
updating of the FS to account for the resource change would certainly
result in lower annual gold production and higher per-ounce production
costs. Furthermore, while the economics are being re-assessed both the
completion of project financing and the decision to proceed to
production have been delayed.
Our valuation of GGN was based on the results of the previously
completed FS, so Monday's news means that this valuation is no longer
applicable. Also, one of the reasons we added GGN to the TSI Stocks
List was that it appeared to be on a fast track to gold production and
positive cash flow, but there's now a good chance that the track will
be significantly slower than originally envisaged.
The question now is: what should we do in response to this new development?
In September we went through something similar with junior silver
producer First Majestic (TSXV: FR), one of our favourite long-term
plays in the gold/silver sector. FR announced some unexpected bad news
in early September that caused its stock price to plunge 30% in a
single day, so in percentage terms the initial market reaction to FR's
and GGN's bad news was the roughly the same.
After FR's price plunged we said the market had clearly over-reacted to
news that didn't materially alter the investment case for the stock.
Our view, therefore, was that the price decline had created a good
opportunity to do some new buying. We've since been proven right
because the stock has fully recovered. In GGN's case, however, the
sharp price decline has not created such a clear-cut buying
opportunity. Whereas with FR we could quantify the likely impact of the
bad news on our valuation and be confident that the impact wasn't
particularly worrisome, with GGN the impact of the bad news is probably
greater and is also, at this stage, non-quantifiable. In fact, one of
the main issues is that there is now a much larger degree of
uncertainty than there was prior to Monday's announcement.
All we can say at this time is that Monday's price decline will
PROBABLY turn out to be another over-reaction by the stock market, but
in the absence of more details from the company we can't be as
confident as we would like to be. Something else worth considering is
that the downgrading of the earlier resource calculations could be
offset by success on the exploration front. However, whereas further
exploration success would previously have been 'icing on the cake' it
might now be a prerequisite to putting the project into production.
If you currently own GGN it would be reasonable to continue holding
because even if we have to substantially reduce our valuation the
risk/reward might still be attractive (our valuation might still be a
great distance above the current price and the market has probably gone
a long way towards discounting the downside risk), especially if
success on the exploration front allows the total in-ground metal
resource to be significantly increased. However, we suggest postponing
any new/further buying until more information becomes available.
Stock Selection Update #41 - Nov-07 2006
In the 16th
October Weekly Market Update we added Gammon Lake Resources (AMEX: GRS)
to the TSI Stocks List and wrote the following to explain why we
preferred GRS to Minefinders Corp. (AMEX: MFN), a similar company that
in some respects offered slightly better value than GRS:
"It was virtually a
toss-up as to whether to add GRS or Minefinders (MFN) to the Stocks
List because the companies are very similar in many respects. For
example, the main asset of each company is a 5M+ ounce gold deposit --
in each case containing gold and silver in approximately equal amounts
-- in Mexico, with the projects having similar economics. MFN sells at
a lower price per reserve ounce and at a lower price per ounce of
expected annual production than GRS, but on a price-to-cash-flow basis
the valuations of both stocks appear to be roughly the same. In other
words, the higher valuation being assigned by the stock market to GRS's
gold/silver reserves appears to be supported by its lower production
costs (GRS is likely to generate more cash than MFN for each ounce of
gold/silver produced, thus its in-ground reserves are more highly
valued).
Due to their similarities
we didn't want to add both stocks to the List, especially considering
the fact that the assets of both companies are located in Mexico.
Mexico is generally not considered to have unduly worrisome political
risk, but the goings-on associated with the recent Presidential
election (the refusal of the losing candidate to accept the result and
his threats to set up an alternative government, for instance) suggest
that it would be wise to limit the amount of money allocated to
Mexico-based investments. With the addition of GRS to the List we now
have three stocks with substantial exposure to Mexico (FR and MRB are
the other two), which is as much exposure as we want.
The reason we ended up
going for GRS rather than MFN is that the development of GRS's flagship
project -- the Ocampo mine -- is about 12 months ahead of the
development of MFN's Dolores mine. To be specific, GRS's mine is almost
fully commissioned and is expected to be producing gold and silver at
close to its design capacity by the end of this year, whereas if
everything goes according to plan it will be late next year before the
Dolores mine reaches commercial production. As a result: a) during 2007
GRS should have a huge cash in-flow while MFN continues to spend a lot
of money to bring its mine into production, and b) there is more
execution risk associated with MFN than with GRS."
Since writing the above the GRS price has gained 21% (from US$11.65 to
US$14.11) whereas the MFN price has fallen 12% (from US$8.98 to
US$7.87), so we are reasonably happy with our decision to favour GRS.
However, the equation has changed because MFN's valuation discount has
become quite substantial as a result of the price action of the past
few weeks. Furthermore, MFN's relatively poor performance can primarily
be attributed to its management's decision to obtain the remaining
funds needed to complete the construction of the Dolores gold/silver
mine by issuing convertible debt securities. In our opinion this was an
ill-conceived move on management's part, but it doesn't detract from
MFN's long-term value in any way whatsoever; it has simply created a
much better short-term buying opportunity than would otherwise have
existed.
We still like GRS a lot and expect it to be a good performer over the
coming year due to its exceedingly low cost of production and the
resultant huge amount of cash that it should generate. But due to MFN's
valuation discount we can't justify keeping this stock out of the List
any longer even though by adding it to the List we will end up with
more Mexico exposure than we would like. We are therefore going to add
MFN at Monday's closing price of US$7.87.
The keys to MFN's value are a) the company has 5M ounces of high
quality P&P gold-equivalent (gold + silver) reserves at the Dolores
mine that are presently being valued by the stock market at a
relatively low US$93/oz (based on a fully diluted share count of 59M),
b) the company is only 12 months away from production and is fully
funded through to production, and c) there is a lot of scope to expand
the Dolores project.
Also worthy of consideration is the likely prospect of MFN being taken
over at some point over the coming 12 months. With takeover fever
spreading through the resource sector and with the dearth of
high-quality gold/silver projects of Dolores's size, we will be
surprised if MFN doesn't attract the interest of a large or mid-tier
gold miner in the not-too-distant future. Gammon Lake and Hecla Mining,
two of the current members of the TSI Stocks List, are potential
bidders for MFN.
On the topic of takeovers, the proposed takeover of Bema Gold (BGO) by
Kinross Gold (KGC) is similar to the Goldcorp/Glamis situation in that
it results in the shareholders of the company being acquired 'making
out like bandits' at the expense of the shareholders of the acquirer.
As far as we can tell, the Kupol project is BGO's only world-class
asset and this asset is located in one of the riskiest countries in the
world for foreign mining companies (Russia).
KGC's decision to pay a sizable premium for BGO dramatically increases
the acquiring company's risk profile and takes it off the list of
potential future TSI stock selections.
Stock Selection Update #40 - Jul-25 2006
Over the past 3
years we've advocated the ownership of NovaGold Resources (TSX and
AMEX: NG) more than any other stock and have consistently described it
as our favourite long-term investment in the gold sector. We most
recently highlighted it as a buy at prices of US$11.50 and US$12.30,
respectively, in our 12th June and 14th June commentaries.
On Monday, Barrick Gold (NYSE: ABX), the world's largest gold producer,
announced its intention to offer US$14.50/share for NG. In
response NG rose to $15.50/share, a price that represents a 7% premium
to the ABX offer.
NG's two main assets are its 30% stake in the Donlin Creek gold project
and its 100% stake in the Galore Creek copper/gold project. ABX has the
remaining 70% of Donlin.
ABX has only been involved in the Donlin project for a short while as a
result of last year's takeover of Placer Dome (NG's original partner at
Donlin), but it obviously likes what it sees. This is not surprising in
that Donlin will probably be developed into a mine that has at least
20M ounces of gold RESERVES and produces at least 1M ounces of gold per
year -- the sort of mine that any major gold producer would want as
part of its portfolio. And Galore Creek has the potential to be
developed into a mine that's just as big, but with more copper than
gold.
We'll be interested to see the response of NG's management to ABX's
bid. The response will probably be that the bid substantially
under-values the company.
Our view is that the bid is very low relative to the potential
long-term value of NG's assets, but is reasonable in light of the
current market environment. In the absence of the bid we suspect that
NG would have spent the next several months oscillating between
US$11.50 and US$15 -- the sort of performance we expect from gold
stocks in general -- so the bid is probably boosting the stock price to
a level that would otherwise not have been seen again until next year.
Also, although NG's current market capitalisation is low relative to
the long-term value of its assets and to where we think it will be in 2
years time, it is moderately high relative to the valuations being
assigned to many other exploration-stage gold miners.
The bid effectively puts a floor under the NG stock price. It's an
all-cash offer, so regardless of what happens in the gold market over
the next few weeks NG should trade at, or above, US$14.50. There is
also the potential for a higher offer, a potential that is already
being partially discounted by the stock market as evidenced by NG
trading at a significant premium to ABX's current offer. There is
therefore probably no reason to sell now UNLESS you want to free up
some cash for other investment opportunities.
In this week's Interim Update we'll take a quick look at some other potential takeover candidates in the TSI Stocks List.
On a separate matter, the gold sector rallied on Monday despite a $7
drop in the gold price. This, however, just continues the pattern of
gold shares behaving like plays on the broad stock market.
Stock Selection Update #39 - May-23 2006
In our opinion the
gold sector is about 2 weeks into a correction that will ultimately
last at least 6 months, so now is not the time to be buying
aggressively. However, opportunities to do SOME buying are already
emerging due to the magnitude of the recent price decline.
The opportunity that we are going to highlight today is the long-dated
call options of Harmony Gold (NYSE: HMY); specifically, the HMY
January-2008 US$10.00 call options (YTBAB). These options ended
Monday's trading session at US$5.20-US$5.40.
With the stock trading at US$13.29 the aforementioned options have
intrinsic value of $3.29 (the intrinsic value of an option is the price
of the underlying minus the strike price of the option, in this case
$13.29 - $10.00), meaning that buyers of the options are paying a
premium of only $2.00 per share for 20 months of 'time'. We won't be
surprised if HMY drops to around $11 at some point over the next couple
of months, resulting in the price of these call options falling to
around $4.00. But $1.30 (or so) of downside risk is trivial compared to
the gains we expect to occur prior to the January-2008 expiry date.
We've therefore decided to immediately add YTBAB to the TSI Stocks List
at US$5.30 (the mid point of the current bid-ask spread).
If a trade such as this interests you then a reasonable approach would
be to purchase an initial position now with the aim of making a least 2
more purchases in the future -- one most likely about 2 months from now
and another during the final quarter of this year. On the other hand,
if options aren't your 'cup of tea' you could consider buying the first
of three positions in the stock (HMY) now. Note that HMY spiked down to
its 200-day MA in US trading on Monday and, along with the entire gold
sector, is ripe for a counter-trend rebound.
Stock Selection Update #38 - Apr-25 2006
With regard to stock market investing, two of the things we've learnt from experience over the years are:
1. When you identify a stock with an excellent long-term risk/reward
ratio you should take an INITIAL position immediately even if you think
the overall market's short- or intermediate-term risk/reward is poor.
2. If you are confident that a market is in a long-term upward trend
but currently don't have exposure to this market then you should do
SOME buying immediately, assuming your goal is to participate in the
long-term bull market, even if you are anticipating a near-term
pullback that affords a superior buying opportunity.
The point is that it's important to manage upside risk as well as
downside risk. No one knows the future and the direction of a market
over the short-term is always more random (less predictable) than its
direction over the long-term; at least, that's the way it is with us
and, we suspect, with most people who place a greater emphasis on
fundamentals than on technicals. In other words, taking an initial
position in a market or an individual stock, even when you think
there's a good chance of weakness in the short-term, provides some
coverage in case the expected weakness doesn't materialise and is an
acknowledgement of the fact that there will always be some uncertainty
when it comes to the future direction of market prices.
Further to the above, as long as we remain confident that gold and gold
stocks are in long-term bull markets we will continue to highlight
investment opportunities in individual gold stocks as they arise,
regardless of what we think is going to happen to the gold sector in
the short-term. As well as accounting for the fact that we don't have a
crystal ball and might therefore be wrong about the market's short-term
performance, we need to account for a) the possibility that
company-specific factors will prevent a stock we want to buy 'on a
pullback' from actually pulling back with the market, and b) the
likelihood that some subscribers have yet to establish a core position
in the gold sector.
With that said, we are now going to introduce a new exploration-stage gold stock (one with an interesting twist).
Chesapeake Gold (TSX: CKG) is a well financed explorer with a top-notch
exploration team -- CKG's exploration team discovered the lucrative El
Sauzal and Marlin gold deposits currently owned by Glamis Gold -- and
several projects with good potential in Mexico. It closed at
C$5.65-C$5.75 on Monday. However, we haven't been interested in owing
CKG in the past, and aren't interested in owning it now, because it
doesn't fit our investment critieria. Specifically, we are not in the
business of making bets on whether or not someone will find a gold
deposit, regardless of the person's track record. Rather, we want to
buy exploration-stage companies that have already proven-up enough
resources to fully justify their current stock prices AND that have the
potential to substantially increase their resources through future
exploration success.
The reason we mention CKG is that its impending merger with American
Gold Capital (TSXV: AAU) does create a company that meets our
investment criteria in that it marries CKG's exploration prowess and
potential with two projects that have substantial existing resources.
Assuming the merger is completed as planned (the expected completion
date is 30th June 2006), the combined company will have:
- CKG's stable of early-stage projects in Mexico
- AAU's Metates property in Mexico, which has a non-compliant
low-grade resource containing 11.7M ounces of gold and 55M ounces of
silver (additional drilling will be required to upgrade a portion of
this resource to measured-and-indicated status)
- AAU's Talapoosa project in Nevada, which has a
measured-and-indicated resource containing 1M ounces of gold and 14.5M
ounces of silver
- C$40M cash and no debt
- 28.7M shares outstanding (42.3M on a fully diluted basis)
Due to the way the proposed merger deal has been structured, the best
way to buy into this situation is through AAU. This is because AAU
shareholders will receive CKG warrants and rights as part of the deal
and the rights are what we are really interested in. Specifically, AAU
shareholders will receive 0.29 CKG shares plus 0.145 CKG share purchase
warrants plus 0.29 CKG rights for each of their current AAU shares.
Each warrant will have a duration of 5 years and an exercise price of
C$8.00, while each right will have a duration of 5 years and an
exercise price of C$1.00. The plan is for the rights and the warrants
to be traded on the TSX.
The twist is that it will only be possible to exercise the rights IF
the spot gold price trades at an average of at least US$850 for 90
days. In other words, the rights will expire worthless unless the spot
gold price averages at least $850 over a 90-day period at some point
during the next 5 years. These rights, therefore, are an extremely
leveraged play on the gold price.
Based on the current CKG stock price of C$5.70, we have estimated a
value of C$2.00 for the warrants and C$2.45 for the rights. We valued
the rights as if they were warrants and then assumed a 50% probability
of the gold price moving above $850 within the next 5 years (we think
the probability of gold moving above $850 within 5 years is actually
greater than 90%, but we wanted to be conservative). We therefore
valued CKG's offer for AAU as follows: 0.29*C$5.70 + 0.145*C$2.00 +
0.29*C$2.45 = C$2.65.
If we assume that the gold price moves up to $850, making the rights
exercisable, and that this rise in the gold price pushes the CKG stock
price up to C$10 (once again we are being conservative because we are
not allowing anything for the possibility that CKG's top-notch
exploration team finds something of great value), then our estimated
value for AAU rises to C$6.15.
Now, because the rights offer extreme leverage to the gold price they
are going to make huge moves in both directions when they begin to
trade. In particular, they will be pushed up to great heights during
periods when bullish enthusiasm is rampant and pushed down to great
depths during the large corrections that will inevitably occur during
gold's long-term bull market. In all likelihood, there will be
opportunities to accumulate the rights at depressed levels during the
second half of this year, but by taking a position in AAU now we will
make sure that we end up with some exposure in case we are
under-estimating gold's upside potential this year in the same way that
we under-estimated it last year.
AAU closed at C$2.20-C$2.30 on Monday, so we will add it to the Stocks
List at C$2.25. Note that the stock doesn't have great liquidity, so
exercise caution when buying.
Stock Selection Update #37 - Jan-04 2006
This year's first
trading day was interesting to say the least. We don't have time to
discuss the market action in any detail right now, but the general
impression we got was that all the financial markets were in a big
hurry on Tuesday to discount the ending of the Fed's rate-hiking
campaign. The minutes of the latest FOMC Meeting certainly encouraged
speculators to bet on an imminent cessation to the rate hiking,
although the markets had clearly been moving rapidly in that direction
for several hours prior to the 2.00pm release of these minutes.
The purpose of this e-mail is to advise some changes to the TSI Stocks
List. A blow-off move to the upside is underway in the gold sector and
although there is no evidence that it is about to end it is time to
consider exiting some positions.
First, we are going to exit Gold Fields Ltd (NYSE: GFI). GFI was added
to the List in May of 2005 at US$9.57, meaning that at yesterday's
closing price of US$19.27 we have a gain of 101%. The technical
objective for GFI based on the upside breakout from its multi-year
consolidation range is around $21, so it wouldn't be surprising to see
the stock move about $2 higher before a short-term top is put in place.
However, we expect the next correction to result in a test of support
at $15-$16, which means that we perceive about $2 of short-term upside
potential versus about $3-$4 of short-term downside risk.
Second, we are going to exit the Harmony Gold (HMY) January-2007 $12.50
call options originally added to the List in March of 2005. These
options ended at $3.80-$4.00 on Tuesday, giving us a profit of 217%
assuming an exit at the current bid price of $3.80.
On a side note, the option trades recommended at TSI were effectively a
'wash' over the past 12 months. We did very well on two HMY call option
positions and we did OK on some Newmont Mining put options, but we are
going to have to write-off put option positions in Phelps Dodge and
Glamis Gold.
Third, we are going to keep EWJ (iShares Japan) in the Stocks List, but
now would be a reasonable time to take PARTIAL profits on this
position. Our intention is to exit EWJ should the Nikkei trade up to
19,000 during the first 4 months of this year.
Although there have recently been big upward moves in some of our
smaller stocks, none of these stocks are close to levels at which they
would be 'sells' (they are all significantly under-valued at Tuesday's
closing prices). However, when a speculative stock moves up a lot
within a short time it can become an unreasonably large component of
your portfolio (unreasonably large, that is, given its risk). In such
cases it is often a good idea to do enough selling to bring the stock's
weighting down to the appropriate level, even though it remains
under-valued. This sort of re-balancing is something that should be
done on a regular basis.
In Thursday's Interim Update we'll mention short-term upside target ranges for some of the stocks in the TSI List.
Stock Selection Update #36 - Oct-03 2005
Regardless of what
happens over the next 6 weeks there's a high probability that gold
stock indices such as the HUI will be trading far below current levels
within the next 6 months. This is not, therefore, the time to be buying
aggressively, but instead a time to be looking for opportunities to
take profits. This will particular be the case if the HUI makes a new
recovery high over the coming month or so, thus setting the stage for
another October-November high and ensuing 6+ month decline.
Having said that, there are many exploration/development-stage gold
stocks that have yet to move much and that offer exceptional value. It
is reasonable to assume that these stocks will take a hit if there's a
sector-wide downturn, but they offer such large upside potential --
both in the short-term if the rally in the overall sector can persist
for just 4-6 more weeks and in the long-term irrespective of what
happens over the next several weeks -- that buying at this time might
be appropriate for those who feel under-exposed to the market.
An exploration/development-stage gold stock that looks attractive right
now from both fundamental and technical perspectives is European
Minerals (TSX: EPM). This stock has been on our radar screen for a long
time, but our concerns about the political risk associated with Central
Asia -- EPM's main asset is located in Kazakhstan -- have prevented us
from adding it to the TSI Stocks List. However, over the past year
we've observed some very smart players in the natural resources sector
making substantial investments in Kazakhstan, the most recent example
being a large uranium venture involving some of the best-known names in
mining finance (refer to http://www.resourceinvestor.com/pebble.asp?relid=13270
for details). We continue to believe that there is significant
political risk in Kazakhstan, but probably not as much as there is in
Russia and in many other parts of the world. We no longer consider
Kazakhstan's political situation to be a 'deal breaker' as far as the
purchase of shares in EPM is concerned.
EPM owns the Varvarinskoye development-stage project, which has proven
and probable reserves of 2.3M ounces of gold and 269M pounds of copper.
The company has about US$70M of cash and is presently negotiating a
US$80M debt facility, the combination of which should be more than
enough to take the project through to commercial production. Production
is expected to commence during the final quarter of next year. The plan
is for the mine to produce 150K ounces of gold per year at a cash cost
of US$87/ounce.
There are about 200M shares outstanding, so at Friday's closing price
of C$0.65 the company's market cap is C$130M (US$110M). Subtracting the
US$70M of cash gives us an enterprise value of only US$40M, meaning
that EPM's gold reserves are presently being valued by the stock market
at only US$17/ounce. This is extremely low for high-quality reserves in
such an advanced-stage project and suggests that there is a very
substantial Central Asian discount being applied to the shares. This,
in turn, creates an opportunity because if Kazakhstan remains
relatively stable and investment continues to be drawn into the country
as a result of its enormous natural-resource wealth, then EPM's shares
will likely be re-rated.
Technically, there is support at around C$0.60 that should limit the
downside as long as the overall sector remains in a short-term upward
trend.
We are going to add EPM to the TSI Stocks List at Friday's closing
price of C$0.65. The stock is fairly liquid (average daily trading
volume is about 430K shares), so hopefully our buy recommendation won't
have a significant effect on the price. However, if the stock does move
sharply higher in response to our recommendation then we suggest that
you put it on your 'watch list' but don't buy it now. There will
probably be an opportunity to buy the stock near current prices in the
future (later this week, perhaps), but if not it doesn't matter because
there will be plenty of buying opportunities in other stocks.
There are, by the way, two series of EPM warrants trading on the TSX.
Of these warrants, only the "A" series (TSX: EPM.WT.A) looks
interesting to us. The "A" series warrants have an expiry date of
April-2010, and exercise price of C$1.20, and with the stock trading in
the mid-60s would be fairly priced at around C$0.20.
Stock Selection Update #35 - Sep-30 2005
The main purpose of
this e-mail is to add a new gold/silver stock to the TSI List
(actually, to return an old favourite to the List), but first a quick
comment on the US stock market.
We turned short-term bearish earlier this week because the senior US
stock indices appeared to be readying themselves for breaks below their
respective August lows (1200 for the S&P500, 2100 for the NASDAQ
Composite, etc.). We also said this view would be proven wrong if the
S&P500 were able to close above 1228. The S&P500 closed a
fraction of a point below 1228 on Thursday, but the strong upward
reversal in the NASDAQ suggests that we should return to the sidelines
(return to a short-term "neutral" view). The upside potential from here
looks small, but a break below support no longer appears to be imminent.
Our plan since the beginning of this year has been to use substantial
weakness in our favourite gold/silver stocks during 2005 to build up
positions in preparation for an expected cyclical bull market -- the
second leg of a secular bull market -- during 2006-2008. This remains
our plan and we will therefore continue to highlight stocks once they
reach suitable levels for new buying.
Western Silver (AMEX: WTZ, TSX: WTC) was part of the TSI Stocks List
during much of the first major upward leg in the gold sector. We ended
up exiting it at a substantial profit during the first quarter of 2004
and have since been looking for a good opportunity to re-establish a
position.
We were hoping that an opportunity to buy the stock at around US$6.50
would occur late this year or early next, and it still might. However,
as a result of WTZ having 'sat out' much of the post-May advance in
gold/silver stocks -- it is presently near the bottom of a lengthy
consolidation pattern and near a 52-week low -- it now looks
significantly under-valued compared to other stocks when the
world-class nature of its major asset (the Penasquito silver/gold
project in Mexico) is taken into account.
The latest resource estimate shows that Penasquito contains 314M ounces
of silver and 4.6M ounces of gold in the measured-and-indicated
(M&I) category (603M ounces silver-equivalent or 9.6M ounces
gold-equivalent at current metal prices). With a fully diluted share
count of 51M, no debt and about US$50M cash, this means that WTZ is
presently being valued by the stock market at around US$38 per M&I
gold-equivalent ounce. This is not particularly low in itself, but it
is low when the quality of the deposit and the huge potential for
future resource expansion are considered.
Penasquito is of sufficient size and quality to be of interest to a
major mining company, meaning that WTZ could become a takeover target
at some point. Companies such as Goldcorp, Glamis Gold and Pan American
Silver, for example, presently have such richly-valued shares that they
could afford to buy WTZ at double WTZ's current price (in an all-stock
deal) and still bring about a sizeable increase in their per-share net
asset values.
The question is: why has WTZ not participated in the recent run-up in the gold sector?
The market might be concerned that the dramatic increases in fuel and
construction costs that have occurred over the past year will mean that
the feasibility study for the Penasquito project -- the results of
which are due to be announced within the next several weeks -- will
reveal a low internal rate off return (IRR). If this is the case our
view would not change because we expect gold and silver to out-perform
other commodities by a wide margin over the coming 2 years; in other
words, if our longer-term view is correct then the project's IRR will
improve substantially over the next 2 years. A disappointing outcome
from the feasibility study would, however, likely cause the stock to
drop sharply in the short-term, which is a reason why investors should
consider taking an INITIAL position now with the aim of building up to
a full position in the future as opportunities present themselves.
Another possible explanation for WTZ's relative price weakness is that
large investors have been positioning themselves to participate in the
equity financing that would likely follow the release of a POSITIVE
feasibility study. That is, investors who expect to participate in the
equity portion of the large financing that will have to be done to fund
Penasquito's development might be reducing their existing positions.
In any case, within the context of a long-term bull market there's
generally a lot less risk involved in buying following a pullback to
near important support than there is in buying following a surge to
near important resistance.
We are going to add WTZ to the TSI Stocks List at yesterday's closing price of US$8.34.
Stock Selection Update #34 - Aug-31 2005
We
remain short-term bearish on gold and gold stocks. However, it is
totally unrealistic to expect to do all, or even most, of your buying
at the absolute bottom of the market. Also, different gold stocks will
hit levels at which new buying will become appropriate at different
times, so even if the overall sector appears to be headed lower it will
be important to scale into high-potential gold stocks after the
individual stocks have dropped to levels where the risk/reward is
exceptional.
Further to the above, we want to highlight some gold stocks that have
just fallen to prices that we believe are good entry levels for those
looking to build exposure to the sector that, as far as we are
concerned, offers by far the best long-term risk/reward in the stock
market.
1. On a few occasions over the past 5 months we've mentioned that a
drop to around C$8.00 by NovaGold Resources (TSX and AMEX: NG) -- our
favourite exploration/development-stage gold stock -- would create a
good opportunity for new buying. There is strong support in the
C$7.80-C$8.00 range and we thought that this support would probably be
tested, but not breached, during 2005.
NG traded as low as C$8.13 on Tuesday before rebounding to close at
C$8.33. There hasn't yet been a volume spike so a low is probably not
in place, but for longer-term investors the idea is to average in when
the stock drops to near support and not to attempt to buy at the
bottom. Therefore, we think a buying opportunity is at hand.
In a previous commentary we also mentioned that the NovaGold warrants
that trade on the TSX under the symbol NG.WT, have a C$7.00 exercise
price and a September-2008 expiry date, would be suitable for new
buying if they dropped to the C$3.20-C$3.60 range. They are currently
in this range. We caution that the warrants are far less liquid than
the stock and are therefore difficult to trade in size. As a result of
this lack of liquidity it is critical that limit orders are used.
By the way, many of the stock-related questions e-mailed to us by TSI
readers have previously been answered in the commentaries. To read all
the comments we've made on a stock over the preceding 18 months just go
to the Stock Selections page at TSI and click on the stock symbol. For
example, when you click on NovaGold's symbol you will get taken to this
page: http://www.speculative-investor.com/new/NG.html
2. We think South African major Harmony Gold (NYSE: HMY) offers
excellent value near yesterday's closing price of US$7.22. The
January-2007 $7.50 call options (OHTAU) are also an interesting
speculation in the US$1.50-$1.70 range.
3. The stock price of Australian-listed gold producer Resolute Mining
(ASX: RSG) was hit hard on Tuesday as a result of the company receiving
an unexpected US$32M tax bill from the Tanzanian Government. The
Government is obviously scrambling to obtain US dollars and have
therefore arbitrarily decided that the revenues generated by RSG's
Golden Pride mine in Tanzania over the past several years were a lot
higher than the company had declared while its costs were a lot lower.
This is a totally absurd act by the government and whether or not they
get away with it will be a good test of both the effectiveness and
impartiality of the Tanzanian court system. In any case, the absolute
worst case for RSG is that the company will be forced to pay US$32M,
but over the past three trading days US$52M has been shaved off the
company's market value. Obviously, this is an over-reaction.
As we write, RSG is trading at A$0.88. We think it is a strong buy below A$0.90.
4. After butting up against resistance at US$3.50 a couple of weeks ago
Golden Star Resources (AMEX: GSS) has dropped back to US$2.84, a level
at which new buying would be appropriate.
5. The Desert Sun Mining warrants (TSX: DSM.WT) are a good speculation near yesterday's closing price of C$0.55.
Stock Selection Update #33 - Mar-07 2005
Our
view is that the gold sector, as represented by the HUI, will make a
sequence of lower lows over the first three quarters of this year
before commencing the next multi-year advance in its long-term bull
market. However, we've also said that good opportunities to buy
individual gold stocks will arise from time to time during the year and
that these opportunities should be taken despite the likelihood that
the sector as a whole will eventually move lower.
There are several stocks we've been following with the aim of adding
them to the TSI Stocks List at some point during 2005. We expect that
each of these stocks will be available at lower levels within the
coming 6 months, but in each case the stock offers value -- from
reasonable value to exceptional value, depending on the stock -- at its
current price, and the ultimate low is probably going to be within 20%
of the current price. Therefore, with our assessment being that the
intermediate-term downside risk is 20% and the long-term upside
potential is enormous we think it would be appropriate to take an
INITIAL position in each of these stocks now with the goal of adding to
positions later this year.
*Here are the stocks that will immediately be added to the TSI List:
1. Golden Star Resources (AMEX: GSS)
Since peaking at over US$8.00 per share in December of 2003 the stock
price of GSS has been hammered, hitting a low of US$2.67 last week.
There are two main reasons why the stock has experienced such a
large decline. First, it was absurdly expensive in late 2003 both in
absolute terms and relative to most other gold stocks. Second, there
has been a marked deterioration in the company's fundamentals (there's
been a sizeable drop in the gold production forecast for 2005-2006 and
an increase in forecast production costs). However, at Friday's closing
price of US$2.97 the stock is at a level where the negatives appear to
have been factored in and the value -- relative and absolute -- appears
to be reasonable.
A likely downside target for GSS over the coming 6 months is US$2.40,
but at its current price the upside risk over the coming 2 years dwarfs
the downside risk.
2. Resolute Mining (ASX: RSG)
Resolute is traded on the Australian Stock Exchange and has operations
in Australia and Africa. When we checked a few minutes ago it was
trading at AUD1.48.
RSG is currently producing gold at the annual rate of around 320K
oz/yr, but assuming a positive outcome for the Feasibility Study (FS)
at its Syama gold project in Mali (the FS is scheduled to be complete
by the end of this month) it will likely be a 500K+ oz/yr producer
within 2 years. However, even if we assume steady-state production of
around 320K oz/yr we find that RSG's production is selling at a
discount of around 50% to the production of comparable North American
miners (GSS, for instance). And on a market-cap-$-per-reserve-ounce
basis RSG is selling at a discount of at least 30% to comparable NA
miners. We see no good reason why these discounts should exist,
particularly given RSG's growth profile.
A potential additional 'kicker' for this stock is the company's
ownership of 33M pounds of uranium resources in Queensland. The market
currently appears to be assigning no value to this asset, but assuming
just US$1/pound for the uranium then this asset would be worth around
AUD0.20 per RSG share.
A likely downside target for the stock over the coming 6 months is
AUD1.20, but given the upside potential we think it would be
appropriate to do some buying now.
3. Golden Queen Mining (TSX: GQM)
GQM is a thinly traded exploration-stage micro-cap gold/silver stock
and therefore not suitable for everyone. Here is a summary of the
Golden Queen story taken from the company's web site:
"The Company is focused on developing an open pit, gold-silver heap
leach operation on its Soledad Mountain property (the Project), which
is located 8 km from the town of Mojave in Kern County in southern
California.
The ore that will be mined as per the current mine design is
57.3million t with grades of 0.83 g/t gold (0.024 oz/ton) and 13.5 g/t
silver (0.39 oz/ton). This minable reserve is estimated to contain
1,529,000 oz gold and 24,870,000 oz silver.
Ore will be mined and leached at the nominal rate of 5.728million t per
year with recoveries for gold and silver of 80 % and 65 % respectively
over a leach cycle of 120 days. It is expected that production will
average 119,000 oz of gold and 1,668,000 oz of silver per year once the
mine is in full production. The initial life of mine will be 12 years.
Only 47 % of the mineral inventory of 122,750,000 t is included in the
current mine design. The potential exists therefore for an extended
life of mine beyond the initial 12 years and this will depend upon gold
and silver prices and the Project economics.
The estimated capital cost to the start of production is U.S.$50million
and this includes the reclamation bonds. A further U.S.$8million will
be required for working capital.
The pre-tax IRR and payback targets are > 40 % and < 3 years respectively.
The Project is fully permitted and can proceed to production once project financing has been secured.
Work is proceeding rapidly on the remaining elements of the revised
feasibility study and it is expected that this work will be competed by
December 31, 2004.
It is expected that the Company will seek production financing in late
2004 or early 2005. Construction could begin in the first quarter 2005
with the start of production 9 months later."
The web site obviously hasn't been updated in a while because the
Feasibility Study is not yet complete. It is, however, likely to be
completed within the coming month.
There are three main reasons we think GQM is a good speculation
anywhere near Friday's closing price of C$0.37. First, the stock is
trading at only US$10 per RESERVE ounce. Second, the economics of the
project appear to be excellent. Third, it could have a 150K
gold-equivalent-ounce/year mine just 9 months after a construction
decision is made.
The risk, and probably the main reason why the stock is trading at such
a low price, is that the company will have to raise US$50M before
construction can commence. This is obviously a huge sum for a company
with a market cap of only US$20M.
For risk-tolerant investors we think it would be worth buying GQM up to C$0.45/share.
On a side note, to consistently make money with these illiquid
micro-cap stocks you have to make the lack of liquidity work for you.
The best way to do this is to place bids well under the market during
the down-swings in order to pick-up the stock that periodically gets
dumped by shareholders who lose interest; and to subsequently --
perhaps 6-12 months later -- place sell orders well above the market to
take advantage of the traders who chase these stocks during periods of
strength. This can entail waiting months for an order to be filled and
might mean that your order never gets filled, but it's a profitable
strategy if implemented consistently.
*We just added three new stocks to the TSI List, but at the same time
we are looking for opportunities to exit some stocks that are currently
in the List. The reasons for exiting will vary, but boil down to the
long-term risk/reward not being as attractive as it is elsewhere.
Two stocks that fit into the above-mentioned category are Patricia
Mining (TSX: PAT) and Nevsun Resource (TSX: NSU); PAT because its
long-term upside potential is lower than many other stocks that we
follow and NSU because the political risk associated with Eritrea has
proven to be unacceptably high. We aren't tempted to exit either of
these stocks near current levels, but would be sellers of PAT at around
C$0.80 and sellers of NSU at around C$4.00.
Stock Selection Update #32 - Feb-25 2005
*Last
week the management of DRDGOLD (NASDAQ: DROOY) warned the market that
the latest financial results were going to be worse than expected, thus
preparing the market for the half-yearly report that was scheduled to
be released on 24th February. However, when the actual results were
issued on the 24th (yesterday) they were much worse than the company
had warned of just one week earlier.
By coming out with results that were much worse than the expectations
set just one week earlier the management of DROOY made a huge blunder
because when you are aware of bad news it is critical to get all the
bad news out of the way at the one time to avoid multiple shocks.
DROOY's latest results reveal a company in dire straits. It's
Australasian operations, which provide about 37% of the company's total
gold production, are making money and performing well, but the South
African operations are bleeding cash at a rapid rate (the average cash
operating cost for gold produced by the SA operations during the second
half of last year was US$472/oz, versus US$206/oz for the Australasian
operations). Clearly, the company is going to have to shut down a
substantial portion of its SA operation in order to stop the bleeding.
With cash of around R143M but working capital of negative R65M it will
also have to obtain additional money via debt or equity financing.
DROOY is currently what we'd call a 'survival bet' because if it
survives it will eventually trade at a multiple of yesterday's closing
price but there is obviously a significant chance that the company
won't survive and that the stock price will go to zero. It has,
however, been in this position before (most recently in 2001) and is
likely to once again survive because if worse comes to worst it should
be able to stay in business by issuing more shares.
So, what do we suggest doing?
First, if you already have a small position in the stock then we
wouldn't sell but we also wouldn't average down. Averaging down can be
a reasonable tactic, but we generally only employ this tactic with
stocks that we think are investment grade or, at least, financially
solid. As we've stressed in the past, DROOY is not investment-grade
because it has poor management and low-quality assets. And it is
clearly not financially solid. It is the sort of stock in which it
sometimes makes sense to take a small position because under the right
market conditions it can generate huge gains very quickly, but it is
too risky to ever be a large part of a portfolio.
Second, if you currently don't have a position in the stock then you
could consider making the 'survival bet', particularly if the stock
drops back to test yesterday's panic low of around US$0.80. This is
because, as mentioned above, we think the odds are strongly in favour
of the company staying in business.
*Cumberland Resources (TSX and AMEX: CLG) issued the results of the
long-awaited feasibility study (FS) on its Meadowbank gold project on
Thursday. We were pleased with the results of the FS and will update
our view on this stock in the coming Weekly Update. Suffice to say
right now that we think CLG is a buy near Thursday's closing price of
C$1.84.
Stock Selection Update #31 - Feb-23 2005
*We
haven't commented on Exeter Resource (TSXV: XRC) for a while, but this
stock remains one of our favourite small exploration-stage gold stocks.
In the absence of company-specific news (drill results, etc.) and in a
subdued gold market the exploration-stage stocks tend to drift lower as
retail investors lose interest/patience and liquidate their holdings.
This, in turn, creates buying opportunities. In particular, a good time
to accumulate the stocks of the small explorers is after they have been
drifting lower for a few months due to a lack of news and just prior to
a period when market-moving news is likely to be forthcoming. By the
same token, a bad time to buy them is after one or two news releases
have generated enthusiasm in the stock market.
XRC has been drifting lower for a few months and is now back to a level
where it offers very good value. Furthermore, some potentially
market-moving news -- a resource estimate for the Cabeza project and
initial drilling results for the Puntudo project -- is likely to be
issued within the next few weeks. Therefore, we think it would be
reasonable to do some buying around current levels (from yesterday's
closing price of C$1.17 up to the mid-1.20s).
*Saskatchewan Wheat Pool currently has quite an unusual share structure
in that members of "The Pool" (farmers) own all the voting shares
(known as Class A shares) whereas other shareholders (us, for instance)
own the non-voting Class B shares that are quoted on the stock market
(the shares trade on the TSX under the symbol SWP.NV.B). Presently,
there are about 71,000 Class A shares and 243M Class B shares. Also,
the board of directors is controlled by the Class A shareholders and no
individual or entity is permitted to own more than 10% of the issued
Class B shares. So, up until now the company has been run by farmers
and has been run primarily for the benefit farmers, although other
people have been able to participate in the company's earnings by
buying the Class B non-voting shares.
However, a re-capitalisation plan that would transform "The Pool" into
a more conventional company with a single class of common shares is
currently working its way through an approval process. Provided the
plan is approved -- it almost certainly will be since it has already
been approved by the current board of directors and the Class A
shareholders -- then:
a) All existing Class A and B shares will be replaced by new shares
with each Class A share being exchanged for 3.62 new shares and every
20 Class B shares being exchanged for 1 new share
b) Current holders of the company's C$173M of convertible notes will receive the new common shares in exchange for their notes
c) A C$150M rights offering to all shareholders will be made following completion of the re-capitalisation
The benefits of the plan are that the company will have improved access
to financing, a stronger balance sheet, and a modified board of
directors more focussed on increasing the value of ALL shareholdings.
Also, the plan will open up the possibility of the Pool being the
recipient of a takeover offer or making takeover offers for other
companies. Obviously, the stock market likes this development (the
shares have gained about 60% over the past 3 weeks).
Final approvals for the plan are expected on 23rd March (this is when
Class B shareholders and convertible noteholders are scheduled to vote
on the re-capitalisation).
By our calculations, there will be about 46M new shares outstanding
after the re-capitalisation and the rights issue are complete. If we
assume that the stock would be fairly valued at 1-times annual sales
then the new shares would be worth about C$30 (equivalent to C$1.50 per
current Class B share) based on last year's revenue of C$1.4B.
Therefore, if this assumption is correct then a lot of upside potential
remains (the Class B shares closed at C$0.52 on Tuesday).
Unfortunately, we don't know if this assumption is valid, but even if
the market were to value the shares at only 50% of annual sales there
would still appear be significant upside potential.
SWP was never supposed to be a long-term investment for us because it
doesn't really mesh with our core competencies or long-term market
views. However, a 3-year chart of the stock looks bullish (we'll
include such a chart in tomorrow's Interim Update) and, as mentioned
above, it remains in under-valued territory. We will therefore continue
to hold it for now, but would probably exit were it to gain another
30-40%.
*Broadwing (NASDAQ: BWNG) issued its latest quarterly results last week
and these results showed that the company continues to do well in a
challenging business environment.
As we've noted in the past, the biggest problem for the stock is that
the management keeps diluting the interests of existing shareholders by
making the quarterly payments on its convertible debt in stock (the
company has the choice of using either stock or cash to make these
payments). If we make the assumption that all future debt payments will
be made in stock at $6/share then the share count will increase from
68M to 99M by next February when the last payment is made. On this
basis our valuation per share would fall from around $30 to $20 (our
valuation assumes that the stock trades at around 2-times annual sales,
a reasonable assumption if the company is able to become cash-flow
positive within the coming 12 months). This means that there's plenty
of upside potential from current depressed levels even assuming further
substantial dilution.
Our view is that BWNG's risk/reward is very attractive at around US$6.00 or lower.
*Copper/gold producer Northern Orion (TSX: NNO, AMEX: NTO) recently
completed a large financing and as part of the financing issued about
17M warrants. These warrants, which trade on the TSX under the symbol
NNO.WT.A, have an exercise price of C$6.00 and an expiry date of
February-2010.
Although it appears to be fairly valued or perhaps even slightly
under-valued at yesterday's closing price of C$3.64, we wouldn't be
buying Northern Orion stock at the current time. This is because we
think there are better opportunities elsewhere and because we expect
that a major peak will be in place for copper by the second quarter of
this year. However, at around yesterday's closing price of C$0.65 the
warrants appear to be significantly under-priced relative to the stock
and therefore look interesting from both short- and long-term
perspectives (we don't think this year's peak in the copper price will
be the ultimate peak for the bull market, so with the warrants not
expiring until 5 years from now they should be around when the next
major advance occurs in the industrial metals).
Further to the above, we are going to add NNO.WT.A to the TSI List at
yesterday's closing price of C$0.65 and would consider them to be a
reasonable speculation up to C$0.75. However, we strongly suggest that
you not pay up for ANYTHING in the current environment because there
will probably be plenty of opportunities to buy high-potential gold and
commodity stocks at lower prices later this year. In our opinion the
rebound in the gold sector that began a couple of weeks ago is at least
two-thirds complete and we are seeing final blow-off moves in many
commodity-oriented stocks, so it would be risky to chase anything.
*It was announced yesterday that Noranda, a major mining company, now
owns 7.3% of Metallica Resources (AMEX: MRB). This, in our opinion, is
a vote of confidence by Noranda in the El Morro copper/gold project
(Noranda and MRB have a joint venture agreement on the huge El Morro
project in Chile).
*Over the past few years the TSI stock selections have been
concentrated in exploration/development-stage gold, silver and
industrial metal stocks, and based on our current long-term market
views we expect that our focus will remain in this area over the next
several years. This focus on the more speculative end of the market has
resulted in some huge profits over the past few years and should result
in additional large gains in the years ahead. However, it also means
that we are inevitably going to incur losses of 50% or more on a small
number of our positions.
One of the failures over the past two years has been micro-cap
Australian gold miner Batavia Mining (ASX: BTV). BTV encountered
metallurgical problems at their development-stage gold project in
Western Australia that made the 400K-ounce deposit uneconomic at
current metal prices. A couple of months ago it looked as though a
solution to these problems had been found, thus allowing BTV to proceed
with mine construction. However, the recent performance of the stock
suggests that more bad news is on the way (share price weakness in the
micro-caps is often not an indication of bad news to come, but based on
the past performance of this particular stock and the fact that new
metallurgical testing was scheduled to occur around mid-February we
think it's a good bet that BTV's recent weakness points to a
fundamental problem).
We don't see much additional downside risk in BTV because the recent
decline has probably factored in any bad news, but if the company has
encountered additional problems then the project will most likely have
to be shelved and the upside potential will be limited. Also, there are
other exploration-stage stocks that are grossly under-valued, have
greater upside potential and are relatively problem-free. As such,
we've decided to take the loss on BTV and move on.
Stock Selection Update #30 - Jan-11 2005
This is a very quick update on one of our current positions.
Things could look quite different by the time today's US trading
session ends, but right now it looks like we are going to get some
consolidation in the currency, stock and gold markets this week. In
other words, the markets look like they are about to partially retrace
last week's moves. This doesn't affect any of our short-term views, but
does prompt a change of plan as far as our Newmont Mining put options
are concerned. The reason is that although we think NEM has a decent
chance of trading well below current levels at some point over the
coming month, an upward consolidation lasting several days would
probably be enough to eliminate all the value in our January put
options (the options expire at the end of next week). We've therefore
decided to take profits on these puts immediately with the aim of
purchasing some longer-dated puts in the future following a rebound in
the gold sector.
On a side note, when dealing in out-of-the-money options there's always
a trade-off between time and price in that it's always nice to have
plenty of time up your sleeve (an expiry date which is many months into
the future) but in order to add just a couple of months to the expiry
date it will often be necessary to pay a lot more for the option. For
example, as at yesterday's close a Newmont Mining $40 put option with a
June-2005 expiry date was priced about 75% higher than a $40 put option
with a March-2005 expiry date; and a $40 put with a March-2005 expiry
date was, in turn, priced about 50% higher than a $40 put option with a
February-2005 expiry date.
Stock Selection Update #29 - Nov-26
2004
We weren't
planning on adding any more junior resource stocks to the TSI List at
this time. Instead, our plan was to take advantage of selling
opportunities as they arose in order to reduce the number of stocks in
the List. However, we are going to momentarily shelve this best laid
plan because we have identified a new stock with such a good
risk/reward that it is most definitely worthy of inclusion in the List.
The company is Crowflight Minerals (TSXV: CML), a nickel explorer that
we've been following since early this year but one that only quite
recently became a potential TSI stock due to important progress made by
the company and, we think, the stock market's lack of appreciation of
how much value is in the process of being created within this company.
General speculation in junior resource stocks resulted in CML trading
in the C$0.70-C$1.00 range during the fourth quarter of last year and
the first quarter of this year despite the fact that it had nothing
other than the mineral rights to some well-located land in the Sudbury
region of Canada. In this respect it was no different than countless
other exploration companies in that it had the hope of one day
discovering something of value but owned nothing to which any
significant current value could be assigned. In other words, it was
just one of many Canadian 'lottery ticket' stocks, and yet the market
was prepared to price this lottery ticket at around C$40M due to the
speculative enthusiasm that prevailed at the time.
However, things took a dramatic turn for CML in August when it was
selected by mining major Falconbridge to be that company's partner in
the exploration and development of the Thompson Nickel Belt. As a
result of the Falconbridge deal CML now has the right to earn 100% of
the Bucko nickel project and 50% of the highly prospective Bowden Lake
property by spending a total US$25M on the projects over the next 5
years.
Here are some details on Bucko, Bowden, and the Falconbridge deal:
1. A recent NI 43-101 report confirms that Bucko has an indicated
resource of 1.22M tonnes of 2.71% nickel (around 73M pounds of nickel,
or roughly the equivalent of 1.1M ounces of gold at current metal
prices).
2. The above resource is almost certainly going to be substantially
expanded over the coming months and years (Bucko's total resource
potential is in excess of 400M pounds), but using only the initial
indicated resource mentioned above a scoping study recently completed
by Micon International came up with the following estimates for the
Bucko project:
a) Bucko could be developed into a 11-14M pounds/year nickel producer
b) The cash cost of nickel production would be US$2.66/pound
c) The project's internal rate of return (IRR) would be 89%
assuming a nickel price of only US$5/pound (the current nickel price is
around US$6.50)
d) The project would have a net present value of US$50M using an
ultra-conservative 15% discount rate and assuming a US$5/pound nickel
price
3. A feasibility study for Bucko is expected to be completed by next
March and it's quite possible that the project will be in production by
late 2006.
4. The Bowden deposit has a historical resource of 88M tonnes grading
0.63% nickel (around 1.2B pounds of nickel). This resource is not NI
43-101 compliant, but a 15000m drilling program that just got underway
should enable a 43-101 calculation to be completed by next Spring.
5. CML will focus on exploration/development of Bucko while
Falconbridge's experienced nickel exploration team will manage the
exploration work at Bowden
6. What Falconbridge gets out of the deal is a) a partner focused on
the development of Bucko, b) a partner that will fund the exploration
work at Bowden, and c) an 11% stake in CML assuming all warrants are
exercised
7. It is reasonable to assume that Falconbridge management did its due diligence before selecting CML
Now, CML has 72M shares outstanding (93M on a fully diluted basis), so
at yesterday's closing price of C$0.28 its market cap is only C$20M.
This clearly doesn't come close to reflecting the value of just the
Bucko project at its current size, that is, assuming NO resource
expansion and allowing NOTHING for the massive Bowden deposit. It is
also worth noting that CML has no debt, about C$7M in cash, and a
strong management team headed by Stan Bharti (Mr Bharti is the current
chairman of Desert Sun Mining and was president of DSM until he
recently handed the reins to Bruce Humphrey).
CML's stock price is a lot closer to its 52-week low than its 52-week
high, meaning that it is a candidate for tax-loss selling over the next
few weeks. We doubt that this will result in much additional weakness
in the stock price, but it will hopefully provide enough liquidity to
enable anyone who wants to take a position in this micro-cap to do so
in the high-20s or low-30s.
Stock Selection Update #28 - Nov-15
2004
*We last
wrote about Lynx Therapeutics (NASDAQ: LYNX) on 17th August in Stock
Selection Update #23. At that time the stock was trading at US$1.48 and
the company had just signed a non-binding letter of intent to merge
with a private UK-based biotech firm called Solexa Ltd. Our view at the
time was that the risk was high, but so was the upside potential.
Since that time a merger agreement with Solexa has been finalised and
the stock price has recovered to $3.30. This merger means that the
downside risk has been substantially reduced because the combined
company is well supported from a financial perspective, but the
intermediate-term upside potential has also been reduced due to the
merger (the merger will result in a massive increase in the number of
outstanding shares) and the subsequent appreciation in the stock price.
The stock's long-term upside potential appears to be good, but this is
not relevant to us because we have always considered LYNX to be a trade
as opposed to a long-term investment.
Our plan is to exit LYNX if it trades up to around US$4 at any time between now and January.
*Since adding Plum Creek Timber (NYSE: PCL) to the Stocks List in
November-2003 we've had a price target of $40 in mind. The stock ended
last week at US$38.81, which is close enough. We will therefore exit
the stock now and realise a gain of about 53% (including dividends).
If you are prepared to take a 3-5 year view then the stock remains a
hold at the current price. Our plan, though, is to take the gain now
with the aim of re-purchasing at around $30 within the coming 2 years.
*Our Australian-based subscribers who are looking for exposure to base
metals should consider buying shares of Zinifex (ASX: ZFX). Zinifex,
one of the world's largest zinc producers, is financially solid and
extremely under-valued at the current price of AUD2.13.
*In our opinion, Metallic Ventures (TSX: MVG) continues to offer the
best value in the gold sector when taking into account financial
strength, management, political risk, and the market value assigned to
in-ground gold resources.
*The stock price of silver producer First Majestic Resource (TSXV: FR)
has perked up over the past couple of weeks. From both technical and
fundamental perspectives the stock is still a buy, particularly if it
pulls back to around C$1.80.
Stock Selection Update #27 - Oct-25
2004
*Part of the
recent extreme weakness in the Broadwing (NASDAQ: BWNG) stock price
could be due to tax-loss selling by institutions prior to their fiscal
year-end (31st October), but we suspect it's mostly due to stock
dilution.
On 19th November a $34.5M payment associated with convertible notes
will become due and a large part of the decline in the stock price
prior to last week was probably related to the market's fear that
BWNG's management would elect to make this payment in stock rather than
cash. Unfortunately, this fear proved to be well founded because a
"Form 8-K" issued by the company early last week confirmed that the
payment would, in fact, be made in stock (refer to
http://www.sec.gov/Archives/edgar/data/1060490/000119312504174522/d8k.htm
for details). Furthermore, the number of new shares that will be issued
will be determined by the stock price during the 20 trading-day period
ending on 16th November, so the holders of the convertible notes have
an incentive to drive the stock price lower over the coming few weeks
in order to maximise the number shares they receive.
Given that BWNG is cash rich (the company has total cash of more than
$400M and net cash of more than $200M) the decision to make the
convertible note payment using under-valued stock appears to be an
incredibly stupid piece of business. We understand that the decision
was made in order to keep the balance sheet as strong as possible on
the basis that balance sheet strength is very important to Broadwing's
customers (BWNG's main customers are large corporations), but we still
don't think it makes any sense with the stock price at such a low level.
Despite being more than a little unhappy with management's decision to
further dilute the stock we do, however, think that Broadwing
represents a better investment now than it ever has because the market
has just reacted to the prospect of a 10% increase in the number of
shares outstanding by pushing the stock price down by more than 40%.
The net result is that BWNG is now trading at an
enterprise-value-to-sales ratio of only 0.26, assuming that around 7M
new shares get issued in November to make the payment on the
convertible notes. This is similar to the valuations assigned to Nortel
and Lucent at the October-2002 bottom in the stock market. Actually, it
is the sort of valuation that would normally be associated with a
company for which there was an imminent threat of bankruptcy, yet
BWNG's balance sheet ensures that it will still be in business 12
months from now.
The bottom line is that if BWNG's management were perceived by the
market to be doing everything right then the stock would be trading at
$30, not $5-$6. For our own account we are therefore averaging-down
near current prices and will probably add some more during November if
the price continues to be forced down by the above-discussed
convertible note issue.
Also, BWNG might be an ideal way to play a "January effect" rally.
Therefore, depending on what happens with the overall market over the
coming two months we might add a short-term trading position in BWNG to
the Stocks List during December.
*Metallica Resources (AMEX: MRB, TSX: MR) has travelled a very rocky
road over the past 8 months. Just to recap what has happened for those
new to the story:
- February 2004: Construction of the company's 120K oz/yr Cerro San Pedro (CSP) gold/silver mine in Mexico commenced
- 14th April 2004: The local (agrarian) court ruled in favour of
a group contesting the lease agreement Metallica had entered into for
the land on which the CSP mine was being built. Metallica and the local
residents appealed the decision to a federal court and construction
work continued.
- 2nd June 2004: Metallica advised that it was having difficulty
obtaining the explosives permit it needed and that the president of the
local municipality was refusing to renew the company's construction
license. The company said that it would have to suspend construction at
CSP unless these permits were received within two weeks.
- 23rd June 2004: Metallica advised that the necessary permits
had not been received and that it was therefore suspending
construction. It also mentioned that a federal court was expected to
rule on its appeal of the agrarian court's decision by October.
- 31st August 2004: The company confirmed that its construction license had been renewed.
Last Friday the stock price gained 16% on news that the explosives
permit had finally been received. So, a couple of legal hurdles remain
but Metallica's management has made substantial progress over the past
two months towards re-starting construction at CSP.
Our view is that if the remaining legal hurdles can be overcome, and we
think it is likely they will be overcome, then current metal prices
would justify a stock price well in excess of US$2.00 (the stock closed
at US$1.37 on Friday). Also, in the worst-case (low probability)
scenario where the company is forced to abandon the CSP project then
the value of the company's cash (US$42M, or US$0.50/share) and its El
Morro copper/gold project in Chile would probably justify a stock price
of US$0.80-US$1.00. Therefore, the risk/reward looks attractive and we
wouldn't be selling at current levels. The remaining legal issues
would, however, prevent us from doing any new buying simply because
there are other gold/silver stocks that offer just as much value but
don't have any legal issues hanging over them. Desert Sun Mining (TSX:
DSM, AMEX: DEZ), for example, is well into the construction of its 100K
oz/yr mine in Brazil and offers as much upside potential as MRB.
*Plum Creek Timber (NYSE: PCL) has been a good and steady performer
since we added it to the Stocks List in November of last year.
Furthermore, as a result of a long-term upward trend in lumber prices
and profits from land sales we expect that over the next several years
the PCL stock price will continue to grow at a faster rate than the
company's timber (trees grow about 7% per year). However, since adding
the stock to the List we've had a price objective of $40 in mind and if
the market gives us an opportunity to exit at close to this price
within the next few months we will take it.
*For those looking for exposure to silver we'll reiterate our view that
First Majestic Resource (TSXV: FR) offers excellent value anywhere near
the current price of C$1.57. The stock has not reacted at all to the
post-May rebound in metal prices, but in this regard it is certainly
not an orphan as many of the juniors have gone nowhere during this
period. However, if metal prices continue to increase then at some
point the high-quality juniors (and some of the low-quality ones) will
rocket higher as investment/speculative demand shifts down the food
chain in search of under-valued situations. When this happens, though,
the stocks will be difficult to buy and buying will be a much riskier
proposition than it is right now.
Stock Selection Update #26 - Oct-18
2004
A few months
ago we said we'd endeavour to reduce the number of stocks in the TSI
Stocks List to enable us to provide more regular updates on the
remaining stocks, but at this stage we've made almost no progress
towards this goal because in the mean time there have been a lot more
buying opportunities than selling opportunities. We are, however, going
to exit two stocks now and suggest profit-taking on a third.
*Although it has gained 42% in C$ terms and considerably more in US$
terms since we added it to the List in April of 2003, Northgate
Minerals (TSX: NGX) hasn't lived up to expectations. It is very
under-valued relative to almost all other mid-tier gold/copper
producers, but environmental concerns relating to its Kemess North
project could mean that the stock stays under-valued. In particular, if
the required permits for Kemess North cannot be obtained in accordance
with the current mine plan then a substantial re-rating of the stock
would be unlikely. We are therefore going to exit NGX now.
*We added Rogers Sugar (TSX: RSI.UN) to the Stocks List in February of
2004 as an indirect play on an expected increase in the price of sugar
(RSI doesn't benefit directly from stronger sugar prices, but as an
intermediary it would benefit indirectly from a sustainable improvement
in the sugar market). Since that time it has returned a very small
profit of 2.6% including dividends, which is actually a reasonable
performance given the generally lousy stock market environment of the
past 8 months.
At the current stock price the dividend yield is 10.3%, and since there
is a good chance that income distributions will at least be maintained
at current levels over the next 12 months the dividend should limit the
downside in the stock price. As such, RSI would be a reasonable stock
to own if one of your main objectives was to earn dividend income. It
doesn't fit with the TSI approach, though, because we generally try to
select stocks that are leveraged plays on our intermediate-term market
views. Therefore, we will exit RSI now.
*The TSI Stocks List is a list of stock ideas, not a portfolio. As
such, it is generally not adjusted to reflect the sort of money
management techniques that we would implement if we were running it as
a portfolio. For example, if it were run as a portfolio then stocks
would generally be entered and exited in stages (averaging-in and
averaging-out over time). There would also be regular re-balancing to
maintain the desired weighting for each stock and to bring the overall
exposure to each sector into line with our intermediate-term market
views.
Once in a while, though, we do implement a modicum of money management
as far as the Stocks List is concerned by exiting a position in two
stages. For instance, when Desert Sun Mining surged to C$2.20 last
November we said we would record a gain on 50% of the position.
We are now going to do something similar with Aquiline Resource (TSXV:
AQI), that is, we are going to retain AQI in the List but realise a
large profit (358%) on half the position. The reason we are doing this
is that the stock has gained 70% over the past 5 weeks and closed just
below intermediate-term resistance on Friday.
The reason we are only exiting half the position is that AQI's
intermediate-term risk/reward remains very attractive. Furthermore, an
updated resource estimate on the Calcatreu project is due to be
announced later this month and there is a significant chance that AQI
will end up with a stake in the lucrative Navidad silver project as a
result of the legal battle with IMA Explorations.
If exiting half of your AQI position would leave you under-exposed to
exploration-stage gold/silver stocks then you might consider switching
the proceeds of the sale into Metallic Ventures (TSX: MVG), Canarc
Resource (TSX: CCM), and/or Exeter Resource (TSXV: XRC), all of which
offer exceptional value at current prices.
*In the Weekly Update we said that GFI and HMY had traded on Friday as
if HMY were about to make a bid for GFI. We also said that such a bid
would be a big surprise to us due to Harmony's smaller size and the
relative cheapness of its shares. However, according to the
below-linked article we are going to be surprised because HMY is about
to announc |
