It's the lazy days of summer and Paul Renken, senior geologist and analyst with VSA Capital, is bottom-fishing. He sees a lot of value in unloved resource equities and spends much of his time sifting through the lot to find juniors that will get the increasingly sparse financing needed to turn potential into production. Renken offers an abundant catch of equity picks in this interview with The Gold Report.
The Gold Report: VSA Capital recently published a research report that reads, "One of the key parts of exploration funding and the acceptance of risk versus monetary reward was the considerable correlation between share price appreciation and the reduction of geological risk." However, this no longer seems to be the case. What's broken?
Paul Renken: What has transpired for the last couple of years, particularly in the junior and very small-cap exploration space, is that the money to find deposits and advance them along the risk profile to a bankable state has largely disappeared. The dollars required to define a resource have been viewed by the market as an opportunity to sell shares to take advantage of any short-term price strength. From the long-term shareholders' point of view, the money was wasted. Companies should have sat on the cash and not bothered with any exploration.
The directors of these companies need to realize that at the early stages of a project, they have to consider the probability of finding a significant deposit and how much it's going to cost to define it. Investors, and institutional investors in particular, are looking for very low costs of discovery.
TGR: Has that become part of your investment thesis for junior resource equities?
PR: Yes, we're looking to bottom-fish particularly good stories with good deposits that have languished for some time but that are now showing good economics. There are many firms out there seeking capital but there just isn't much capital to finance all of them, or even the majority. If you're going to commit capital to bring some of these stories to production, why not cherry-pick the best stories and the best deposits at the most economical cost? The smaller you get in the resource space, the good deposits or good corporate stories are available at very low valuations simply because the sector has been so out of favor for so long.
TGR: When is risk capital going to return to the sector?
PR: The exploration side of the business, a subsector of the mining space, needs to show that it has the same or greater potential for a return on investor capital versus other sectors. It is a competition for the available dollars among all the different companies in all the different sectors-as well as debt capital and currency markets-not just other mining companies.
We seem to be at the bottom or bouncing along the bottom in the small-cap mining space. I'm looking forward to seeing some signs, likely in a matter of weeks, that we have seen the bottom of the market.
TGR: Where in the bulk commodity space should investors look for performing equities?
PR: Companies that have a strong component of their earnings in industrial metals-lead, zinc, nickel, etc.-should do better than those in the iron ore space. As a large-cap company, Glencore International Plc (OTCPK:GLNCY) is likely best positioned among large mining firms listed in London. Glencore is pretty well situated in metallurgical coal and base metals concentrates, particularly lead-zinc concentrates. It is also getting involved in vanadium. It has its finger on the pulse of a variety of different bulk commodities that are traded on the London Metal Exchange, as well as on the mining side.
TGR: You cover a number of industrial commodities, including tungsten. Tungsten has the highest melting point of any metal, but at $370/metric ton unit [$370/mtu], it's not exciting many investors. What's the investment case for tungsten?
PR: Tungsten's primary use is in carbide cutting tools, essentially a proxy for manufacturing activity. If the banks and governments across the world are going to get the economy moving faster, they have to increase manufacturing activity. Manufacturing activity means being able to create, cut and sell metal-everything from fabricated products to metallic tools to sheet metal, including auto body panels.
Auto manufacturing is increasing in both China and the United States. And because China wants to maintain its manufacturing dominance, it is no longer exporting tungsten as it did in the 1980s, when it essentially swamped the worldwide tungsten market. These days, some sources say as much as three-quarters of the arable land in China is contaminated. The Chinese must address this issue and that means no longer accepting quick and dirty methods of metals production. We expect Chinese tungsten exports to continue to tighten, and therefore tungsten should have fairly robust demand going forward.
TGR: You also follow the rare earth elements [REE] subsector. It seems to be the most volatile, yet Reuters reports that one of its biggest players, Molycorp Inc. (MCP), may have finally overcome their many challenges to become bona fide REE producers. Should investors believe the hype?
PR: Molycorp has disappointed investors simply because they are taking too long and using too much money to reach their goals. Molycorp continues to have issues with bringing its mine back to the level of commercial production that it had achieved decades earlier. Institutional investors are going to have to be very patient to realize any return on capital.
TGR: What's your view on the REE space in general?
PR: I'm positive on the REE space. Further down the food chain there are a number of interesting REE stories with simpler mineralogy that should require simpler plants and processes to produce REE. That means their capital expenses should be a lot less, too. The Chinese have controlled REE production for a number of years but China is trying to seize greater control of the market inside its borders because there has been so much illegal REE mining and smuggling.
The Chinese realize that the volatility experienced in REE pricing just a few years ago caused many end users to seek alternatives. The subsequent steep decline in REE prices has been difficult for Chinese REE producers. By the same token, annual REE demand growth is in the high single-digit range. That's expected to continue for some time.
TGR: Perhaps one more REE junior?
PR: Another one is Tasman Metals Ltd. (NYSEMKT:TAS). Tasman has two REE deposits, but the primary one is called Norra Kärr in Sweden. That particular deposit is relatively low grade in total REE at below 1%, but geologically it is skewed toward the heavy rare earths. It may also very well be quite profitable. The other interesting thing is that it is the only rare earth deposit in the development stage with a direct market into the European Union [EU]. The EU has declared REEs to be among a number of different metals and materials, including tungsten, that are critical to its industrial future as a trading block. I suspect that once the Norra Kärr feasibility study is complete, some financing doors will open in short order.
TGR: In a February 2014 interview, you told us that investors should be in precious metals, gemstones and uranium. While precious metals' prices were up in the first half of this year and the diamond equities you mentioned have performed, uranium continues to flounder. Is it as simple as asking investors to have more patience?
PR: It certainly has been a disappointment for uranium investors and for analysts who can see that it should be performing much better. The issue is that Japan has not brought its nuclear program back on-line. Japan has a surplus of uranium from long-term contracts that it can't use because those reactors are not operating.
Japan is forced to resell that material for whatever it can get. This is costing the Japanese economy billions. How long will it continue to do this? It has already gone on longer than any of us anticipated. The government intends to bring these reactors back on-line at some point, when it is satisfied that it is safe to do so.
TGR: What should investors do?
PR: If they are still holding uranium equities, they must decide whether it's worth holding that position. A few uranium equities out there are definitely good bottom-fishing situations because the grade or size of the deposit dictates that they will be put into production as long as there is a global nuclear industry.
TGR: Could you give us an overview on the nickel space?
PR: The nickel space has been quite interesting ever since the Indonesian export ban went into effect in January. It's done wonders for the value of nickel. The price moved to the $9/pound [$9/lb] range from about $6.50/lb. We expect nickel to stay in that range until Chinese pig iron producers are able to source other nickel-laterite ore or cheap nickel concentrates. Until a source is found, we think the price will remain strong.
TGR: Do you want to discuss gemstones?
PR: The fundamentals for diamonds were looking quite good at the end of 2013 and that has proven to be the case. Most diamond equities, particularly the producing equities, are showing nice gains this year. That's based on improvements in both cut and raw stone prices on the auction tenders of these companies over the first seven months of 2014. U.S. and Asian retail demand continues to improve and we're comfortable projecting further gains.
TGR: In a report titled, "Emerging Market Forex and the End of the Commodity Market Super-Cycle," Goldman Sachs says that bulk commodities, like iron ore, copper and oil, will see five years of price softness to the tune of $80/ton iron ore, $6,600/mtu copper and $100/barrel for Brent crude. Do you concur?
PR: We'll probably see some volatility in that very flat marketplace. Goldman Sachs is quoting prices that are 10-20% under the current prices, yet some of these prices are moving in the opposite direction. For instance, geopolitical risk is pushing up the price of Brent crude.
To reach $3/lb or lower for a sustained period, copper would require a significant surplus over the next five-year period. The amount of copper coming into the market has been consistently lower than analysts' projections. Last year, there was a slight deficit. There may be as much as a 400,000-tonne surplus this year in my view, but that isn't significant enough to sway prices. I would peg the five-year average copper price closer to $3.20/lb.
As far as iron ore is concerned, it may try to test $80/ton at some point, particularly if there's a decline in steel output in China. I suspect that the overall average for five years would be closer to $90-100/ton for 62% iron CFR [cost and freight].
TGR: Parting thoughts?
PR: I'm hopeful that we are looking at the bottom for mining equities. We may see another trading range for gold and for silver. Silver is certainly playing out according to what we had anticipated at the end of last year. Gold is a bit stronger than we had expected, largely because of geopolitical risk and retail interest from Asian investors. Platinum group metals prices are looking quite good and will continue to because of labor risk in South Africa and geopolitical risk in Russia. Overall, we see strength in a number of different commodities. It's time for equities to catch up.
TGR: Thank you for talking with us, Paul.
This interview was conducted by Brian Sylvester of The Gold Report and can be read in its entirety here.
Paul Renken has a broad range of experience in various aspects of the mining and minerals business. He began his career as a geologist for Canadian junior resource companies in the western United States. Owning a stake in a private consulting firm as vice president of exploration, Renken searched for various base metals, precious metals and industrial minerals. In the UK, he worked in the equity market media outlets of Digitallook and Hemscott before joining VSA as mining analyst in 2006.
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