Tanzanian Royalty's Short Interest Growing -- Stage Set For A Big Reversal

May.14.12 | About: Tanzanian Royalty (TRX)

Tanzanian Royalty Exploration (NYSEMKT:TRX) is one of my favorite gold stocks -- it constitutes the second largest position in my entire stock portfolio. There are a few notable developments in the stock that I thought warranted a discussion:

1. Short Interest Growing. TRX's short interest has been steadily growing thus far in 2012. High short interest in quality gold stocks is something I really like to see, as invariably these shorts are going to need to cover -- and when they do, price could really take off if the company is as solid as bulls believe it to be.

2. New Drill Results. TRX just announced some new drill results pertaining to its Buckreef Gold Project in Tanzania. The drill results suggest some high grade ore, with grams per ton routinely ranging from 2 to nearly 10. In a world where ore grades under 1 gram per ton are commonplace, these results are impressive, and suggest TRX will have very favorable mining costs.

3. Growth in Tanzania. A common reason many are reluctant to invest in TRX is because its operations are based in Tanzania -- an economy that, like many in Africa, has struggled greatly over the past decades. It seems, however, that things may be changing. The country's GDP is expected to continue to grow at an even higher rate than last year; the country's officials realizes this is due to its gold and natural resource deposits. The growth will fuel additional foreign investment and improvement in the country's infrastructure. As an investor this is something else I really like to see; the distrust towards Tanzania and many other African countries is not entirely warranted when one looks at the growth numbers and support from China, and I think there are some especially great buying opportunities as a result.

Why the Stock Remains Undervalued

For those unfamiliar with the stock, I wanted to quickly recap why I remain bullish -- even more so in light of the aforementioned news items:

1. Management. The company's founder and CEO, James Sinclair, has been in the gold market for 50+ years known for his legendary long-term calls; Sinclair called for gold to reach a minimum of $1,650 in 2011 back in 2003. I believe investing is all about finding top management in the right sector, which basically sums up why I'm bullish on TRX.

2. Growth Prospects. The company has 7 projects, three of which are advanced stage with production set to commence in 2013, all located in the Lake Victoria belt in Tanzania -- a historically prolific gold region. Tanzania is the fourth largest producer of gold in Africa, and given the aforementioned drill results, it seems as though the company has access to some high grade ore that should be able to be mined at very economically viable rates. Just as I like to invest in the Carlin Trend in Nevada and the Athabasca Basin for their long history of producing minerals at economically viable rates, I like the Lake Victoria belt in Tanzania for the same reason. It's worth noting that Barrick Gold's (NYSE:ABX) African division is nearby -- setting the stage for potential joint ventures, an acquisition, cost-sharing, as well as robust presence to boost the overall mining industry in Tanzania.

For these simple and straightforward reasons, I expect TRX to rally substantially once the gold market really heats up and goes well past its all-time highs.

Contrary Arguments in Perspective

Some of the contrary arguments to consider are:

1. Gold has topped. The view that gold peaked last September near $1,920 is an increasingly common one, especially as price is now below $1,600 and gold is trading below major trendlines and the 200 day moving average. If you believe gold has topped, gold mining stocks are not a good opportunity. I believe gold is a function of the sovereign debt crisis, which is alive and well -- and thus I believe the bull market in gold is alive and well too.

2. No mania coming in mining stocks. Another perspective is that mining stocks are not a good opportunity and will not become one any time soon; the argument is that if one wants exposure to gold, they should simply buy bullion. Mining stocks are even less interesting now, the argument goes, thanks to ETFs that make it very easy to own bullion. Moreover, mining stocks are very prone to hedging, in which hedge funds buy bullion and short exploration stocks; indeed, I believe this is what accounts for the high concentration of short positions in stocks like TRX and MUX among others. Ultimately though, I believe this gold bull market will share some similarities to the one in the 70s, in which mining stocks really took off in the latter half of the decade. Likewise, I believe a mania in mining stocks will emerge as monetary expansion from the Fed's policies will ultimately fuel a number of bubbles -- and with mining companies perpetually increasing their dividends, I think they will be a preferred target for funds looking to move out of bonds as the sovereign debt crisis grows. Moreover, I believe that the issuance of dividends by mining companies that are in production (TRX is set to commence production in 2013) will throw off the shorts, as shorts will find it easier and less expensive to short stocks that do not issue dividends.

Buying Opportunities in Perspective

Below is a chart. The recent lows near $3.75 mark a level price previously bounced sharply off of in March; based on this, I think the lows could be in. My average entry position on TRX is $3.64, and as I'm already well-positioned in this stock and in my gold portfolio in aggregate, I'll need to see a fall to $3.30 before I can justify adding more.

Disclosure: I am long TRX.