Hyperinflation's  Instablog

The new junior mining Etf is rather impressive and gives great exposure to the potentially more lucrative Junior Miners. This is not to say investors can't create their own bundle or personal "ETF" composed of a better mix of Junior and/or mid-tier miners. Due to the difficulty deciphering between Junior and Mid-Tier miners, I believe the addition of those on the border between the two and the removal of some unnecessary components included in the GDXJ, would make for a better overall portfolio of miners. The following is a brief rundown of those I think deserve their spot in the recently launched ETF and those who could be replaced.

Van Eck did a good job with the heaviest components such as:

• Silver Standard Resources - On track to become a major silver producer with a resource base which is nearing two billion ounces from world class silver mines in geo-politically safe countries i.e Canada
• Coeur d'Alene Mines - Though still rather hated by the investment community due to the years of shareholder dilution while nearing bankruptcy, CDE has quickly transformed itself not onlt into a top primary silver producer, but a free cash flow machine ready to reward shareholders with what will turn into a handsome dividend. I talk about CDE this way while excluding one of their flagship operations in Bolivia, well because it's in Bolivia. So any production derived from that operation is an added bonus. I'm referring to their current ramp up at Palmarejo in Mexico and the Kennsington operation commencing in 2010. The Latter will diversify their revenue stream by including between 200-250k oz of gold by 2011/2012, giving them approx 25m oz of silver production and 250-280k of gold production within the next 2-3 years. - Click Here for a detailed Analysis
• New Gold - Great emerging junior company with increasing production, upside potential and declining cash costs. Having production come from four operations is a definite benefit as mining interruptions have less of an impact relative to those who have one or two operations.
• Alamos - I would re-move Alamos and Eliminate Gammon
• Jaguar Mining - One of my top five favorite junior gold producers -Click here for an in depth analysis.
• Kirkland Lake Gold - Kirkland has enormous potential beyond the 500%+ output growth from 2009-2012 (48k- 250). The upside exploration potential could mean peak production upwards of 600-700k assuming the best case scenario, but 400-500 is more than likely especially given the news that continues to flow out. - Click here for an in-depth analysis.
• Lake Shore Gold - Lake shore is another great story both in terms of near and intermediate term production growth, diversified set (4) of operating mines and future upside exploration potential. From around 30k oz produced from one mine in 2009E, Lake Shore will ramp up production as three mines come online and ramp up production to 100k in 2010E , 220k in 2011E, 350K in 2012E and 380-400k in 2012E.
• Removing Golden-Star Resources due to geo-political issues and removing San Gold  due to more ideal suitors for this spot. The same goes for Northgate.
• Silvercorp - Starting to show its true potential
• Andean Resources - They are moving up the list as they continue to find high grade ore making them appear as a buyout candidate. They would add 250k+ from no production by 2011-2012, solely based on current findings (which are likely to increase guidance).
• Aurizon - A valuation play, with a nice set of operations in Canada, notably CasA Berardi. Though growth is stagnant going forward, exploration and acquisition catalysts seem like the likely outcome. In the meantime it is a good free cash flow producer in a mining friendly country,
• Allied Nevada - A great junior producer, with a high likelihood of being bought by the likes of Barrick, Newmont or Kinross.
• Semafo - Along with Red Back, Semafo is the only other miner I would buy whose sole focus is in Africa.
• Rubicon - My second favorite exploration company, behind Andean. As the drill results come out, the more potential Rubicon shows.
• Silver Wheaton - Click for analysis
• Franco -Nevada - Click for detailed analysis
• Red Back - Click for analysis
• First Majestic - click for analysis

If I were to replace and re-weight various components of GDXJ it would look as follows ( 6 new additions included ) - 36.6% Silver Miners , 63.4% Gold Miners

8.04%		Coeur d'Alene Mines
8.01%		Jaguar Mining
7.93%		Silver Wheaton
7.71%		Silver Standard
6.32%		New Gold
6.29%		Kirkland Lake
6.15%		Red Back Mining
6.67%		Lake Shore Gold
5.42%		Andean
4.62%		First Majestic
4.40%		Fortuna Silver
4.40%		Rubicon
3.99%		Franco-Nevada
3.96%		SilverCorp
2.79%		Allied Nevada
2.74%		Aurizon Mines
2.71%		Semafo
2.66%		B2B Gold
2.65%		Great Basin
2.54%		Detour Gold

Disclosure: Long SLW, KGILF.PK, RBIFF.PK, JAG, FRMMSF.PK, FNNVF.PK, CDE, NGD WARRANTS

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  Newmont mining did investors a huge favor by spinning off/ IPO'D what is now Franco-Nevada(FNNVF.PK) , a royalty company focused on mainly on gold, with additional interests in Oil & Gas, Platinum, and Base metals. While Royal Gold (RGLD) garners more investor and media attention, Franco-Nevada has more upside potential, especially given the current valuations. Franco failed to take part(at least to a meaningful degree) in the $150 rally in gold over the past two months, while Royal Gold is sitting close to its 52-week high, sporting a rather rich valuation. Part of the reason may be due to the fact it only trades on the TSX or Pink Sheets, but Franco-Nevada is and looks like it will continue to be a superior free cash flow machine. Don't get me wrong, Royal Gold is a great company as well, but it lacks the depth in their royalty portfolio as well as depth in their soon to come online, medium and long term royalty pipeline ( relatively speaking). 

Franco made a gutsy albeit brilliant investment in Coeur d’Alene’s Palmarejo mine ( as Coeur d’Alene(CDE) was flirting with bankruptcy not that long ago, going on to be an amazing turnaround story for 2009).

What I think gives Franco the upper hand is their more or less recent spree of acquisitions, and more importantly, the 750 million available to fund additional growth ( 600 million in cash and short term investments + 150 million un drawn debt facility). It was not until today in which I realized Franco made not one but two acquisitions recently. Not only does Franco have great leverage to the price of gold, but as key flagship streams ramp up production and/or come online over the short, medium and long term, their war chest will transform Franco into an enormous free cash flow generator. Franco’s Oil & Gas royalties ( which account for 12-15% of income) also offers investors some exposure to oil & gas ( which should rise past its 2008 high’s as inflation sets in).

Current Flagship Royalties:

• Goldstrike,
• Palmarejo
• Gold Quarry,
• Stillwater,
• Marigold,
•  Robinson 
• Oil & Gas, others.
  

Near Term Growth Pipeline – 2010 – 2011

• Holt -
• Holloway
• Hollister
• Hemlo ,
• Tasiast - 30% increase in reserves and updated production not included
• Palmarejo – Expected to add 25million in 2010 and 30-40 in 2011
  

2012+ Pipeline –

• Hemlo – 2nd royalty
• Detour –
• Others - Include several of what may prove to be flagship streams from the likes of Great Basin Gold, Kirkland Lake Gold and others
• 131+ exploration interests In gold royalties

 Back of the page Pro-For

Revenue	2009	2010	2011	2012	2013
Gold	$110,000	$160,000	$190,000	$225,000	$300,000
Oil & Gas	$30,000	$50,000	$60,000	$70,000	$80,000
Others	$9,000	$10,000	$10,000	$10,000	$10,000
Total	$149,000	$220,000	$260,000	$305,000	$390,000
FCF	$104,300	$150,400	$182,000	$213,500	$273,000
Gold Price Assumption	$940	$1,050	$1,150	$1,250	$1,400
Oil Price	$55	$85	$110	$135	$150

 

Not only does Franco-Nevada have a diversified royalty portfolio, but it will continue to become increasingly diversified with excellent growth in attributable gold production. They also have several potential catalysts with their exploration interests and the high likelihood of multiple value adding acquisitions. Take advantage of the Stigma that plagues many Pink Sheet stocks before Franco debuts on another major stock exchange. Some other notable attributes worth mentioning:

• $5.50/share in net cash ( or 20% of the current market cap )
• 33% year/year increase in dividends paid
• Royalty revenue from gold will increase to 80-85% of total revenue with Oil and Gas accounting for almost the rest
• Over 300 royalty interests in total

Disclosure: Long FNNVF.PK , RGLD , CDE

 Silver Wheaton followed in the footsteps of fellow royalty giants, Royal Gold and Franco-Nevada with regards to their quarterly results. These royalty companies not only have a high leverage to gold and silver but have other comparative advantages over a typical mining company. While many premier gold companies had atrocious quarters, these three companies are firing on all cylinders coming off the back of a quarter characterized by the highest average gold price recorded and more importantly, at the footsteps of a new decade that will see unprecedented domestic and worldwide inflation.

RISK: Precious metal royalty companies by their very nature have a more favorable risk profile, as they can diversify some of the risk away through a large portfolio (opposed to most miners, who rely on one or two flagship operations).

Silver Wheaton:

• 15 Income producing streams, Pascua-Lama (8-10m oz/yr) on the back burner until 2013, 5 in advanced or exploration stage and options to purchase 2 different zinc streams (should the price of Zinc be right).

• These streams have at least 25% ownership interest (Pascua-Lama and Penaquito, both for the Life of the Mine) and several contracts of 50, 75 and 100% interests (notably Luismin and Yauliyacu).

·         Though Silver Wheaton does have three flagship streams and several of moderate size, they have their largest contracts with some of the biggest miners in the world ( Goldcorp, Barrick,, Lundin Mining) Goldcorp will supply 15-16 (SEO) million ounces a year through Penaquisto and Luismin. Barrick will provide 2.5 million ounces until 2013 at which time it will ramp up to 9m oz a year.  Glencore and Lundin will provide 5.5m/oz annually, while the three streams acquired in the Silverstone acquisition will add 5-6m annually. A large royalty portfolio also diversifies the geopolitical risks.

·         In other words, they aren’t as reliant on just one or two operations. It isn’t to say this is a niche market in mining that very little risk, but rather far less risk relative to the overall industry. Silver Wheaton has royalty streams based out of Mexico, Chile, Argentina, Sweden, Peru, Greece, Canada, Portugal & The USA.

·         Q3 Highlights:

-  Record attributable production of 4.3 million silver equivalent ounces   (4.0 million ounces of silver and 3,698 ounces of gold) at a total  cash cost of US$3.97(1) per silver ounce, representing an increase of  59% over the comparable period in 2008.
-  Record silver equivalent sales of 4.6 million ounces (4.0 million  ounces of silver and 9,953 ounces of gold), representing an increase   of 70% over the comparable period in 2008.
 -  As of the end of the third quarter, approximately 1.0 million silver equivalent payable ounces attributable to the Company have been produced at the various mines and will be recognized in future sales as they are delivered to the Company under the terms of their contracts.
  -  Record net earnings of US$33.6 million (US$0.11 per share) compared to US$20.2 million (US$0.09 per share) for the comparable period in 2008.
 -  Record operating cash flows of US$45.4 million (US$0.14 per share) compared to US$26.7 million (US$0.11 per share) for the comparable period in 2008.

Royal Gold –

• 21 producing streams, 13 development, 25 evaluation and 60 exploration projects.
•  Like Silver Wheaton, Royal gold’s flagship royalties are also produced by the world’s largest gold miners.
• They will have several streams come on-line over the next several years, providing them with more diversification.
• They also have a diversified portfolio, geopolitically speaking. Most of their current revenue is from Canada, USA , Mexico, various places in Central America, Australia as well as an interest In the world class Pascua-Lama project in Argentina ( 2013).

Q3 Highlights: Can Be Found Here

Dramatic Increase In Reserves and Production: Click Here

Franco-Nevada –

·         Franco Nevada is a bit unique in that 20% of their royalty revenues come from Oil & Gas and a few others commodities i.e potash, base metals, platinum

·         Like Royal Gold but has a larger portfolio of royalties in the advanced and exploration stages. They focus mainly on the USA, Canada, Mexico, Australia and Indonesia, and also do business with the like of Barrick, Goldcorp, Coeur d”Alene, New Gold, IAMGOLD among others.

·         They have 27 streams online (16 of which are gold, 3 Oil and Gas, 3 Platinum and Potash and 5 base metals) 19 advanced stage projects and nearly 300 exploration stage projects.

- They continue to increase the size of their portfolio, adding purchasing three streams over the last twelve months which will be there anchor for growth going forward.  

-  Though they have already added the Palmarejo and Gold strike streams so far in 2009, adding even more diversification, they announced today a $58 million purchase for a 2% smelter royalty from Newmont's gold mine in Ghana. This leaves them will $400 million in cash and no debt.
 

Q3 Highlights

• Gold Royalty Revenue(1) for the quarter of $25.5 million was a record high. Overall Royalty Revenue was $36.4 million and the contribution from precious metals was 77%.

• Free Cash Flow(3) was $32.5 million ($0.29 per share) representing a margin of 89% of Royalty Revenue.

• Net income for the quarter was $12.3 million ($0.11 per share). Adjusted Net Income(4) for the quarter was $7.3 million ($0.07 per share).

• 75% of Royalty Revenue in the quarter was earned in the US, Canada and Australia.

• At September 30, 2009, Franco-Nevada had a strong financial position with no debt or hedges and

working capital of $559.0 million, marketable securities of $59.4 million and an undrawn $150 million revolving credit facility.

Recent Acquisition Details:

Growth:

The previously mentioned companies also have great production growth profiles led by Silver Wheaton, Royal Gold and the Franco-Nevada . The growth potential is enormous going forward as they are all incredibly well financed.

 Silver Wheaton has made it clear they are seeking another flagship stream or several medium size streams. They have a credit facility available to draw upon in addition to funding some with operating cash flow and further possible equity offerings.

Royal Gold has Andacollo, Penaquito and Pascua-Lama to help propel high growth out to 2013-2014. They are also likely on the prowl for more acquisitions as they have about $150 million in net cash. 

Franco-Nevada’s growth Will come more from the ramp up of some streams currently online, but will also see some advanced stage projects contribute to future growth (not to mention their recent acquisition). The more or less recent acquisitions of Palmarejo and Gold Strike are nice additions to the portfolio and key to sustaining strong production growth out to 2012-2013. But having 400 million in cash with no debt, allows Franco to potentially add 2 or 3 flagship royalties. It is worth noting Franco will be able to purchase the best deal that may come along as their superior balance sheet ( relative to Royal Gold) allows them to beat any bid made by Royal Gold. A bidding war is unlikely to erupt as both companies will try to allocate capital as efficiently as possible, so I wouldn't worry about any of them overpaying.

Leverage to the Underlying Commodity: As these companies will meet expectations compared to the mining complex as a whole, it is much easier to determine cash flows, and thus narrow the likely range for the intrinsic value of the company. This makes it more of a leveraged play to the underlying commodity, and less to company specific developments (development setbacks, etc). Cash Flow estimation will also be aided by fixed input costs, which is important in an inflationary environment.

Dividends: These companies have said they plan to and in some cases have already started paying dividends. Silver Wheaton will payout all excess profits after it can no longer acquire assets on an economic level, in order to maintain its tax exempt status. Royal Gold already has a 34% payout ratio, with Franco around the same area.

I mention these companies for those who don’t feel they know enough about the mining industry and feel the inherent nature of the business is too risky. All three of the aforementioned equities reduce a lot but not all of this risk, so it can almost be looked like an ETF or Mutual Fund in that one bad asset will not necessarily ruin the whole bunch. It isn’t a coincidence all three met or beat expectations while many premier miners failed to execute their goals. Kinross had a very ugly quarter and Agnico- Eagle had a sub-par quarter, among several others. 

Disclosure: Long SLW, RGLD, FNV.TO Warrants

To supplement my numerous articles regarding royalty giant Silver Wheaton (SLW), The following may interest those that fear mining is too inherently risky but desire exposure to appreciation in the precious metals. I will focus on one of the two largest streaming gold producers.
The aforementioned companies had one thing in common, having a great grasp of the future of the precious metals and foresight to purchase the majority of their royalties at a deep discount at a time when credit was very easy to come by. These acquisitions look like a stroked of genius in hindsight because they were. Royal Gold took advantage of easy money to purchase real assets. This has made it much more difficult for those who lacked this foresight to enter the market, as the financial crisis made it extremely difficult for smaller companies to access financing ( both debt and equity). A great example of this is Gold Wheaton (GLW), who can't compete with the likes of a Silver Wheaton or Franco Nevada.

Before the solid quarter reported by Royal Gold (RGLD) , the stock was about 15% cheaper, but the recent announcement has pushed Royal Gold near its 52-week high. Estimating an Intrinsic value for these two royalty companies is far more difficult then something like Silver Wheaton or another mid/top tier gold producer. This is due to the variation in the sliding scales for each individual royalties as well as the variation regarding the conditions of these royalties and how they may or may not change over time.

But on the other hand, it is also fairly easy to forecast cash flows if you put in the time and focus more time on the major flagship streams, which should help you get a rough estimate. Though many say otherwise, these royalty companies reduce operating risk substantially due to the fact they aren't reliant on one or two streams for 80-100% of their income. Of course there is risk involved, but the business models of something like Royal Gold, minimizes this risk. Not to mention the fact they have royalties around the world making it geopolitically diverse as well.

Royal Gold -

• Royalty Interests in the US, Mexico, Africa, Argentina, Chile, Australia, Finland, Guinea, Central America and more.
• Flagship streams contracted with the largest Gold producers ( Barrick Gold, Goldcorp, Newmont Mining) and others.
• 22 Royalty streams on-line with 12 more in advanced stage development including Barrick's world class Pascua-Luma mine ( expected to commence in 2013), over 20 evaluation stage projects and over 60 in the exploration stage. This excludes the Andacollo property bought from TECH ( purchased at an all in costs per ounce under $450.
• Executing brilliantly - reported at 62% increase in year over year revenue and more importantly a 70% year over year increase in free cash flow.
• Well capitalized - Miners are trying to move their projects ahead as they are aware of the beginning of a sustained bull market in gold and want to reach full capacity sooner than later. Many of thes projects will need external financing from sources like Royal Gold (RGLD). It is likely they are in several talks at the moment but as Silver Wheaton has shown, talks can go on for extended periods without anyone noticing.
• They also have set themselves up for a nice growth spurt over the next several years. Penaquito, Dolores, Holt and Canadian Malartic will provide an additional 45-50m in revenue from 2010-2012 as key growth drivers come online and ramp up production. This is assuming a sub $1,000 gold price, so gold at 1300-1600 by 2012 should add an additional 20-30 million.
• Following the next stage of growth will be the production (expected to commence in 2013) from Pacua-Luma and Andacollo, which at sub- $1,000 gold, would still add 45-50 million in revenue.
• I can almost guarantee accumulating royalty streams to supports future growth is still far from complete. They hold over $310 million in cash, have access to $125 million of debt and has no debt currently outstanding. They have also increased their payout ratio above 30%, making this a likely dividend machine within a few years.

Like Silver Wheaton, they have contractual agreements to purchase gold at a specified price with a minimal annual inflation adjustment. In other words, they will not be subject to rising input costs, which will allow them to maintain a superior operating margin profile relative to the complex. I would assume those who are invested in silver wheaton (SLW) would also have an interest in this gold counterpart.

Disclosure: Long SLW, RGLD (Common Stock and Calls) , FNVVF.PK ( Warrants)

 It should be rather clear to the everyday investor that the market has reached the bear market rally top ( I can't imagine the Dow advancing past $10,500). Therefore the way any investor should approach entering the market should be drastically different from 3,000 points ago. For those who have read my previous articles, you know I'm convinced inflation will only augment the resumption of the commodity bull market, for the second leg ( and likely decade) of this 15-20 year bull market. In my opinion the window of opportunity has closed temporarily (at least with regard to high quality equities, trading at enormous discounts), altering my strategy at least until a meaningful correction has taken place. The rationale behind a more than likely correction can be found in previous articles

My Current Strategy: 

• Go short the major market indices using ultra short ( be cautious with regards to your choice in hedging instruments especially double or triple inverse equities) call options, expiring in March 2010 or later. SDS and DXD, are my preferred vehicle and a substantial amount of downside protection makes these portfolio hedges very attractive as the markets test 52- week highs.
• Sell Long term GLD call options - which provide a hefty premium if you go out 6+ months. Though I believe the long term trend in Gold is much higher, it has gone up day after day making me think a 5-10% pullback is in the cards. Due to the sensitivity of long dated options a 5-10% movement will allow you to buy back the written calls at a much cheaper price. To be prudent but still collect the premium, use between 25-50% to buy out of the money GLD options (shorter dates) or GDX options which tends to move 3 - 4x as much as the underlying commodity (gold).
• The name of the game now is to protect your unrealized gains/losses, while using various hedging instruments to increase the size of the long positions in one's portfolio should this correction occur. Even if my forecast turns out to be wrong, these are exactly the times where protecting yourself on the downside far outweighs the additional 5-10% or so one may be able realize on the upside.
• The economy continues to worsen, making it more likely that various assets ( some more than others) can be had a bargain prices. I would expect this to the oil complex the most due to the fact that negative economic data will make market participants assume the price should fall due to a fall of in demand. 10.2% unemployment, GDP consisting of nearly 40% of non-recurring items & the apparent realization by the FED that the economy is still on the brink of collapse ( record reserves being pumped into the system week after week, which is likely a pre-emptive move by Ben Bernanke to prevent a solvency crisis that could hit at any moment) while maintaining record low interest rates. Even if the economy has growth below 1% ( though the numbers say 3% GDP growth in Q3), couldn't the FED raise rated to .5% or .75%? 
• I am keeping 10% or so in cash, that way after a correction has occurred and you sell your hedged positions, you can accumulate equities selling well below intrinsic value, and do so more aggressively (depending on how big the degree of the correction is). 
• Aside from equities - Futures should also provide great entry points, though the window of opportunity will not be open nearly as long as that seen in 2008. I will be looking to add to my wheat and silver positions, among other commodities if the price is right.

The preceding is solely the approach I’m taking at the moment and am not recommending others to follow suit. Given my exposure to the precious metal miners, oil companies and to a lesser degree agriculture, I find the aforementioned strategy appropriate.

2010 Forecast:

·         Dow testing the 7500-8000 level
·         S&P testing 700- 775 level
·         Oil going back to the $100-$120 level towards the latter half of the year but not before testing the mid-60’s
·         Gold will have seen triple digits for the last time after the first half of 2010. Gold will also make record high between $1300- $1500.
·         Silver will trade higher on a combination of higher investment and industrial demand. I expect silver to average $22/oz-$25/oz
·         Another financial crisis plagues an already frail banking system leading to bankruptcy’s for many regional banks while the large money center banks will remain capitalized, courtesy of the FED.
·         Unemployment reaches 11% – 13% and 25% if you include discouraged workers ( how they calculated unemployment pre-Clinton era)
·         Foreigners catch onto the fact the US will never repatriate their debt ( either via an outright default or through inflation), refusing to buy any more US debt securities, causing the FED to monetize the debt via treasury purchases. This will likely happen towards the end of the year and far exceed the $300 Billion announced earlier this year. This spills directly into the money supply, sparking inflation expectations.
·         Another Stimulus is introduced
·         Deficit Spending is far greater than originally forecasted.

2011

·         Gold reaches $1750-2000/oz in the latter half of the year
·         Silver averages 34 – 37/oz
·         The USDX reaches an all time low in the mid – high 50’s
·         Major Market Indices are driven more by the debasement of the USD than by real economic growth.

Timely economic forecasting is very difficult to do but extremely important. That was my best case scenario based on all the damage we have done to our currency( stimulus, low interest rates, debt monetization, purchase of worthless mortgage back securities, deficit spending, other toxic commercial paper, defense spending, unfunded healthcare liabilities) etc and economic foundation, ( i.e lack of savings promoted by artificially low interest rates and the exportation of our manufacturing base). 

If you buy into the inflation story, many gold and silver miners are still trading at bargain basement prices. The same goes for many oil equities ( though they tend to be more accurately price at the moment). 

Disclosure: Long SDS Calls , DXD Calls, Wrote GLD Calls, Long GDX Puts, SLW , RGLD, RBIFF.PK, FRMSF.PK, KGILF.PK , AUY , JAG , CDE , SSRI , TLM , SU , PGH, ERF, PWE