Jayant Bhandari, an institutional investment adviser to the junior mining market, is like a leopard stealthily scanning for market inefficiencies that will make his clients more money. The most promising arbitrage situations-trades that exploit price differences between similar financial instruments-come about as a result of takeover bids, while others happen when a company's shares trade significantly below its cash on hand. In this interview with The Gold Report, Bhandari shares arbitrage opportunities he's stalking and some company stories with management teams that he thinks are close to perfect.
The Gold Report: In a recent article, you argued that investors in the West will find their way to gold when the new reality dawns on them that losing a bit of money to preserve the rest is "a good deal." Please explain further.
Jayant Bhandari: What has to happen does not have to happen right away. Everyone in the world is flocking to the U.S. dollar. It offers liquidity, but eventually the U.S. dollar will become too expensive. When that starts happening people will look for other opportunities to safeguard what they own, and gold is something that will become increasingly visible.
TGR: How long is the U.S. dollar going to continue its ride?
JB: The U.S. dollar could do well for quite a period of time because while the U.S. is sinking, everything else is sinking faster. The European Union is in worse shape. Most of the developing countries, apart from China, are in horrible shape. They consume pretty much everything that they create. The U.S. dollar, despite all that is going on, remains one of the better currencies.
TGR: You also relate gold buying to how in India people buy gold and cattle-not necessarily because these are excellent investments but rather that these things will ultimately lose less value than other investments.
JB: A lot of people buy gold because of inflation but I don't think that's the reason why Indians, people in the Middle East and people historically in China have bought gold. As I mentioned in that article, the return from 300 million cattle in India is about minus 50-70%, depending on the kind of cattle. People invest in negative yield investments because they have few options in these societies. But that is what's increasingly happening in the West. It started with the European bond market. This morning I see Swiss bonds trading at a negative yield, which tells me that this society is no longer offering people opportunities to make money by investing. When that starts happening people do what they have to do to safeguard whatever they can safeguard.
TGR: You present a rational argument for buying and holding gold. Yet you buy and sell precious metals equities, mostly small-cap gold and silver equities, which carry more risk than owning gold. Why are you active in this space?
JB: The reason I'm in the junior gold equity market has almost nothing to do with gold per se. These are two different beasts: gold is gold and gold equities and gold mining is a business. When I invest in a mining company or a junior mining company, I assume a very low gold price, something generally lower than the spot price, and then I do a valuation based on that price. Now, when I enter the gold market I presume that gold will go up and if gold actually goes up it will trigger a higher valuation of these equities. I am increasingly more optimistic about gold and as a result I think this will underpin an increase in buying volume and investment in the junior mining space.
TGR: Is the junior mining market largely undervalued given current metal prices or is it fairly valued?
JB: There are still lots of useless companies in the junior market, most of which are "lifestyle" companies. Yet the market fall has resulted in the fall in the share prices of some very good companies, too. That's where the future value is and where money will be made.
TGR: What do you mean by lifestyle companies?
JB: Junior mining companies exist in an interesting space. The CEO often decides his salary, expenses and what kind of accountability he wants. If he chooses, he essentially has a company credit card to live the life that he wants, and regulations cannot help you there because as long as they are expenses, and the CEO signs off on those, they are legally legitimate. This is a lifestyle company.
TGR: In a different opinion piece on JayantBhandari.com you wrote, "The real problem with the junior mining industry is that investors have lost faith in those who run these companies." What are some red flags for you when you're working out junior mining company valuations?
JB: I usually spend one or two hours talking face to face with management. I have seen again and again that a lot of decent people managing junior mining companies are essentially financially illiterate. You want people who understand the business but who are also decent people. It takes a while to get an understanding of how they process information. I want to see if they are rational people. If they talk rational things with me, I'm prone to assuming that they are honest people. Honesty is usually the best way to create a name for yourself and make money. I have confidence giving my money to such management people in the hope that they will do a good job with it.
TGR: Most people don't have the opportunity to sit and talk with management. How do they get this information?
JB: You don't always have to sit with the management or visit the property, but you should only buy these companies using a worst-case valuation. For example, if my worst-case valuation of a company is $1/share and I can buy shares in that company for about $0.20, then perhaps I have enough margin of safety not to have to visit the project or meet the management. But I still need to be reasonably sure about the public profile of such management teams.
TGR: What are some common errors made by junior mining investors?
JB: People invest without really knowing what they are doing. They think that a $0.05 stock is cheaper than a $0.50 stock. That's completely irrational. You have to multiply the share price by the shares outstanding, and that is assuming that the two companies have exactly the same kind of projects. Other people over-glorify company management. Do not expect management to turn around the impossible. Try to rationally value these projects. Try to understand where these projects are situated, whether they are economic, and whether the locals approve of a project in that area. I was looking at a project in Argentina. It's a fabulous project with fabulous grade but the locals are completely against it, so it will likely never be a mine. There's a series of things you should understand and connect and then make a worst-case valuation on these companies before you invest.
TGR: Anything else?
JB: Patience is big. Don't chase a stock. I have seen feeding frenzies in this market and that sort of activity will eventually return. When the feeding frenzy starts people don't think in terms of valuations. They ignore things like jurisdictions, which are also important. A project in the Democratic Republic of Congo [DRC] versus a similar project in Canada would have completely different risk profiles and thus completely different valuations. Investors should always try to understand what is underpinning the valuations of these stocks, royalty structure, tax structure and how much money will go to local governments. All these costs should be factored into the valuation.
TGR: What discount do you use for a high-risk country like the DRC versus a low-risk country like Canada or the United States?
JB: I typically use a 20% discount rate and use metals prices that are lower than spot prices.
TGR: Did you use a 20% discount rate when the markets were better in, say, 2010?
JB: No, but by not doing that I stayed vested in the market when I should have left the market in 2011. We all make mistakes but if the industry is trading at a discount rate of 5% or even in the future, I will no longer be invested in the junior mining space.
TGR: In different articles you have said you expect 20% returns from your junior mining equity investments. How did you determine that number?
JB: It's a very risky business. Unfortunately, investing in any kind of stock market is risky because you're handing your money to someone you don't necessarily know. My overall return in a portfolio will be much less than 20%, but the 20% leads to a buying decision for me. That's how I built my portfolio.
TGR: Once a company has appreciated 20%, do you sell?
JB: No, I might not sell until much later. My selling is decided by the kind of discount rate the market is using to value projects. I'm going to buy based on a 20% discount rate, but I intend to sell using a valuation based on a 5% discount rate-if the market is using a 5% discount rate to value projects.
TGR: Let's discuss some arbitrage situations. Are there any arbitrage situations outside the precious metals equities space?
JB: Sprott Asset Management has made a hostile takeover move via its
Sprott Physical Gold Trust (PHYS) and Sprott Physical Silver Trust (PSLV) to acquire Central Gold Trust (GTU) and Silver Bullion Trust (SVRZF)[SBT.U:TSX]. Sprott Physical Gold Trust is trading close to its net present value [NPV] whereas Central Gold Trust and Silver Bullion Trust are trading at about 6.5% discounts to their respective NPVs. There's another fund held by the same group called Central Fund of Canada Ltd. (CEF), and that is trading at an 11% discount to NPV. By investing in these three funds you get gold and silver at about a 7-11% discount to the spot prices for these metals. These funds usually trade at a premium to spot metals prices in a bullish market, so you might even make money when a bullish environment returns.TGR: Please leave us with one piece of junior mining market wisdom.
JB: The quality of management is extremely important. In the past I have owned companies that had cash value three, four or five times more than the share price of those companies, and over a period of time the financially illiterate management team destroyed its cash advantage. I no longer tempt myself by investing in companies that offer me very good valuations unless the management is exceptional. That is truly the key.
TGR: Thank you for talking with us today, Jayant.
This interview was conducted by Brian Sylvester of The Gold Report and can be read in its entirety here.
Jayant Bhandari has been an Asia-based institutional investor adviser for the last three years. Prior to that he worked for six years with U.S. Global Investors in the United States, a boutique natural resource investment firm, and for one year with Casey Research. Prior to his involvement in the investment industry he established and managed Indian subsidiary operations of two European companies. He received his Master of Business Administration from Manchester Business School [UK] and holds a Bachelor of Engineering from SGSITS (India). He frequently writes on cultural, political and social issues for several publications.
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