Renowned investor Peter Lynch once said, "The person who turns over the most rocks wins the game." All resource investors should be turning over rocks, but who has time to track hundreds of companies, to visit projects, to meet with management? The Gold Report has asked Sprott's Rick Rule, Canaccord Genuity's Joe Mazumdar and Oil & Gas Investments Bulletin'sKeith Schaefer to identify a select group of natural resource companies they feel are poised to make a move before the end of the year. We will be tracking these precious metals and oil & gas companies with game-changing catalysts on the newly launched Natural Resources Watchlist.
The Gold Report: A catalyst is identifying a future event that will materially impact a share price for better or for worse: A maiden NI 43-101. Funding from a strategic partner. Permitting and feasibility studies. Before we talk about specific companies, would you tell us what types of companies you follow and why you are following them?
Joe Mazumdar: I primarily cover exploration and development companies in the precious metals sector. There is a difference between catalysts for explorers and for developers. For explorers, it's like buying a lottery ticket-we're looking for that drill result. With the developers, the investor audience tends to be more risk averse. They're waiting for the company to meet their bench points. So the companies I cover tend to be the ones that the risk averse invest in. They want this thing to come to function. They need a management team that can raise the funds and put the asset in production.
Keith Schaefer: I follow mostly the junior energy sector in Canada and the U.S., looking at both producers and service companies in oil and gas all around North America. Their assets can be anywhere in the world as long as they list them on a reputable exchange in North America. So I'm looking for something with some leverage. Leverage does not mean depth. Leverage means either few shares outstanding or a very large land position that hasn't been developed yet that perhaps the market doesn't appreciate. So I look for a pure play with leverage and a great team that has built and sold a company before.
Rick Rule: At Sprott, we have to be a bit broader. We manage about $10 billion in the resource space so we can't be too narrow. We have several preferences. One would be companies that have an unanswered question where we think that a yes answer will give us a ten- or twentyfold return. Sprott is, in part, an alpha shot, and those characteristically are ones that don't have definitive catalysts or else they wouldn't go up in value. What Keith does is of special interest to Sprott. We are looking for oil and gas companies that are new and for converging technologies to unlock access to oil and gas resources where there's no exploration risk but there's exploitation risk, where getting yes answers is repeatable 10,000 or 20,000 times.
The other thing that we really like in markets like this is what we call reality at a discount. $200, 300 or 400 million [$400M] was spent in the last bull market, money that was raised very cheaply. The money delivered a conclusive answer but it didn't deliver a conclusive answer in a timeframe that satisfied a market that has a problem with holding stock long weekends. We also like commodities that are deeply out of favor, ones that sell at discounts to their production cost. In that circumstance, either the cost of the commodity goes up or the commodity becomes unavailable.
TGR: When should an investor accumulate a position leading up to a catalyst?
JM: It depends on the catalyst. If it's something happening with development plays in a recovery, it all depends on the market's thinking. If you're waiting for a permitting decision, permitting risk is the issue. For feasibility studies, we all make estimations and forecasts as to what those will look like. So already embedded in the market is an expectation. The issue is does it meet or not meet that expectation? That's really where you have to depend on the management team to meet that expectation. A lot of the risks for mining development companies are about meeting expectations and potentially surpassing them.
TGR: Keith, are the catalysts the same in oil and gas investing as they are in hard rock mining?
KS: The reality is that both games are about production and reserves. On the exploration side, a drill hole and a reserve report would be major catalysts. One thing that investors can take some comfort in is, despite all the nuances between the industries, it really does come down to production and reserves and finding a team that has done it before. So on the junior side, the catalysts are very similar.
TGR: When do you believe an investor should start to accumulate a position leading up to a catalyst?
KS: Three things: The time factor: How much time before the catalyst? The further away the catalyst is, the more likely you are to buy the stock in advance to take advantage of any speculative premium. Two, what's the downside of that catalyst not happening? That's where I really want to find a catalyst that's basically for free. Then the other thing I want to know is how well known is this catalyst on the Street because if I'm reading it in a research report that has just gone to 6,000 retail clients, chances are I'm not going to play that catalyst nearly as much because everybody knows about it. But if I've been digging around myself and figured out a catalyst in advance of the Street, then I'm way more apt to buy the catalyst.
TGR: Rick, when should we accumulate a position?
RR: I'm perpetually early. I would say that irrespective of the nature of the business with regard to catalysts, you're better off buying in a bear market rather than in a bull market because the price of success and the price of failure is lower. But it depends, and I think Keith gave a very good answer to the question. It depends on the nature of the catalyst and its importance to you. If you're a large institutional investor, moves in the market don't matter. You have to be right, which means that the only catalyst that really matters to is a takeover because if you buy Sprott-sized positions, you only have one way out.
A lot of what I do is invest in prospect generators, process and being willing to take advantage of the time arbitrage. Convergence in technologies proves up a large acreage spread where you can project success to over 10,000 locations is a catalyst that becomes apparent to somebody who works, but it isn't apparent to the broad market until it sees it's on a report of financial statements. The type of catalysts that one pays attention to has a lot to do with one's disposition and temperament as a speculator, and it varies from person to person.
TGR: Traditionally, stock prices have been driven by news, but in the current environment, some companies aren't getting the bumps that they would expect from the catalysts that they deliver. Why is that? Do you see that changing?
JM: In my sector, we've seen over the past few years some people selling into the news. There might be a positive event as expected, but the stock actually trades down because people are selling to look for the next one. With quality stocks, we've seen positive news have positive impacts.
KS: In the oil and gas space, we've actually almost had the opposite problem where catalysts are getting priced in immediately, and they're getting priced in two years in advance. The leading stocks in Canada make no sense whatsoever on current metrics. These are companies that have the lowest profit margins, and, yet, they have the highest valuations.
Why is that? Because they're pricing in the catalysts two years in advance. They're saying there won't be any negative surprises because gas prices now are at absolutely rock bottom, and I totally trust this team to meet its numbers every single quarter for the next three years.
That's where you see a big difference between the hard rock and the soft rock sides. On the oil and gas side, catalysts are being priced in really fast for the simple reason, as Rick has said, this new technology has brought in an entirely new industry. That says it's very low risk and we're going to take that to the bank two to three years out.
RR: This discussion about stocks moving on news and the fact that they're not moving on news, to me, is a real blessing. It means that the analyst can buy reality at a discount. You can have time to study the data and make an informed decision. In good markets, you don't have that luxury. You have to anticipate the market's reaction to news. So when you ask how long it's going to last, my hope as a check writer is that it lasts forever. The process right now is rational, as it was in 1998-2002, as opposed to irrational.
The greatest investor today, Warren Buffett, famously said you shouldn't buy the stock if you didn't know it well enough that you would be delighted to see it fall in price 30% in two weeks after you bought it so you could buy it more cheaply. Sadly, I've tested that thesis dozens of times in my career, but the truth is that it speaks to the market that we're in. We're in a market that's rational. Of course, maybe that's why medical marijuana is so popular right now. People don't want rational expectations.
KS: All the stocks in my sector, oil and gas, have had a hell of a run, and this is a pretty difficult time to be dipping your toe in the water. It's been undergoing a six-week plateau/correction. About 10 days ago we started to see some upward movement, but most of these stocks have run anywhere from 50-100% since the beginning of February. In my sector, this is traditionally not a smart time to be buying. You want to wait probably another month to see really what's happening. But we've seen a lot more seasonal strength than I would think. To be going whole hog into something right now is really difficult.
TGR: Keith, let's talk about some oil and gas companies. What companies have you outlined?
KS: One is Chinook Energy Inc. (OTCPK:CNKEF) [CKE:TSX.V]. It has one of the top management teams in Calgary; it's valuation has been masked by the fact that 20% of its production is in Tunisia. In the last few years Tunisia has not been one of the hot spots in the world for oil production. So Chinook suffered through a huge discounted valuation.
Canadian production usually gets valued in the market today around 8x cash flow; international production gets valued at about 2x cash flow, or, if you're lucky, 3x.
There's a huge disconnect in value there and the Street has forgotten really who it is, that Chinook has one of the top teams in Calgary. The industry will value it much higher than the market will. This team should be able to sell that Tunisian asset, 2,000 barrels a day [2 Mbpd], for about $80M. I think the sale is imminent; this sale could cause a dramatic revaluation of that company. Most of the Street has a pretty good idea of who the buyer is, and we're just waiting for this to happen.
That sale will leave Chinook with net cash of around $50M, an asset based in Canada and a team that really knows how to extract value both out of the ground and in the market. Chinook's management team comes from the Storm group of companies, and Storm has had three or four iterations that evolved and have done very well for shareholders. Right now, its sister company, Storm Resources Ltd. (OTCPK:SRMLF) [SRX:TSX.V], trades at 11x cash flow, which is crazy. But that's what happens when you have a good team develop a good asset in Canada. Chinook's Tunisian assets should get sold in the next quarter, which would be a big jump for it.
TGR: What's the time frame on the news?
KS: The two wells have been spud already. We should see that within two months for sure. The sale of the Wolfberry assets is totally up in the air. That's a $130M deal, so it will take time.
TGR: Rick, what companies have you outlined for today?
RR: This is truly a target-rich environment, but we don't think in six-month terms. One of the things that's interesting to me is how many of my potential names have been used up by this panel. People need to be more investment oriented and less speculatively oriented. My belief is where we are in the market, that is, a cyclical decline of the secular bull market, many people would be well advised to buy the very, very best companies in the industry and look at a return with raw materials as the catalyst. In that regard, you'd then buy names like Randgold Resources Ltd. (NASDAQ:GOLD), PotashCorp. (POT), Cameco Corp. (NYSE:CCJ). In 2000-2001 we could buy BHP Billiton Ltd. (NYSE:BHP) at $12 without too much downside, knowing that the upside was equivalent to a penny stock. I would say buy the very best, wait five years and then come back and chuckle and say thank you to me.
I'm going to name one big stock, an oil and gas company called Devon Energy Corp. (NYSE:DVN), where I have a natural gas warrant. The company has 100,000 oil shale drilling locations in the U.S. that are proven with existing economics and existing technology and a rapidly improving balance sheet. That's my sensible pick.
Then I'm going to be nonsensible, and I'm going to talk about one that everybody hates-Ivanhoe Mines Ltd. (OTCQX:IVPAF) [IVN:TSX], where the catalyst is Robert Friedland not dying, which I don't think will happen.
My top pick is really self-serving. My biggest single position, conflicts of interest up and down, if the natural resource market responds in the next five years the way I think it will, is Sprott Inc. (OTCPK:SPOXF) [SII:TSX]. The leverage to the upside is that we have $340M in cash on the balance sheet with $50M/year free cash generation; if the resource market does half as well as I think it will, it's going to be stupidly pleasant.
TGR: Thank you for identifying these companies. Any parting thoughts?
RR: This is my fifth cycle; I can't tell you when a recovery is going to take place, but I can tell you that it is going to take place. Day follows night. This market may take 12 months to recover. It may take 18 months to recover. Good markets are going to come back just as good markets came back in 2002-2003. We'll be having a very different discussion then. The truth is tiny companies, as long as they survive for two or three years, as long as they have reasonable properties and a management team that has enough respectability on the Street to catch a bid, are going to triple. The catalyst that you need to happen is the normal insanity around mining stocks to return halfway. That's all that you need. I just can't tell you when.
TGR: Thank you all for your time, and good luck.
This interview was conducted by Jason Mallin of The Gold Report.
Joe Mazumdar joined Canaccord Genuity in December 2012 from Haywood Securities, where he also was a senior mining analyst focused on the junior gold market. The majority of his experience is with industry including corporate roles as director of strategic planning, corporate development at Newmont in Denver and senior market analyst/trader at Phelps Dodge in Phoenix. Mazumdar worked in technical roles for IAMGold in Ecuador, North Minerals in Argentina/Chile and Peru, RTZ Mining and Exploration in Argentina and MIM Exploration and Mining in Queensland, Australia, among others. Mazumdar has a Bachelor of Science in geology from the University of Alberta, a Master of Science in geology and mining from James Cook University and a Master of Science in mineral economics from the Colorado School of Mines.
Rick Rule, CEO of Sprott US Holdings Inc., began his career in the securities business in 1974. He is a leading American retail broker specializing in mining, energy, water utilities, forest products and agriculture. His company has built a national reputation on taking advantage of global opportunities in the oil and gas, mining, alternative energy, agriculture, forestry and water industries. Rule writes a free, thrice-weekly e-letter, Sprott's Thoughts.
Keith Schaefer is editor and publisher of the Oil & Gas Investments Bulletin, which finds, researches and profiles growing oil and gas companies that Schaefer buys himself, so Bulletin subscribers know he has his own money on the line. He identifies oil and gas companies that have high or potentially high growth rates and that are covered by several research analysts. He has a degree in journalism and has worked for several Canadian dailies but has spent over 15 years assisting public resource companies in raising exploration and expansion capital.
1) Jason Mallin conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an employee. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. Streetwise Reports does not accept stock in exchange for its services.
3) Joe Mazumdar: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Keith Schaefer: I own, or my family owns, shares of the following companies mentioned in this interview: Chinook Energy Inc. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
5) Rick Rule: I own, or my family owns, shares of the following companies mentioned in this interview: Sprott Inc. I personally am, or my family is, paid by the following companies mentioned in this interview: Sprott Inc. My company has a financial relationship with the following companies mentioned in this interview: None. Sprott funds owns shares of Randgold Resources Ltd., Goldcorp, PotashCorp., Cameco Corp., BHP Billiton Ltd., Devon Energy Corp. and Ivanhoe Mines Ltd. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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