Strategic Metals: A Prospect Generator Waiting To Shine

Summary

• Gold and many gold equities are up.
• Now that most gold names have rallied, a question is: are there gold names which have yet to shine?
• Strategic Metals is one of those laggards.
• Despite the underperformance, Strategic appears compelling for certain investors.
• Interested investors must carefully consider the risks associated with this company’s business model, size, and commodity exposure.

Introduction

Gold and gold-focused ETFs including the GDX and GDXJ are up. COVID-19 uncertainty, the economic downturn, and unprecedented government plus central bank actions have given gold new life. Here at Contra the Heard, we have benefitted from gold's return to form. Positions in Alacer (OTCPK:ALIAF) and Sprott (SPOXF) have shone, and others in Gold Resource Corp (GORO) and Major Drilling (OTCPK:MJDLF) show promise.

These investments were initiated between 2014 and 2018. Adding gold names at the time was not done because we are gold bugs or foresaw something like COVID-19; instead, mining, much like banking between 2009 and 2012, appeared undervalued and unloved which sparked our interest.

Strategic Metals' YTD performance vs GDX and GDXJ via Yahoo Finance

Now that many gold names have rallied, a question to be asking is, "Are there gold names which have yet to shine?" While Major Drilling mentioned above is one such name, another is Strategic Metals Ltd. (OTCPK:SMDZF) or SMD.VN on Toronto's Venture Exchange. Strategic Metals is a prospect generator based in the Yukon.

In 2015, I visited some the company's properties in the Yukon as part of the territory's annual tour for investors, analysts, and reporters. After the trip I wrote about Strategic Metals for the Globe & Mail. While there are many attractive attributes associated with Strategic Metals, it will never end up in a Contra the Heard portfolio because it is pre-revenue and is too small. This said, I did take a minor position for myself in various personal accounts and continue to hold it.

What is a Prospect Generator?

A prospect generator is a junior miner which maintains a portfolio of mineral exploration properties. They stake, explore, and purchase what they hope are promising precious or base metal deposits. Their goal is to explore or develop their most enticing deposits (often with a partner), generate royalty streams, or sell them to larger miners who can build the resource into a mine.

Prospect generators are not generally mine developers, and aren't typical junior explorers either - instead, they sit somewhere in the middle. This article by Small Cap Power provides a summary of prospect generators including Strategic, EMX Royalty Corp (EMX), Ely Gold Royalties (OTCQX:ELYGF), Lara Exploration (OTCPK:LRAXF), Azimut Exploration (OTCQX:AZMTF), Golden Valley Mines (OTCQX:GLVMF), Aurion Resources (OTCQX:AIRRF), Globex Mining Enterprises (OTCQX:GLBXF), Auryn Resources (AUG), and Teuton Resources (OTCPK:TEUTF).

Thesis, Overview, and Risks

I purchased a small position in Strategic Metals because it is cheap and well capitalized; it has huge upside potential too. During the last bull market in gold, it spiked from CAD$0.15 in 2009 to CAD$4.24 in 2011. Insiders are also material owners of their own stock, appear to be experienced operators, and the organization resides in in a mining friendly and geologically rich jurisdiction.

Although I am skeptical of junior miners and pre-revenue stocks in general (more on that below), Strategic offsets some of these concerns. While prospect generators are inherently risky, they are less risky than most gold explorers. By owning many properties, they increase the odds of finding a good deposit and decrease the risk of coming up empty handed. This diversification reduces (but by no means eliminates) the risks associated with mineral exploration.

Core holdings via Strategic Metal's May 2020 Corporate Presentation

In Strategic's case, they own, have options on, or are joint venture partners on 130 projects. This includes some publicly traded miners such as ATAC Resources (OTCQB:ATADF), Rockhaven Resources (OTCPK:RKHNF), Precipitate Gold (OTCQB:PREIF), Silver Range Resources (OTCPK:SLRRF), GGL Resources (OTCPK:GGLXF), and Trifecta Gold (OTCPK:TRRFF).

They own a 57.8% stake in Terra CO2 Technologies as well. This entity is attempting to commercialize a replacement for Portland cement and thereby reduce carbon dioxide emissions. It is hard to value what this non-mining asset may be worth. For now, I have assumed it is worth nothing (as has the market apparently), but this business unit could be icing on the cake as reducing carbon emissions from cement has big potential.

As far as the Yukon is concerned, it is a mining friendly territory with good mineralization. The Klondike Gold Rush gets all the attention, but the Yukon remains geologically rich. In addition to the companies in Strategic's portfolio, the Yukon is home to deposits including the Coffee Gold Project owned by Newmont (NEM), Keno Hills owned by Alexco Resources (AXU), and the Eagle Gold Mine owned by Victoria Gold (VITFF). Collaboration with First Nations appears strong too, with most (11 of 14) land claims signed and ratified. This said, the Yukon is also remote with limited infrastructure, a harsh environment, and exploration activity is highly seasonal given the long, dark winters.

Despite Strategic Metal's positive attributes and my own stake in the name, it will not end up in either of Contra the Heard's portfolios. The first major reason why is its size. The market cap is under $50 million, the float is narrow, and the average daily trading volume is very low. This illiquidity makes it hard for investors to purchase or sell shares on the open market.

The business model doesn't fit Contra's mold either, as we only invest in companies with revenues. Pre-sales corporations are highly speculative. While huge rewards can come from junior miners, tech start-ups, and innovative biotech, for every success there are many failures. Furthermore, timing what limited success may occur is incredibly difficult.

Investors who purchase pre-revenue stocks must also be aware of debt and dilution. Unlike firms with sales and cash flows, pre-revenue outfits must fund operations and survive by selling off assets, taking on debt, or diluting shareholders. Strategic Metals has a solid track record selling or spinning off assets, and its balance sheet is sound, but it has not escaped dilution. Over the last decade, the share count has jumped from roughly 67 to 96.5 million shares. In the future, it is likely the share count expands further.

Conclusion

Gold and many gold focused ETFs including the GDX and GDXJ are up, but Strategic Metals has underperformed. Despite the underperformance, Strategic Metals is cheap, well capitalized, and operates in the Yukon which is a mining friendly territory with rich mineralization. The stock also holds significant upside potential. During the last bull market in gold, for example, it rallied from CAD$0.15 in 2009 to CAD$4.24 in 2011.

Unlike most junior miners, it is a prospect generator and owns, has options on, or is a joint venture party on 130 prospects including a number of small publicly traded mining companies. This means Strategic is more diversified than typical junior miners.

Upside and diversification aside, the stock is risky. It's a micro-cap, has low liquidity, and does not produce revenues. Its fortunes are also dependent on a favorable commodity price backdrop and - of course - striking gold. As a result, it is not owned at either portfolio here at Contra the Heard, but is held in a handful of my personal accounts.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long SMDZF, ALIAF, ALACF, GORO, MJDLF, SPOXF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer The opinions expressed - imperfect and often subject to change - are not intended nor should be taken as advice or guidance. Contra the Heard Investment Newsletter is not an investment advisor or financial advisor. Contra the Heard Investment Newsletter provides research, it does not advise. The information enclosed in this article is deemed to be accurate and reliable, but is not guaranteed by the author.