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Be Bold And Seek The Sizzle, Says VSA Capital's Paul Renken

|Includes: Endeavour Silver Corp. (EXK), FNLPF, FSM, GOLD, TSLA

It's time to be bold, says Paul Renken, senior geologist and analyst with London-based VSA Capital. He seeks the "sizzle," or the narrative, in mining equities because the sizzle moves the story. But Renken remains selective and likes to see a significant discovery or acquisition that provides a clear path to investor returns. In this interview with The Mining Report, he recommends a veritable laundry list of companies in numerous commodities operating around the world.

The Mining Report: You're a survivor. Mining investors want to know what they will need to survive 2015. What's your message?

Paul Renken: Always know how much you can afford to risk in any particular situation, but it's probably the time to be bold simply because the sector has done worse than anyone has expected over the last year or so. That is essentially forcing out the weak players.

TMR: Weak players?

PR: Weak players are those looking for a short-term turn in a particular stock in order to make a short-term gain. There just hasn't been a significant move upward in virtually any of the commodities. In fact, just the opposite has happened. We've had a significant selloff.

TMR: How should investors play this market? Are you seeking specific situations across all commodities?

PR: We're being quite selective. For instance, the difficulties in the iron ore market are widely known-iron ore just dipped below US$70/ton-but there are some specific circumstances that warrant a closer look, simply because they were hit early and had the opportunity to fall farther than their peers. The firm is not particularly bullish on iron ore going forward but we expect that the price will be somewhat higher next year, so there is going to be a modest recovery.

TMR: Are other commodities showing favorable support levels in this market?

PR: We think that there is going to be continued strength in diamonds and colored stones. That has been a good market this year for equity investors as auction prices have strengthened. The growth market is in Asia for polished stones, both colored and white stones, diamonds and colored gemstones like rubies and sapphires. And that seems to be continuing.

Another commodity that we like here is lithium. The confirmation that Tesla Motors Inc. (NASDAQ:TSLA) will build the "Gigafactory" in Nevada definitely strengthened the outlook for lithium. And other automobile manufacturers are attempting to make electric and hybrid vehicles both popular and commercially profitable, too.

TMR: Gemstones and lithium. Any others?

PR: We also see some good support on a longer-term basis for tungsten, simply because the market hasn't been flooded with too much material, unlike what has happened in iron ore and oil.

TMR: Please outline your investment thesis for junior mining companies in this market.

PR: We want to see sizzle in the story. It could be a deeply discounted cash flow position that the company is either acquiring or that has been inappropriately discounted. Some investors are also looking for a dividend yield that's relatively secure even though the commodity that the company produces has witnessed some weakness. Another angle is a significant discovery or an acquisition that was made via exploration drilling through a deal. These kinds of sizzle will help move these stories because there are too many junior companies where the project is going to stay where it's at without something to sell it. You also have to have confidence that the story will come to fruition rather than just a blind punt on the gambling table.

TMR: What are some telltale signs that something is a legitimate story?

PR: One thing is a clear timeline that is achievable for what the company intends to accomplish. That could be how long it will take to get a permit or how much money it will take to finance a portion of the exploration or development. Those two things let us know that management has a good understanding of the project as it develops. Another one is three-dimensional evidence that there is continuity of high-grade mineralization. An additional good sign is a simple and clear path to how a potential investor would make money because complications essentially make stories much more difficult to believe.

TMR: How many mistakes are you willing to forgive before you sell?

PR: If I were an investor in a project, I would have a clear vision as to how much I was prepared to tolerate. I could probably tolerate only one or two errors. But if I owned shares and it becomes clear that the reason I initially invested is not going to happen right away, I would be prepared to exit a position after the first mistake.

TMR: Are you more willing to discount delays in a market where money is difficult to find?

PR: The short answer is no. The reason is that most investors are not solely invested in natural resources. They have more than enough other opportunities to risk their capital. That's part of the problem with the sector. Equity performance has been so poor across natural resources for so long that the money has exited to less risky places.

TMR: Let's start with gold. Gold has bounced up from its bottom of US$1,140/ounce [US$1,140/oz] in early November to as high as a little above $1,230/oz in early December. Please give us your thoughts on gold's fundamentals and how those numbers will influence its performance in 2015?

PR: At the beginning of the year VSA Capital thought that gold would spend some significant time between US$1,100/oz and US$1,200/oz, but not below that level. We're still working on our forecast for 2015; we expect some modest improvement, but we don't see any big move to the upside-given what we see in current economic and trading activity. There is, however, a tremendous sense of concern-I wouldn't call it foreboding but there is concern-about what is going to happen when the U.S. starts to implement rising interest rates and, in particular, what will happen with the bond market because institutional money is heavily vested there.

By all measurements the bond market is significantly stretched. If everyone decides to leave bonds and head for the exit at the same time, not everybody is going to get out without significant losses. The U.S. Treasury market is so big and liquid that most of the money will go there, but some of it could go into gold and silver. Even small percentages of the bond market money moving to gold and silver would cause a significant price jump.

TMR: What are some gold-focused equities that you're following?

PR: We follow quite a few gold stocks for various reasons. Randgold Resources Ltd. (NASDAQ:GOLD) is a producing stock that is considered a bellwether for gold. It only produces gold, so it's a clean measurement as to the equity movement with gold prices. It's widely followed.

TMR: Will silver rebound in 2015?

PR: Silver has been anything but steady over the last couple of months, with a rather drafty fall from US$21/oz all the way down to US$14/oz. It is now around US$17/oz. The real disappointment is that worldwide industrial manufacturing activity is not stronger because silver is largely an industrial metal. The silver-gold ratio is into the 70s-something we haven't seen for years. Silver should outperform gold if manufacturing activity improves because the uptake on ounces produced would be far better. I expect silver to be more volatile than gold as it moves into the $19-21/oz range again next year. That would be a 20% gain.

TMR: What are some silver-focused equities VSA is tracking?

PR: We regularly follow Fresnillo Plc (OTCPK:FNLPF) [FRES:LSE]. It's one of the stocks that institutions tend to have in their portfolios, particularly Mexican institutions. By the same token, it's also a stock with consistently falling grades in its overall production profile. We want to see how that affects its margins.

Another stock that we follow quite closely is Endeavour Silver Corp. (NYSE:EXK). It has a $280M market cap but has witnessed declining margins in 2014 as a result of the declining silver price. It is well-run company, though, so we think those margins will improve.

Also, Fortuna Silver Mines Inc. (NYSE:FSM) has outperformed its production guidance in the two recent quarters. We think investors should take a look at it.

TMR: What's the sizzle with Fortuna?

PR: It caught my attention because it exceeded its production guidance on its operations, as well as its forecast margins between cash costs and all-in costs. We want to see companies that are improving their economic fundamentals on a production basis and don't have to worry about making those improvements by selling assets.

TMR: When we talked with you in the summer, we discussed tungsten and its market fundamentals. You said earlier that you see modest long-term growth in tungsten prices.

PR: Earlier this year the World Trade Organization ruled against China's export tariffs on molybdenum and tungsten, and we are uncertain how the Chinese will react. Some commodities like tungsten are highly dependent on one particular country's production or export activity. In this case, it's China. China imposed tariffs because it wants to make sure that it has as much tungsten and molybdenum as necessary to support domestic manufacturing. We doubt China would flood the market with tungsten as it did in the 1970s because the market dynamics are very different. The current ammonium paratungstate [APT] price is around US$350/metric tonne unit [$350/Mtu], which is fair. We think that the tungsten price overall is going to stay steady, if not rise in tandem with inflation in 2015.

TMR: Can most of the suppliers make money at $350/Mtu?

PR: Yes, most of the established suppliers can make money at that price.

TMR: And, finally, let's talk about lithium. Should investors buy into the hype surrounding the lithium necessary for the growing market for lithium ion batteries?

PR: There is an awful lot of hype and the hype has gotten ahead of what is actually happening. We recently published a lithium piece that determined that the economies of scale would finally develop in the electric vehicle market when at least 0.5-1M vehicles were produced per annum. Tesla is building its Gigafactory in Nevada to produce enough batteries for 0.5M vehicles, so it is definitely trying to produce enough batteries for the commercial electric vehicle market to take off. The Chinese have been locking up lithium deposits in order to be sure that if the market does reach critical mass, it will be the Chinese automakers that have secure lithium supplies for these batteries.

TMR: Are you following some graphite companies?

PR: Yes. One is producing now out of Madagascar on a small scale, StratMin Global Resources Plc [STGR:AIM]. It has a £7M market cap.

TMR: What's one thing we should watch for in 2015?

PR: You can be quite certain that commodity prices are going to be more volatile than they have been this year, particularly if we start seeing changes in U.S. interest rates, because institutional money will look for places to allocate money. We're talking about billions and billions of dollars moving from one asset class into another.

TMR: Thank you for your insights, Paul.

This interview was conducted by Brian Sylvester of The Mining Report and can be read in its entirety here.

Paul Renken has a broad range of experience in various aspects of the mining and minerals business. He began his career as a geologist for Canadian junior resource companies in the Western United States. Owning a stake in a private consulting firm as vice president of exploration, Renken searched for various base metals, precious metals and industrial minerals. In the U.K., he worked in the equity market media outlets of Digitallook and Hemscott before joining VSA as mining analyst in 2006.

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