Thursday, October 6, 2016

Miners I'm Buying And Why - Part VI: Gold Foundations; Monkey's Dilemma; What Summer Doldrums? - Small-Cap Stock Observer

Strong And Timely Gold Foundations Going Forward

I have been holding off writing about gold and silver since the Brexit vote to leave the EU pushed gold prices in June above last year's highs. This unexpected outcome was a key marker to me that gold's cycle bottom was in, but I wanted to wait for several short-term crosscurrents to work out first.

Why were gold's commitment of traders (COT) reports so persistently short at record levels? This can be seen as bearish or bullish, but in the long-term should not matter. Gold had to fall for them to win, or instead could turn into aggressive loss cover buying at the next technical breakout level at around $1,400. Conspiracy theories aside, nobody knew gold's next major move and in the meantime a rest was needed for its 200 day moving average of around $1,255 to catch up to this year's higher prices.

On the macro side we are now in a strong retail gold buying time during the Indian wedding season, but we have been distracted worrying about Deutsche and other banks failing which could violently move gold either way. And the Fed is still crying wolf about hiking interest rates with its gold price dampening effect as seen by this week's $60+ drop to $1,250, its first time below $1,300 since Brexit.

I could go on about fears from wars to the USD, deflation to hyperinflation, negative interest rates to currency collapse, but what's the point? You just have to get the longer-term trend correct and get in early, or wait for the next correction which is where I believe we are at. Else becomes noise which can cause rash decisions or paralyse us into giving up and not doing anything. Over the last year I wrote about some of the gold and silver miners I own or like and thought an update could be timely.

Last October's article, "my gold value thesis, miners I'm buying and why - Part I" reasoned why the bottom for precious metals appeared to be close. Nobody knows exactly when a market will turn, which is why I wanted leverage to higher gold prices but not to debt. Major gold and silver producers typically move first, but I also considered mid-tier to junior mining stocks as the big boys' balance sheets seemed a mess. I have no problem giving up some potential upside for a less risky bet, however the numbers suggested certain smaller-cap miners offered superior safety in addition to extra alpha.

My go to major is (NYSE:ABX)(TSX:ABX) Barrick Gold which I thought was still not cheap. ABX was up from its $6 lows to $7.51 then, with a market cap of $8.75B, a negative P/E and still paying $0.02 per quarter yielding 1%. Although ABX was down 85% from its $50 high in 2011 and was trading below $10B in shareholders equity, long-term debt was over $12B. ABX has sold assets and cut debt by over $3B so far with the stock now at $15.30 and was a three bagger at $23.47 in July.

November's Part II detailed three exceptional value penny stock gold producers, which are still on our Top 30 Small-Caps. Gold's bear claws were still slashing mining shares back then, with financings next to impossible. Pure exploration plays were avoided as my filters focused on producers and developers with at least survival cash, low to no debt, and deeply discounted resources plus growth potential. The best value miners game was to data mine gold under $10/oz. from financial statements and quietly accumulate shares until precious metals signal a bottom and upward momentum returns.

You had to dig but they were out there. Well timed and informed investing in mining shares can be extremely rewarding, just keep in mind that if you don't know the real value of what you own then even the best traders will eventually end up holding a load of crap. Many companies promise millions of ounces someday but the stocks I first focused on were significantly de-risked with permits or already producing, with economic resource studies reflecting value trading at a fraction of book.

(TSX:PRU)(ASX:PRU) Perseus Mining was C$0.33, now C$0.46, year high C$0.67, 2011 high C$4.21; (AMEX:BAA)(TSX:BAA) Banro was $0.18, now $0.27, year high $0.48, 2012 high $6.05, 2006 high $14.60; and (AMEX:TGD)(TSX:TMM) Timmins Gold was $0.20, now $0.42, year high $0.63, 2012 high $3.47. Doubles are nice but these three have actually lagged others I also still hold. They were bought as longer term value and growth plays and it's my eventual sale prices that really matter. Every miner has hiccups and I'm satisfied these three producers are executing their plans.

As an update, Perseus had record profits when producing 220k ounces of gold last year in Ghana and should soon be back to that level as transitions complete to Edikan's higher grade pits. With higher gold prices their Ivory Coast Sissingue mine is again under construction and should be ready late next year. Even bigger news was the acquisition of Amara Mining and its large Yaoure gold project.

With ~12M ounces in all categories, plus half as much added this year, in a few years PRU expects to be a multi-country, multi-mine producer of half a million ounces per year. I like the Amara deal and that July cash was up to C$175M still with no debt, but not the dilution indigestion as shares doubled to 1B. Even so, PRU's June equity was C$733M versus today's market cap of only C$471M.

Last year Banro had record revenues and EBITDA with gold production guidance of 175k-195k ounces. Twangiza started in 2012 and their second mine, Namoya, entered commercial production in January. Located 210km apart on the same gold belt, production after ramp-up should exceed 250k ounces per year. Between them are Lugushwa and Kamituga, two more large mines to be developed. In February a Chinese group with others provided ~$100M in equity, streaming and debt financing.

BAA has tons of upside potential with over 15M high-grade, low-cost ounces in all categories, ~$1B in assets and $391M in shareholders equity versus a market cap of only $82M—Namoya alone cost $400M to build. I'm not as worried about Africa's DRC as some, but I do want to see the terms met later this year to move $196M in short-term debt to long-term debt. With rising production and higher gold prices BAA can quickly unlock value and become a rocket again just by paying down its debt.

I thought Timmins would be a no-brainer instead of a roller coaster ride. San Francisco was a simple heap-leach mine in safe Sonora Mexico producing gold profitably for years that could expand through exploration. TGD's Caballo Blanco and Ana Paula were advanced new projects to develop and grow. (NYSE:GG)(TSX:G) Goldcorp had just bought 9.9% of TGD and sold them a processing plant for C$8M that will save US$40M-$60M. As TGD's market cap fell under $75M, (NYSE:GDXJ) Market Vectors Junior Gold Miners ETF had dumped its 18M share hoard making the stock even cheaper.

TGD had $300M in assets and no long-term debt but had warned a significant impairment charge was coming. To me that means 20%-30%, not 80% or $227M in writedowns. TGD's CEO was gone and the next surprise was how long it took to replace just a $10M short-term loan. Then their mine was going to close in 2017 if gold prices didn't rise, and later Caballo Blanco was sold cheap to pay back the loan. My producer was turning back into a developer with two instead of three mines—then gold prices pushed higher. Long story short, TGD is back on track. August Q2 cash flow was $11.5M and mine operations are now extended into 2023. Ana Paula had 4 to 7+ g/t drill results last fall and TGD just outlined its complete pre-construction program with $9.2M for drilling, feasibility and permitting.

Monkey's Dilemma

In hindsight, some might shake off my timing as just lucky and say that everything gold and silver related has soared this year. Any monkey with a list of mining stocks and a few darts could have out performed. This is somewhat true, but how would the monkey have known to avoid mining shares as they fell for four years by around 90% until last summer 2015? How will it know when to get out?

An early monkey can get lucky and have fun for a while. Its IQ pretends to dramatically go higher as it confuses brains with a bull market. Decisions are based on a stock's story and market moves after news releases. Simple balance sheet comparisons like cash to current liabilities and assets to debt are way too much effort, forget about reading feasibility studies. Yes this is sarcasm, but true.

Mining stocks tend to move in big percentage pre-news fits and starts, called "rips", which can make for frustrating short-term technical analysis (TA). Market makers read charts too and know how to make the price spread and bid/ask sizes look weak to shake out traders before ripping higher, or how to make them look technically strong to suck in buyers before a down rip. It's fine to track longer-term trends and use TA to scalp a bit more out of a trade, but value should drive what and when to buy/sell.

The monkey believes a good story on high volume has worked great so far and in a bull market nobody really cares how high the market cap is because the company has cashed up and will be generating much more news. Why even bother comparing the stock's market value to things like shareholders equity and book value, or to resource net present values (NPV) and internal rate of returns (IRR)? Without understanding these real tangible asset values how will the monkey know whether a pullback is just temporary before the next double rip, or that the story has already ended?

I'm not an accountant and I'm not suggesting we need to be. These values can easily be found at a glance at our site when quoting any stock, and then clicking the "financials" tab which has every company's balance sheet, income statement and cash flow report. Company news releases and websites usually provide them, as well as any AISC mine plans showing all CapEx/OpEx needed to build and operate. AISC means all-in sustaining cost per ounce, CapEx/OpEx are upfront capital and ongoing operating expenditures, and PEA is preliminary economic assessment. If your mining stock's balance sheet shows little cash or equity and doesn't at least have a PEA, know that it's a story stock.

After considering these financial details, I need to understand a company's capital structure and how it is distributed. Are there hundreds of millions of common shares outstanding and if so are expectations big enough to churn higher through all that stock? Do fickle retail traders own most of the stock, or is it closely held by loyal institutions and insiders incentivized to raise the share price?

Junior explorers with nothing but a bloated share structure, exhausted story and little cash usually can't get financed until they roll back the stock. This destroys value as resulting fragments of board lots are discarded by frustrated monkeys and eventually new shares issued at even lower prices with warrants attached, both representing dilution. Paying attention to private placements (PP) is especially important now as many miners were able to refinance earlier this year as precious metals prices started rising. Miners have capital to grow again with gold's bull market tailwind, however PPs can also create a headwind after the four month hold ends as shares are sold to just ride the free warrants.

Just as important is to pay attention to any debt financing terms. I pass on miners with even large, valuable assets if the debt seems scary. (TSX:JAG)(OTCBB:JAGGF) Jaguar Mining was in the mid teen cents last winter and it was not the amount of debt but the early warning disclosures I didn't like, which seemed like a heads you win, tails I lose situation. On default, debt holders typically have first claim on assets and the common gets nothing, but debentures also get 12% interest as they wait and represent huge potential share dilution if and when they can convert to equity at C$0.15 per share. JAG story buyers are winning so far as the shares are now C$0.64 with an August high of C$0.85.

Our Hot Sheet focuses on timely short-term technical trades, but for longer-term investments I rely on fundamental filters to source some of our best value and growth plays to write about. Last year my research was precious-metals balance-sheet driven; in a bear market you have time to accumulate these potential ten bagger stocks as they remain out of favour and quiet with little news at their decade lows. Back then you could find gold stocks with lots of cash and millions of proven low cost ounces trading at a fraction of book value and well under $10 an ounce, but today this is getting harder.

Some miners I invest in and hold core positions, others I trade. Investors have a longer-term focus that weighs risks and values financial details, while monkeys tend to just react to headlines and are drawn to preachy doom and gloom videos I call stock operas. Avoiding a monkey's dilemma comes down to knowing the difference between fundamentals with undervalued assets and a hot potato speculation.

What Summer Doldrums?

Part III: 2016 market stages set was about macro events in a tired bull market with predictors, the Fed, debt, USD, China, oil, and the US elections. With markets down -5.5% the January Effect predicted a down market this year, but we all know that ever higher debt and Fed actions are what traders fixate on. I still believe that lower oil prices stimuli may be the only reason we don't already have QE4.

China has been quiet and falling behind in the world's currency devaluation race. This may change with the Yuan now officially added as an IMF SDR and with the US elections over next month. As for the next president, both parties mismanage debt but voters might ask in the last three decades which party has started wars versus ending them, who was in power during the last three market crashes versus the last two bull markets and for the only four years with budget surpluses since 1969.

Part IV detailed three quality mid-tiers which are significant producers with large development projects to grow. I watched these stocks drop from around $10 for years before writing about them in February as their mid-January lows were made at well under $1 per share. Although the math shows these miners were already cheap for over two years, TA saved me from getting in far too soon. All have been five to seven baggers at recent highs and still look good: (TSX:AR)(OTCBB:ARNGF) Argonaut Gold then C$1.52 up from C$0.78, now C$2.72, high of C$4.45; (AMEX:BTG)(TSX:BTO) B2Gold then $1.11 up from $0.60, now $2.15, high of $3.65; and (TSX:SVM)(OTCBB:SVMLF) Silvercorp Metals then C$1.27 up from C$0.60, now C$3.31, high of C$4.73. These can double again.

After topping $1,920 an ounce in 2011, gold continued to slide each year as the usual writers kept claiming gold's lows were in—eventually they had to be right. For me, I needed to see gold close above last year's high close of $1,302 before being convinced. Gold was up an impressive 21% from $1,063 at the start of this year to $1,283 going into May, but by the end of May was back down to $1,213. Gold had still not breached $1,300 on a closing basis and looked ready to top out going into the weak summer doldrums, but then instead of going sideways or sliding further, gold strengthened.

Any good TA monkey knows to protect profits and to sell in May and go away. I don't agree about selling everything, but rebalancing by trimming oversized positions at times makes sense. Other than instinct I can't explain why I fully rode out this summer and didn't sell anything, but I'm glad I didn't. I mean I don't know anyone who believed the Brexit vote would be to leave the EU and had the guts to bet on it. That surprise is what finally ripped gold above last year's highs, where it held until Tuesday.

As of June I became convinced that we have seen gold's low this cycle, and for holding all my gold miners this summer you might say I'm no better than a lucky monkey. Even as gold pulled back in May to the low $1,200's, almost every major and mid-tier precious metals producer was still up multiples of its January low. My articles planned to go from the safer majors, to mid-tiers, to developers and finally to riskier explorers as the new gold bull market trickled down to each group. This can take years but in less than six months everything was starting to fly. Always in pursuit of more alpha, this gold strength with breadth focused my May article on mine developers.

Developers are often called optionality plays as they require higher metals prices to be economical. These five stocks have some of the world's largest undeveloped gold and silver resources, plus other metals. Most had no debt and traded well below book—one traded at cash. Some already work at today's metals prices: (AMEX:XRA)(TSX:XRC) Exeter Resource was $0.87 up from January's $0.31 low, now $1.10, high of $1.48; (TSXV:CKG)(OTCBB:CHPGF) Chesapeake Gold then C$3.45 up from C$1.75, now C$4.62, high of C$6.50; (TSX:NDM)(AMEX:NAK) Northern Dynasty Minerals then C$0.45 up from C$0.28, now C$0.76, high of C$1.48; (AMEX:THM)(TSX:ITH) Intl. Tower Hill Mines then $0.64 up from $0.18, now $0.69, high of $1.40; and (TSX:MSV)(OTCBB:MISVF) Minco Silver then C$1.22 up from C$0.385, now C$1.17, high of C$2.05. Check out their 2011 highs.

I bought NDM shares at C$0.45 and MSV at C$0.50 and continue to hold both. I believe NDM can find a salmon workaround to get its enormous Pebble Project permitted, which seems supported by last week's news of its lawyers capping legal fees in return for a success fee. MSV remains quiet with no real news since purchasing the Changkeng gold project over a year ago. I still say they are waiting for $20+ silver and a higher MSV share price before letting the market know its development plans.

I hesitated on buying XRC at C$0.60 and CKG at C$1.50 hoping for even lower prices, which I regret as I think they could be taken out some day near their 2011 highs. Both provided staged development plans last winter with lower costs. THM's low grade, negative NPV until $1,700 gold, huge CapEx and negative working capital still bothers me. THM's reworked mine plan last month also lowers costs but now their recoverable ounces have been slashed. All of these developers have great potential in a rising gold market but also have specific hurdles to clear, identified in my Part V May article.


Earlier this year gold rose sharply, it needed a breather and has been going sideways for three months. Gold either had to break below $1,300 and test its 200 day moving average or the shorts would be caught as gold blew through $1,400. Now that gold's 200 DMA support at around $1,255 has caught up, and with much of the speculative margin excess wrung out, gold can soon resume its uptrend.

The Fed follies featuring the we're gonna raise gang is a broken record which surprised nobody last month. After the election, in December again, I believe rates can go up another quarter point but they are so far behind the curve can it matter? How can history's largest debtor nation get to even 1%, and forget about anything like 20% Fed funds rate seen in 1979 needed to stop gold's 25X rise at $850/oz. Gold actually moves higher as interest rates rise and GATA should dare the Fed to put up or shut up but we all know rates will keep being talked up as doing it reveals that tiny yearly bumps don't matter.

Precious metals were due and did finally turn higher this year. Gold bull cycles typically last around four years, although gold was up twelve straight from 2001-2012. It feels like the second inning and that gold's September Fed pause will soon end when the bull can reawaken. Later this month Part VII will focus on five speculative plays of substance, which I own and believe have moonshot potential.

My calculations and observations are as an individual investor and are not recommendations. Data comes from financial reports, news releases, company websites and other public sources that may not be accurate, complete or up to date. There may be conflicts of interest as I own stock in some of these companies. I share these ideas in hopes that readers will comment on them and on other company stock boards at our website with your own insights, opinions and anything I may have missed.

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