Finding Value Gold Mining Stocks

A sector analyst shares his views...

SIDDARTH RAJEEV heads the research department at Fundamental Research Corp. in Vancouver, which covers over 150 small- and micro-cap companies and 15 exempt market/private issues from a broad array of industries including energy, mining, real estate and technology. 

In his search for value, Sid digs deep into that world to find undiscovered gems. In this interview with The Gold Report, Sid reveals why he views gold as a currency rather than a commodity...

The Gold Report: Sid, you're an electrical engineer by training. How did you end up the head of research at your boutique investment bank?

Sid Rajeev: I initially worked for an engineering firm for a few years. I developed a strong interest in finance and investment analysis in those years, so I decided to pursue an MBA degree. Soon after I got my degree, I joined Fundamental Research and it's my sixth year here. 

At Fundamental, we have a team of analysts, including financial analysts and geologists. We cover about 150 companies; three-quarters of them are in the natural resource sector. The rest are from agriculture, technology, aerospace and other industries. 

TGR: Instead of putting target prices on stocks, your firm uses a fair-value metric. Does that imply perfect pricing, a theoretical point at which there's no upside or downside?

Sid Rajeev: Fair value is basically the intrinsic value of a stock on a particular day, which is calculated based on the stock's fundamentals. And you're right — it's basically the point at which there's no upside or downside.

TGR: When shares reach fair value do you recommend them as momentum plays?

Sid Rajeev: No, our valuation methodology is always based on fundamentals; we will not give a buy recommendation on a stock if its share price is higher than its intrinsic value. We tend to evaluate or review our valuations on a particular company every three to four months — sooner if some significant news develops. 

TGR: With a fundamental theory, you recommend taking money off the table when a company achieves fair value and seeking fair value in another company's shares.

Sid Rajeev: Exactly.

TGR: You cover a lot of metals, from gold and silver to rare earths and others. Sid, I assume you think of gold as a currency and believe it has different drivers than the commodity industries you follow. Could you tell me about the different drivers of these industries?

Sid Rajeev: You're right, we think of gold as a currency simply because most investors Buy Gold to preserve their capital. All the other commodities — except silver — are driven by supply and demand. If a supply deficit is forecasted, that means prices should go up and vice versa. 

Silver is unique because it's priced as a commodity and as a capital preservation asset. 

TGR: Do gold and commodity stocks correlate or do they provide diversification?

Sid Rajeev: As the drivers of gold and the drivers of the rest of the commodities are different, I would definitely view a good diversification strategy as one that includes gold and commodity stocks. 

Commodities' main driver is supply and demand. When an economy does well, so do commodities. But gold, on the other hand, tends to do well when there's uncertainty in the economy. When the value of paper money is expected to depreciate, gold tends to do well. It's definitely good to have gold and other commodities in a portfolio.

TGR: What are you trying to achieve for your clientele through your general investment theory?

Sid Rajeev: Our main goal at Fundamental is to bring out those underexposed small- to mid-cap companies that no one really follows. Those are the ones that are most likely to be undervalued. Our geologists look at the technical aspects. They work in conjunction with our financial analysts to come up with the intrinsic value and a recommendation. 

TGR: Are you generally bullish on commodities right now and which ones?

Sid Rajeev: I've never been a big fan of gold or silver since gold crossed $1,100 and silver crossed $20. Although I don't see any major upside from current levels, gold should stay at its current price for the near term. Slow recovery in the US and the continued weakness in the US Dollar should keep gold high. In the long term, three or four years down the line, we expect gold and silver to soften from current levels.

In terms of the other commodities, we had predicted a correction when we last spoke to The Gold Report early this year. Although we have experienced some kind of correction since then, we think there is a little bit more room for downside. If you look at copper, for example, at $4.11 per lb., most of the projects out there are making a lot of money. Producing companies and upcoming projects can still make good margins at lower copper prices. 

Even though we don't think there's much upside in the base metal sector in terms of commodity prices, there are a lot of companies in those sectors that are very undervalued — companies with quality assets, quality management teams and solid cash positions. 

TGR: I'm wondering about industries where the resources are not traded by open outcry or electronic markets. You follow some markets like that?

Sid Rajeev: Yes. One good example is the vanadium market. We have a long-term positive outlook on the vanadium segment. 

TGR: How do you value a company based on underlying assets that don't have a published commodity price?

Sid Rajeev: That's a very good question. Investors typically find it easy to value revenue or cash-flowing companies. Over the last eight years in business, we have developed a strong expertise in evaluating juniors who have no revenues. At Fundamental, we use three valuation models, the discounted cash flow model, real options model and a comparables valuation model. For comparables, we use a metric called "EV-to-resource," which is basically enterprise value to resource of a company. 

TGR: Thanks. I've enjoyed meeting you very much, Sid.

Sid Rajeev: I've enjoyed our discussion as well. Thanks.

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