Shrewd Buyers in Junior Gold Miners
Friday, 7/19/2013 09:23
Junior gold miners are poised for a "vibrant recovery" with gold prices this low...
MIKE KACHANOVSKY is a consultant providing analysis of junior mining and exploration stocks, and author of the Mexico Mike column in
Investor's Digest of Canada.
Kachanovsky is also a founder of
SmartInvestment, which serves as an online community for the discussion of all topics relating to junior mining stocks.
Here, and even though precious metals stocks are going through a nasty and unpleasant interval, he tells
The Gold Report why shrewd accumulators are buying all the gold and silver juniors they can.
The Gold Report: Mike, the prevailing wisdom in the market favors producers over explorers in the precious metals equities. The thinking seems to be why buy the pasture when entire farms are selling at nearly the same price? What do you think of that strategy?
Mike Kachanovsky: That is a good summary of current affairs. Market values for the entire sector have been trimmed dramatically; even many of the highest rated stocks are down 50% to 60%. From a value perspective, it makes sense to buy higher up the food chain when you have the opportunity, to buy more established companies that offer legitimate earnings and established infrastructure.
TGR: Kenneth Hoffman of Bloomberg Research notes that production from the world's biggest gold mines has dropped 17% since early 2011. He predicts that gold mines, especially high-cost mines in Africa, will start to close as gold hovers around $1200 per ounce. Is there a bullish medium-term case to be made for gold prices given the shrinking supply?
Mike Kachanovsky: We have been through similar severe gold price corrections before. At the beginning of this century, gold's market value was below what it cost to produce it. Mines closed and companies went out of business. That scenario evolved into the bull market we have today and the achievement of all-time high metals prices.
TGR: But this is not a bull market.
Mike Kachanovsky: A lot of the mainstream commentary is telling us this is a bear market for gold prices. I consider this to be a very severe correction within the context of a long-term bull market, a volatile event that will lead back into an even more bullish case down the road. I think we will see new highs for both gold and silver before this is over.
TGR: Predicting how long this will last is not easy, but what is your best guess?
Mike Kachanovsky: In my last
Gold Report interview just over a year ago, I thought we would see a recovery before the end of 2012. I was dead wrong, obviously. Trying to predict the timing is just asking to be proven wrong.
The longer we get into this correction, I believe we are setting up for an even higher and more vibrant recovery. I would like to think the selling pressure would be washed out by this fall, but who knows? Silly can always get sillier.
TGR: Could gold test the $1000 per ounce threshold this summer?
Mike Kachanovsky: Putting this in perspective, when gold was setting new highs in 2011, we had a parabolic short-term price curve. People speculated the price would break through $2000 per ounce on the upside. We are now looking at a parabolic decline, which is just as unsustainable as a parabolic rise.
TGR: If silver and gold do rebound, what will underpin those rebounds?
Mike Kachanovsky: Demand for actual physical bullion is running at all-time highs. That is what will trigger more bullish conditions.
Both gold and silver exist in finite quantities. Speculators are panicking at these low prices, but shrewd accumulators who understand that gold and silver have always been money are buying all they can at these prices.
I saw it for myself in Hong Kong this April: people lined up three deep screaming, wanting to buy metal. That demand, along with supply curtailed by the lack of new development projects, will cause a shortage. That will trigger the next new high in gold as the market reacts.
TGR: If investors do return to precious metals, what would that mean for junior miners?
Mike Kachanovsky: After metals prices have recovered, people will realize that mining stocks have been driven down to generational lows and money will rapidly flow back into the juniors. The selling today comes from hedge funds, exchange-traded funds and mutual funds. The recovery will be the mirror image of that, when the same funds want to accumulate these stocks again.
TGR: Until then, what do junior precious metals miners need for you to make a bid on them?
Mike Kachanovsky: It still makes sense to look at explorers one-by-one and find miners that are sitting on a large cash position and good projects. Many good stories are priced at generational lows. Even in this weak market, it is a good time to accumulate companies positioned for the day sentiment swings back to more bullish. This is an opportunity to buy cheaply and establish positions at very low cost averages.
But you must be selective. Warren Buffett once compared investing in stocks to playing a game of baseball where there are no called strikes. You have to wait and look for that really fat pitch to come across the middle of the plate before you swing the bat. The willingness to wait until you find that one company that is priced cheaply and has all the attributes to succeed will define the investors who make the most money after this downturn in market sentiment is resolved.
I look for companies with great cash positions, strong management, robust projects and low operating margins. Even really good stories are trading as if they were impaired.
TGR: In Nevada, some companies have suspended operations due to gold prices. Is this strictly about the gold price or are things just getting tougher in Nevada?
Mike Kachanovsky: Things are tough everywhere. Cash costs in every significant gold-producing region of the world have risen more than the metals prices. Now that the metals have corrected, operating and profit margins are under severe pressure.
Whenever there is a longer term correction in prices, production will revert to the lowest margin producers; the smaller companies and the higher cost producers will be taken offline. That is what we are seeing now.
The oldest cliché in the commodities sector is that the best cure for low prices is low prices. The longer gold remains in its current price range, the more mines will go offline, limiting the gold supply. Low supply will eventually contribute to a recovery and to higher prices.
TGR: You are well known as Mexico Mike. What attracts you to that jurisdiction?
Mike Kachanovsky: Mexico is one of the premier spaces for investors in the junior mining space. Many good companies have been active there for years, but today their price ranges are so low that you can accumulate them almost as new entrants.
TGR: Some companies in Mexico host high-grade, polymetallic mineralization. How important are byproduct credits to margins in this market?
Mike Kachanovsky: Most Mexican mines produce concentrates with silver in a zinc or a lead concentrate. The value of the concentrate itself has come down. These polymetallic mines get a lot of their total cash value from the base metals they produce along with the silver.
Silver has lost about 60% of its value off its peak, and other base metals have been affected by the same deflationary price trend. Right now both zinc and lead are at much lower price levels than when they were trading near their peaks. The companies will not gain as much benefit from byproducts as they did in the bull market.
TGR: What about collaboration among the junior miners?
Mike Kachanovsky: There are probably a dozen strong producing juniors, which would be a good candidate for partnerships. In some cases they are operating individual mines immediately adjacent to each other, working very similar projects.
It is just a question of whether or not managements are willing to agree to a transaction. That has been the problem all the way through this market; the smaller juniors resist any efforts to merge.
TGR: What prompts that reaction? Self-preservation? Ego?
Mike Kachanovsky: Most junior miners were built from the ground up by one or two people. For a merger to succeed, some of those senior people would have to hand over the reins to a new management structure where they are no longer leading the charge. That is a difficult transition, even if it makes better sense for the company as a whole.
Unless merger becomes a necessity, I think most management teams will continue to resist mergers. The market conditions of today may create that necessity.
TGR: Mike, you have made a lot of money in this space and obviously believe that can happen again. Can you share one unsung aspect of your success, a trick of the trade?
Mike Kachanovsky: Probably the most significant thing that I did, starting with a very small amount of money at the beginning of this bull market, was to spread it around and get onboard a number of speculative stories.
All you need is one tenbagger, a company that goes from $0.10 to more than $1/share. You then redeploy those profits into other similarly positioned companies. In a robust bull market it is like firecrackers going off; one junior mining story after another suddenly becomes a huge winner.
The trick of course is to understand when the market rolls over and conditions become less bullish. Then you take some money off the table, back away and wait for the next speculative cycle to kick off. That is the next phase I am dealing with now.
TGR: You are waiting for the next cycle?
Mike Kachanovsky: Yes. I am convinced we will see another, even more intense bull market. The ability to keep your options open and be positioned in the next round of winning companies will define the next round of successful speculation. My attention is focused on finding the companies that have the potential to lead the entire market higher.
TGR: Mexico Mike, thanks for your time and your insights.
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