Gold News

No Rock Unturned in Resource Stocks

Buying "reality at a discount" in a market struggling to hold over long weekends...
"The PERSON who turns over the most rocks wins the game," renowned investor Peter Lynch once said.
Natural resource investors in particular should be turning over rocks. But who has time to track hundreds of companies, to visit projects, to meet with management? The Gold Report here asks 40-year veteran broker Rick Rule, now of Sprott US, as well as senior gold mining analyst Joe Mazumdar at Canaccord Genuity, and Keith Schaefer of newsletter Oil & Gas Investments Bulletin to explain what they look for when turning rocks for big portfolio wins...
The Gold Report: What types of companies do you follow, and why?
Joe Mazumdar, Canaccord Genuity: I primarily cover exploration and development companies in the precious metals sector. There is a difference between catalysts for explorers and for developers. For explorers, it's like buying a lottery ticket – we're looking for that drill result. With the developers, the investor audience tends to be more risk averse. They're waiting for the company to meet their bench points. So the companies I cover tend to be the ones that the risk averse invest in. They want this thing to come to function. They need a management team that can raise the funds and put the asset in production.
Keith Schaefer, Oil & Gas Investments Bulletin: I follow mostly the junior energy sector in Canada and the US, looking at both producers and service companies in oil and gas all around North America. Their assets can be anywhere in the world as long as they list them on a reputable exchange in North America. So I'm looking for something with some leverage. Leverage does not mean depth. Leverage means either few shares outstanding or a very large land position that hasn't been developed yet that perhaps the market doesn't appreciate. So I look for a pure play with leverage and a great team that has built and sold a company before.
Rick Rule, Sprott US: We have several preferences. One would be companies that have an unanswered question where we think that a yes answer will give us a ten- or twentyfold return. We are looking for oil and gas companies that are new and for converging technologies to unlock access to oil and gas resources where there's no exploration risk but there's exploitation risk, where getting yes answers is repeatable 10,000 or 20,000 times.
The other thing that we really like in markets like this is what we call reality at a discount. $200, 300 or 400 million was spent in the last bull market, money that was raised very cheaply. The money delivered a conclusive answer but it didn't deliver a conclusive answer in a timeframe that satisfied a market that has a problem with holding stock long weekends. We also like commodities that are deeply out of favor, ones that sell at discounts to their production cost. In that circumstance, either the cost of the commodity goes up or the commodity becomes unavailable.
TGR: When should an investor accumulate a position leading up to a catalyst event for the stock price, like a maiden NI 43-101 or funding from a strategic partner, permitting and feasibility studies?
Joe Mazumdar: It depends on the catalyst. If it's something happening with development plays in a recovery, it all depends on the market's thinking. If you're waiting for a permitting decision, permitting risk is the issue. For feasibility studies, we all make estimations and forecasts as to what those will look like. So already embedded in the market is an expectation. The issue is does it meet or not meet that expectation? That's really where you have to depend on the management team to meet that expectation. A lot of the risks for mining development companies are about meeting expectations and potentially surpassing them.
TGR: Keith, are the catalysts the same in oil and gas investing as they are in hard rock mining?
Keith Schaefer: The reality is that both games are about production and reserves. On the exploration side, a drill hole and a reserve report would be major catalysts. One thing that investors can take some comfort in is, despite all the nuances between the industries, it really does come down to production and reserves and finding a team that has done it before. So on the junior side, the catalysts are very similar.
TGR: When do you believe an investor should start to accumulate a position leading up to a catalyst?
Keith Schaefer: Three things: The time factor: How much time before the catalyst? The further away the catalyst is, the more likely you are to buy the stock in advance to take advantage of any speculative premium. Two, what's the downside of that catalyst not happening? That's where I really want to find a catalyst that's basically for free. Then the other thing I want to know is how well known is this catalyst on the Street because if I'm reading it in a research report that has just gone to 6,000 retail clients, chances are I'm not going to play that catalyst nearly as much because everybody knows about it. But if I've been digging around myself and figured out a catalyst in advance of the Street, then I'm way more apt to buy the catalyst.
TGR: Rick, when should we accumulate a position?
Rick Rule: I'm perpetually early. I would say that irrespective of the nature of the business with regard to catalysts, you're better off buying in a bear market rather than in a bull market because the price of success and the price of failure is lower. But it depends, and I think Keith gave a very good answer to the question. It depends on the nature of the catalyst and its importance to you. If you're a large institutional investor, moves in the market don't matter.
A lot of what I do is invest in prospect generators, process and being willing to take advantage of the time arbitrage. Convergence in technologies proves up a large acreage spread where you can project success to over 10,000 locations is a catalyst that becomes apparent to somebody who works, but it isn't apparent to the broad market until it sees it's on a report of financial statements. The type of catalysts that one pays attention to has a lot to do with one's disposition and temperament as a speculator, and it varies from person to person.
TGR: Traditionally, stock prices have been driven by news, but in the current environment, some companies aren't getting the bumps that they would expect from the catalysts that they deliver. Why is that? Do you see that changing?
Joe Mazumdar: In my sector, junior gold mining, we've seen over the past few years some people selling into the news. There might be a positive event as expected, but the stock actually trades down because people are selling to look for the next one. With quality stocks, we've seen positive news have positive impacts.
Keith Schaefer: In the oil and gas space, we've actually almost had the opposite problem where catalysts are getting priced in immediately, and they're getting priced in two years in advance. The leading stocks in Canada make no sense whatsoever on current metrics. These are companies that have the lowest profit margins, and, yet, they have the highest valuations.
Why is that? Because they're pricing in the catalysts two years in advance. They're saying there won't be any negative surprises because gas prices now are at absolutely rock bottom, and I totally trust this team to meet its numbers every single quarter for the next three years.
That's where you see a big difference between the hard rock and the soft rock sides. On the oil and gas side, catalysts are being priced in really fast for the simple reason, as Rick has said, this new technology has brought in an entirely new industry. That says it's very low risk and we're going to take that to the bank two to three years out.
Rick Rule: This discussion about stocks moving on news and the fact that they're not moving on news, to me, is a real blessing. It means that the analyst can buy reality at a discount. You can have time to study the data and make an informed decision. In good markets, you don't have that luxury. You have to anticipate the market's reaction to news. So when you ask how long it's going to last, my hope as a check writer is that it lasts forever. The process right now is rational, as it was in 1998-2002, as opposed to irrational.
The greatest investor today, Warren Buffett, famously said you shouldn't buy the stock if you didn't know it well enough that you would be delighted to see it fall in price 30% in two weeks after you bought it so you could buy it more cheaply. Sadly, I've tested that thesis dozens of times in my career, but the truth is that it speaks to the market that we're in. We're in a market that's rational. Of course, maybe that's why medical marijuana is so popular right now. People don't want rational expectations.
Keith Schaefer: All the stocks in my sector, oil and gas, have had a hell of a run, and this is a pretty difficult time to be dipping your toe in the water. It's been undergoing a six-week plateau/correction. About 10 days ago we started to see some upward movement, but most of these stocks have run anywhere from 50-100% since the beginning of February. In my sector, this is traditionally not a smart time to be buying. You want to wait probably another month to see really what's happening. But we've seen a lot more seasonal strength than I would think. To be going whole hog into something right now is really difficult.

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