The Secret Is Research

A guide to avoiding pitfalls in resource investing...

 

MATT BADIALI is the editor of the S&A Resource Report, a monthly investment advisory that focuses on natural resources, including silver, uranium, copper, natural gas, oil, water and gold.

 

A regular contributor to Growth Stock Wire, a free pre-market briefing on the day's most profitable trading opportunities, Badiali has experience as a hydrologist, geologist and consultant to the oil industry. He holds a master's degree in geology from Florida Atlantic University.

 

Here he talks to The Gold Report about how successful resource investors have to make their way past a lot of money pits before they find a stock that will make it to the top...

 

The Gold Report: You've said that natural resource investors need to be open to opportunities wherever they occur. How do you separate the hype from fact to determine a real bargain?

 

Matt Badiali: My secret is research. I'm a scientist. I love digging in the dirt and looking in places where other people don't want to look for opportunities. I also have a secret weapon in that I work with a guy who is a forensic accountant. He can read a balance sheet and annual and quarterly reports and spot the trouble spots. He warns me of any potential land mines.

 

TGR: What are the red flags you find most often?

 

Matt Badiali: Debt is a big one. You have to be wary of natural resources companies piling on debt. Miners have no say in what they will be paid for the material they are selling. If you mine gold, you are paid whatever the gold price is that day. You are a price taker as opposed to Apple, which sets the price of the iPhone at $700 and that is what it thinks the market will pay. Debt is a fixed cost that has to be paid regardless of the price of gold or silver. Investors have to figure out whether a company can sustain itself based on the cash coming in and the money going out.

 

TGR: You also have the luxury of being able to visit these projects and talk to the CEOs, to the geologists. Conferences like the Sprott/Stansberry Vancouver Natural Resources Symposium, where you will be speaking, allow investors to talk to company representatives. We recently interviewed Rick Rule and Porter Stansberry. Rick talked about some of the questions that he asks when he's face to face with companies. What are the questions you think investors should be asking when they get the chance to meet with a junior mining company representative?

 

Matt Badiali: The number one question is "What is your burn rate?" I need to know how much money a company is going to spend this year. The second question is "How much money do you have in the bank?" Companies are notorious for having $ 2 million in the bank and a $6m burn rate. Often the plan is to make up the difference by selling a bunch more shares. That is when I turn on my heel and walk away. I would rather buy after the company has diluted the current investors.

 

We wrote a report called "A Guide to Avoiding the Most Popular Mining Scam in the World". It dissects the smoke and mirrors in preliminary economic assessments (PEAs), the reports required by the Canadian Securities Administrator after the Bre-X scandal. The goal was to force mining companies to disclose their economics, assay results, everything. Actually, all they really did was facilitate more frauds because companies find a way to say whatever they want in PEAs.

 

Often a PEA states that when a mine is built, it will be worth a bazillion Dollars. But the truth is buried in the details. Many will assume $1500 per ounce gold prices when reality is $1200 per ounce today. Or they use a pretax estimate or an undiscounted present value for a mine that will operate over 30 years. There are lots of ways for folks to manipulate these things.

 

TGR: Has picking winners gotten easier now that there are fewer companies to choose from? Has the bifurcation that Rick Rule has talked about happened?

 

Matt Badiali: It is a lot easier today to see which companies have real assets, real value. There is absolutely a group of companies that have been lost in the declines in the price of gold and the general rout of mining stocks. What I'm looking for right now are real assets, like major discoveries or mines that are in the process of being built.

 

TGR: In a difficult capital market, some miners turn to royalty and streaming companies to make up the difference between their balance sheet and their burn rate. Has the nature of royalty deals changed during the current market cycle?

 

Matt Badiali: At its core, a royalty is the right to a percentage of the production of a mine without the obligation of paying the costs associated with that. If I own a 2% royalty on a mine that produces 100 oz of gold a month, I get 2 oz of gold a month or the value of that if it's sold. And I don't have to pay for the costs. So I just get 2 oz of gold in my hands because that's my royalty.

 

Over the last decade or so, royalty deals morphed into what are now called streaming deals where I agree to pay you some amount of money for those 2 oz of gold. Maybe I pay you $400 per ounce, and then I get all the upside after $400 per ounce. I'm not as big a fan of streaming deals because they introduce commodity risk into the royalty model. The pure royalty models are wonderful, like a lot of the oil royalties, because they're basically free cash coming into the business. There is almost no cost of revenue, so most of it goes straight to the bottom line.

 

TGR: Any comforting words you can offer investors trying to outlast the wiggles in the market today?

 

Matt Badiali: When you hike to the top of the mountain, you don't worry about the gullies. You just look at the peak and say that's where I'm headed, and that's where these things are headed.

 

The things that I am most excited about right now are the companies that have big, robust deposits and are building mines. Those are the companies that are going to benefit most from the coming market cycles.

 

TGR: Thank you for your time, Matt.