Mike Berry’s New Secret for Finding Winners—Optionality
Wed, Feb 27, 2013
The Gold Report: Dr. Berry, the market for junior mining stories is confusing and unpredictable. You have a Ph.D. in investment theory and decades of experience. Can you explain to our readers why precious metals equities are underperforming the benchmark indexes?
Michael Berry: As you know, market cycles are sometimes long. Right now, the junior market is in a risk-off mode. There probably is no other class of stock as risky as junior mining stocks.
In addition, most juniors do a poor job of managing their sustainability, of getting enough money in the treasury and making it work for them. Consequently, they run out of capital. This situation is likely to last for another year or two.
TGR: Despite being in a risk-off market, is money coming back into the market as a whole?
MB: There is a lot of money on the sidelines, but significant problems remain in the market. What cash is returning to the market is not finding its way into the juniors.
Advisers suggest buying large caps and dividend payers and so forth. But even companies like Goldcorp Inc. (G:TSX; GG:NYSE)—a great company with lots of cash and cash flow—is trading for $33/share and a recent dividend increase.
TGR: Does Goldcorp offer a lot of value at $33/share?
MB: Yes, for two reasons. One, it is undervalued relative to Gold And Silver Prices and has 67 million ounces (67 Moz) of gold reserves. Two, it produces a very nice, recently increased dividend.
Gold is still cheap at over $1,600/ounce ($1,600/oz). The dollar got a little bit stronger recently and gold, in dollars, took another tumble. But I cannot believe the dollar will continue to strengthen. When the dollar falls, gold will go up.
TGR: Over the course of 2012, the gold price increased by 6.2%. Should we expect similar performance in 2013?
MB: I would think so. I expect both gold and silver to appreciate this year. However, there is a disconnect between commodity prices and share prices, especially in the exploration space.
TGR: Do you see any meaningful rebound in the mining sector in 2013?
MB: That is a tough question to answer. Last month at the Vancouver Cambridge House Symposium, I sensed that we may be at a bottom, but we may stay there for quite a while.
“I expect both gold and silver to appreciate this year.”
You have to buy into these market bottoms. Look for companies that can sustain themselves. If you can put together a few good companies now, good defined by our 10 discovery factors, and hold them, one or two years is a likely timeframe for a rebound.
TGR: So, the rebound may lift select stories?
MB: Yes, and that relates to the discovery hypothesis.
Gold Standard Ventures Corp. (GSV:TSX.V; GDVXF:OTCQX) is one example of a junior with a wonderful discovery. The stock has been beaten down, but is holding near $1/share. There are a number of companies whose stocks have held their value. Another example is Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.MKT).
Other junior mining stocks are trading for pennies. I have a friend, a fund manager, who buys these stocks. He says that the stock prices in his mining portfolio do not add up to a dollar because the prices are so low. That is true across the market.
We use the Discovery Investing Scoreboard. Through the end of January, the top decile of junior miners, as selected independently by the Crowd, was down 16% over the past four months. The worst stocks, those in decile 10, were down 30%. Almost all of the juniors have been taken out to the woodshed.
TGR: At the Cambridge House Conference your presentation was entitled, “The Leavening of the American Quality of Life.” Among other things, you discussed the impact on global investors of raising America’s debt ceiling. What do investors need to know from that presentation?
MB: Bottom line, increased taxes in the U.S. will affect business. There will be very low growth in gross domestic product, maybe even negative growth. We might even have another recession. There will be a wealth transfer from one segment of the economy, the president’s top 1%, to another. There will be more government intervention in the marketplace.
TGR: Will we see a double-dip recession?
MB: I think that is likely. The Federal Reserve Bank is spending $85 billion ($85B) a month buying up paper. That is not working. Officially, we have 7.9% unemployment, but it is actually much higher, and underemployment is higher still. We have headwinds in student loan default possibility. Housing seems to be turning up a bit.
TGR: Do you pay much attention to the Dollar Index?
MB: Absolutely. Every country is devaluing its currency and trying to inflate its way out. The U.S. will do it too.
It is very appropriate to follow the dollar, because as the dollar weakens, a lot of commodities—which are priced in dollars—will have to go up in value. You can see it in copper already due to increased demand. Analysts are talking about $4/pound copper now.
TGR: The Dollar Index is roughly at 80 right now. In 2011, it dipped below 75. Could we return to that by the end of 2013?
MB: Yes, I think we could. Keep in mind that we are in the beginning of a mercantilist war being fought in the currency markets. The U.S. is not going to promote a strong dollar. Currency strength is always relative in a dirty float world. Washington wants to see the dollar fall relative to the basket of other currencies. You cannot print this much money without having an impact on the value of the currency. I think we could see 75 again.
TGR: Despite a string of dismal responses to my questions so far, generally speaking you are an upbeat guy. Can you give us a few positive thoughts or themes?
MB: Overall, I am positive. I am not happy with what is happening in the U.S., but that is a political issue and I only have one vote.
“This is the time and this is the market where a good contrarian strategy will generate tremendous wealth over the next couple of years.”
Globally speaking, there is a convergence of lifestyles. I, and many others, have written about this concept of lifestyle convergence at length. I have called it a quality of life secular trend. I think this convergence is very positive.
However, the U.S. might not lead that convergence. In Vancouver, I talked about the leavening or the regression of the quality of life in the U .S. In the emerging countries—with a combined population of 6B people—the quality of life will improve. As the quality of life improves, infrastructure is built out. You need more and better food, potable water, fertilizer, metals and energy.
The U.S. and the Western countries will not lead us out of this mess; it will be the tremendous growth in quality of life in the rest of the world. Hand in hand within the next decade the dollar must lose its reserve currency status.
TGR: In a recent edition of Morning Notes, you wrote, “After studying the junior markets and brainstorming strategies to generate returns, we have come to believe in the theme of optionality.” What is optionality?
MB: Basically, optionality is about a company having choices, or options. Most companies do have choices. Options should always convey value to shareholders. The trick is to pick the companies that have multiple, good choices and know how and when to exercise their options.
For example, International Enexco Ltd. (IEC:TSX.V; IEXCF:OTCQX; I6E:FSE) has the Contact copper deposit, a massive project in northeastern Nevada, not far from Twin Falls, Idaho. It also owns 30% of the potentially rich Mann Lake uranium deposit in Saskatchewan, Canada. Its partners in Saskatchewan include Cameco Corp. (CCO:TSX; CCJ:NYSE) and AREVA SA (AREVA:EPA). Enexco has the option to be valued on its uranium or on its copper or both. The most likely scenario, in my opinion, is that the company’s shares will get a boost from discoveries in the uranium project.
TGR: Drill results at Mann Lake are encouraging. Enexco is deciding whether to exercise its option to earn a greater interest there. What do you think will happen?
MB: Two holes at Mann Lake have hit what I would call discovery-grade uranium.
I would think Enexco would benefit from its uranium option. Enexco has a good chance to create value by staying in that joint venture and increasing its participation.
TGR: Do you think Enexco could spin out the uranium asset?
MB: It depends, in part, on how the copper resource expands at the Contact deposit. I think it is likely Enexco will be bought out of its position and spin the copper out into another vehicle; I do not think it will take long.
TGR: Does Enexco have enough cash to develop both assets simultaneously?
MB: Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT) bought $1.8 million ($1.8M) into Enexco.
That takes care of the drill program, and while the stock does not trade a lot, it is a $0.55 stock. So, yes, I think the company can sustain itself.
TGR: Many of the companies you write about operate in Nevada, some in Mexico. What are some of their stories?
MB: From Vancouver, we went to visit Quaterra Resources Inc.’s (QTA:TSX.V; QMM:NYSE.MKT) Yerington project, Pershing Gold Corp. (PGLC:OTCBB) and NuLegacy Gold Corp. (NUG:TSX.V). There are a lot of discoveries in the goldfields of Nevada and many more junior gold explorers are setting up operations.
Nevada has a great mining culture and geology. I prefer a good property in Nevada as opposed to Mali or South Africa.
These are the companies that will pop back first. If we get any move in gold, exploration plays in Nevada will revert in price first. They are very cheap right now. I could probably name 20 of them. Gold Standard Ventures is well-known. It owns 100% of the Railroad project, 19,000 acres close by Elko. It is an advance-stage project in the Carlin Trend.
TGR: Gold Standard expanded its gold envelope along the North Bullion Fault Zone at Railroad, but elsewhere on the property, an intersect recently returned silver-copper-molybdenum mineralization. What should we read into that?
MB: I do not think we need to read anything into it. Gold Standard needs to focus on drilling out the gold resource, not get distracted by another discovery hole. If Gold Standard focuses on Railroad and develops something bankable, then Newmont Mining Corp. (NEM:NYSE) or Barrick Gold Corp. (ABX:TSX; ABX:NYSE) or another major will take the company out.
TGR: Unlike other juniors, Gold Standard’s share price seems to follow drill results.
MB: Yes, Gold Standard had great drill results at Railroad: more than 64 meters (64m) of 4.25 grams/ton (4.25 g/t) gold. That is a great discovery hole. The company found 160m of almost 3.5 g/t gold. That does not happen often.
I think the stock is a tremendous buy at a currently $1/share price. Gold Standard’s person on site, Dave Mathewson, is ex-Newmont and is considered one of Nevada’s great exploration geologists. The company has a district-scale system developing. I think the stock will be much higher in a few years.
TGR: Who else is active in the U.S.?
MB: Terraco Gold Corp. (TEN:TSX.V) is trying to find its mission in life. Does it want to be a royalty company or a gold mining company? Its Moonlight project in Nevada needs more drilling. Looking at the trend there, going from Pershing’s Relief Canyon at the bottom, past Coeur d’Alene Mines Corp.’s (CDM:TSX; CDE:NYSE) Rochester mine and Midway Gold’s Spring Valley property, Moonlight, is almost certain to be mineralized. However, Terraco has pulled back on Moonlight.
It also has about 1 Moz of gold in Idaho at the Almaden project. The company is testing the metallurgy there. Some of the gold is encapsulated in silica. With the current gold price, Almaden remains a valuable project.
Then there is the royalty Terraco has on the Spring Valley joint venture between Barrick Gold and Midway. No matter how you value that, it is worth about $60M. That definitely represents optionality because it could be sold tomorrow. It is very liquid. This is indeed an option that Terraco can exercise. And even if the property cannot be sold, Terraco’s royalty could be sold to a number of players.
TGR: What did Terraco pay for Spring Valley?
MB: It paid $20M for the royalty. Now Todd Hilditch and his board have to decide if it is going to be a royalty company or a mining company. Either way, there is so much value there that I would buy the stock and sit on it. I own the shares and act as a adviser to Terraco.
TGR: Will Almaden be a simple open-pit, heap-leach operation?
MB: Yes, it will be open-pit, but not necessarily simple because of the metallurgy. Charlie Sulfrian, the chief geologist, is working on upgrading it now. The resource is probably over 1 g/t, and there is 1 Moz. Even at 600,000–700,000 ounces (600–700 Koz), it will be very valuable.
The source of the gold has not been found yet, so that will require more drilling. Terraco might monetize its royalty and go after more discoveries at both the Moonlight project and Almaden.
TGR: Is that the strategy you would take?
MB: Yes. I think a company has to be in either the royalty business or the exploration/development business, not both.
TGR: Golden Predator Corp., which just changed its name to Americas Bullion Royalty Corp. (AMB:TSX), has certainly chosen that path.
MB: I think the company found that, aside from this being a very difficult market, you cannot be on both sides. That is why I appreciate what Steve Alfers has done over at Pershing Gold.
Steve Alfers knows more of the history of Nevada gold and has done more deals in Nevada gold than anyone I know. When I first saw Relief Canyon years ago, it was a mess, checkerboarded by Newmont and others. Steve pulled it together. Pershing now has 538 Koz Measured and Indicated and close to 700 Koz Inferred. That Relief Canyon resource will only get bigger. Pershing has three pits on its property and has deals with Newmont to explore its properties.
Pershing also owns 24% of Valor Gold Corp. (VGLD:OTCBB), which has the Red Rock property in the Battle Mountain Trend. Money is coming into that project as well—another example of optionality. Art Leger is heading up the discovery drilling on Red Rock. There is a lot of excitement there as well.
There is not a lot of downside to what Steve Alfers has done with Pershing. The stock moved from $0.30/share to $0.51/share. I think it will move again.
TGR: Would you say that’s another example of optionality?
MB: Absolutely. Steve has some great geologists and a fully permitted heap-leach plant. He also has one of the world’s wealthiest investors backing him. Dr. Phil Frost, a life sciences guru, owns a significant percentage of Pershing Gold.
There are 300M shares out, which is not a real positive. Right now, it trades on the OTC Pink, but I expect to see Pershing listed on the NASDAQ or the NYSE Market.
TGR: Not on the TSX Venture Exchange or Toronto Stock Exchange?
MB: Eventually, but I expect a U.S. listing first.
TGR: Any other Nevada names?
MB: NuLegacy has several projects. The company has a deal with Barrick on the Red Hill project, a Carlin-type deposit. There are some good drill holes and discovery holes. Barrick can come in and claw back to 70%, but the stock is really cheap now. NuLegacy also has the Wood Hills project, on the Pequop Trend. The company has a 70% earn-in agreement with AuEx Ventures Inc. (REN:TSX.V).
TGR: Looking to the south, what names do you like in Mexico?
MB: There are lots of great silver projects in Mexico. For example, Quaterra Resources owns 50% of the Nieves project. It is a 110 Moz, open-pittable silver mine. Because it is monetizable, optionally offers Quaterra some liquidity. Goldcorp owns 8% of Quaterra and it funds exploration of the 20 other projects Quaterra is exploring in Mexico.
Then there is Geologix Explorations Inc. (GIX:TSX; GIXEF:OTCQX). Its gold-copper project, Tepal, is located in Michoacán state. The gold equivalent, when you add in the copper, is about 4 Moz now, and there may be closer to 2 Moz gold and 1 billion pounds copper. The company is trading for nothing. I worry a little bit about sustainability, but it has a great deposit.
TGR: Will stories like Geologix get a bump now that copper demand is ticking up?
MB: On the whole, I do not think people realize Geologix has 800 million pounds or more of copper. That story needs to get out.
No company gets a bump unless it has good investor relations. One of our 10 factors for the Discovery Scoreboard is how a company presents itself to the market. Does the company explain its optionality? I think a lot depends upon on how active a company is and how good it is at dealing with the market.
TGR: Do you have any parting thoughts?
MB: The companies we have talked about may be the first sign that this terrible junior market is turning around. There is a lot more action now in Mexico, Nevada, even British Columbia. The money has to start to flow; when that happens, these companies will really take off in the capital markets.
It is important to analyze companies to understand their degree of sustainability. It is difficult to be a contrarian, but this is the time and this is the market where a good contrarian strategy will generate tremendous wealth over the next couple of years. In other words, buy and hold.
TGR: Dr. Berry, thanks for your time and your insights.
From 1982–1990, Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia, during which time he published a book, “Managing Investments: A Case Approach.” He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He travels the world with his son, Chris, looking for discovery opportunities for his readers.
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ContrarianInsights.com:More Information On Gold Investment
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Report as an employee or as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Goldcorp Inc., Gold Standard Ventures Corp., International Enexco Ltd., Pershing Gold Corp., Terraco Gold Corp. and Geologix Explorations Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Michael Berry: I or my family own shares of the following companies mentioned in this interview: Quaterra Resources Inc., Goldcorp Inc. and Terraco Gold Corp. I personally or my family am paid by the following companies mentioned in this interview: Valor Gold Corp. My company has a financial relationship with the following companies mentioned in this interview: Terraco Gold Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned and may make purchases and/or sales of those securities in the open market or otherwise.
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