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Frontier Markets Harbor High-Reward Investment Opportunities: Carlos Andres

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Carlos Andres Select frontier markets, once eyed skeptically as fraught with danger, are now some of the most robust economies in the world. But the shares of companies exploring and producing in these markets often continue to lag based on long-held fears that are no longer valid. How does an investor decipher that fine line between real and perceived? Carlos Andres, the chief analyst and managing editor of the Frontier Research Report and the Global Resource Investor, makes his living informing retail investors about risks in the junior resource space. In this exclusive interview with The Gold Report, Andres discusses how to capitalize on the narrowing gap between real and perceived risks in South America and beyond.

The Gold Report: Carlos, you note in the January edition of Frontier Research Report, entitled "2011 In Review: A World in Turmoil," that only three countries with major stock exchanges finished 2011 in the black: Indonesia, the Philippines and Malaysia. Is the face of global risk changing?

Carlos Andres: In a word? Yes. Some emerging and frontier markets with significant natural resource endowments continue to emerge as robust places to invest and weather economic storms for savvy investors. Paradoxically, the world's developed economies have become the more risky markets.

TGR: What factors are contributing to that?

CA: On the one hand, robust natural resource demand has asserted itself over the last decade, led by Asia in general and China in particular. Latin America deserves favorable mention as well. This is reflected in the rise in global commodity prices over the same period. It's being fueled by factors such as population growth, industrialization, urbanization and infrastructure development driving income growth and middle-class expansion. As a result, when you are operating in these markets, there is a strong sense of economic activity, optimism and wealth creation. It's tangible. You can see it and feel it.

On the other hand, as has been covered ad nauseam by media of all kinds, developed world markets are mired in myriad types of interlinking crises: financial, political, budgetary, debt, employment, military, etc. This fuels a high degree of uncertainty for investors in these markets. To a certain extent this is masking the economic growth on other markets.

TGR: Can you rank what you consider the top risks in the junior resource space?

CA: There are a lot of risks competing to be on that list! Consulting firm Ernst & Young recently released its annual metals and mining Top 10 report. At the top of the list, and I don't disagree, is resource nationalism. There's a resurgence of resource nationalism and it does seem to be taking on a rather virulent strain as of late.

"Some emerging and frontier markets with significant natural resource endowments continue to emerge as robust places to invest and weather economic storms for savvy investors."

Second on the list is a significant shortage of skilled geoscientists. An all-time record of $18 billion was spent on non-ferrous metals exploration in 2011. As mining activities have picked up, so has the demand for skilled and experienced workers. There are not enough of them to go around.

Another rising risk factor, stemming from the success of the sector, is cost inflation. There is competition for the factors of production, including capital equipment. This is a significant factor underpinning the viability of mining projects.

Ernst & Young also lists capital project execution, or the ability to raise enough capital to execute projects successfully. That's obviously a problem given current weakness in capital markets. Despite record production levels and profitability, investors have fled the sector. There's a large disconnect that should spell opportunity for discerning investors

TGR: Does that particular risk speak to a lack of skilled management, too?

CA: Yes. Management has to shepherd capital very carefully and conservatively when cash is tight. It does come down to experienced management teams who are shrewd and very nimble on their feet. They must be creative about where and how to obtain financing as well as how they allocate it. Also, their accomplishments and reputations often have a lot to do with being able to bid away financing from management teams who are weak in this area.

Ernst & Young also talks about maintaining a social license to operate, which is a sophisticated way of saying it's a good idea to get along with the locals near the mine. As we are learning, management teams ignore this issue at their peril.

TGR: The industry has done a poor job of that, by and large.

CA: It has. It's becoming an increasing area of concern and focus for management teams as problems have flared in various locales. The shrewd companies are beefing up in that area to respond to social needs and concerns. It requires an added dimension of expertise. These issues have added to the costs for many companies. It has become a problem for both mines that have been operating for a very long time as well as new projects.

TGR: Investing in small-cap resource plays can be a high-risk game. What are some things that investors routinely do that expose them to more risk than is necessary?

CA: It's obviously important for investors to pick the right management with the right projects in the right jurisdictions with financial firepower. The average retail investor often falls down on the job in this area despite the fact that there are lots of good news and research resources out there to help separate the wheat from the chaff.

"Robust natural resource demand has asserted itself over the last decade, led by Asia in general and China in particular."

There are maybe 3,000 publicly traded junior resource stocks and a lot of them are not worth their listing. The first step is to eliminate the worthless, which means the list of 3,000 quickly becomes 300 or less that are worth considering.

However, many investors who are committed to this sector tend to engage in very poor trading strategies. This is not covered nearly as much as it should be. I'll try to reduce it to some simple ideas: When trading, investors often feel as if they have to get in on this before it's too late and, therefore, they will chase price as it moves up. Although it is certainly possible to make money this way in some cases, it is a bad habit that will work against you in the long run.

Investors also tend to allocate far too much capital to individual companies while at the same time not maintaining sufficient cash reserves. When price moves against them, their investment capital is fully deployed. Given the inherent volatility in junior resource stocks in particular, the prices of shares can move dramatically against them. These folks end up selling with large losses. They become demoralized and never return to these markets. Whereas if they had pursued a different trading strategy, they might find themselves not only being able to endure the storm, but able to generate wealth and become successful long-term investors in the sector.

TGR: What would you suggest?

CA: Something along these lines: Investors first find a company they like. It's at a certain price. It's a good price, but good strategy says you shouldn't allocate all your money at once. Given that many investors will allocate far too much of their capital to one stock, once decided on an amount, an investor should probably reduce it. It's a good risk-management practice in volatile markets.

If you decide to allocate $10,000 (K), maybe you just spend $1K at the current price and wait and watch. If the price falls significantly, say 20%, and you still think it's a great company in a great jurisdiction, you spend another $2.5K. You are buying on the way down because you believe in the fundamentals, rather than chasing the price up because you are relying on the herd as proof for the value of the stock. You want to be selling to the herd and not buying from them. The only way to do this consistently over the long-term is to make a habit of buying value at distressed prices, like now.

Therefore, the lower the price goes, in 20% increments, for example, you would spend larger and larger chunks of your allocation of $10K. Thus you are lowering your basis as you go. When the price finally does turn around, you will have made a significant purchase right near the bottom. It allows investors to manage emotions and risk while accumulating value. If the company's stock takes off just after the initial investment of $1K, you may have missed out on putting $9K in, but you still get to participate in the upside and you will sleep well at night.

There are, of course, more nuances to this type of approach to trading. These are the basics just to give some idea of how investors should be thinking.

TGR: Resource nationalization is a big part of jurisdiction risk. My sense is that there's greater jurisdiction risk now than there was even five years ago. What's your view?

CA: It was always there, but more countries are jumping on the bandwagon and asking for a bigger slice of the pie by raising taxes, royalties and the ownership interest a country takes in a mine. In some cases, such as in Africa, there is free-carried interest where the state is entitled to 10–20% of the mine without having to bear any of the development costs. It is creating uncertainty so the analyst has to wade through this.

"With any good fortune, the buying season for gold, and potentially for mining stocks as well, is ahead of us in the fall of this year."

Some countries, like Indonesia, are adding a new twist. In order to capture a bigger piece of the pie, the government wants to require companies that extract natural resources to build refineries and smelters to refine products in-country before they are exported. Going from ridiculous to sublime, Indonesia is also requiring that after 10 years of owning a mine, a company must divest itself of 50% by selling to Indonesian concerns.

Where it starts to get really intense is outright nationalization. We've seen some of that in Argentina and Bolivia lately. There were rumors in mining-powerhouse South Africa as well, but cooler heads appear to have prevailed for now.

TGR: When companies are investing the kind of capital it takes to develop a large mine, they don't want to lose half of it after just 10 years. That's quite extreme.

Frontier Research Report has success identifying countries where there is more "perceived risk" than there is actual risk. What are some of those jurisdictions?

CA: We like to profit on the difference between perceived risk and actual risk because we're able to buy things really cheap if perceived risk is higher than the reality. A company's true value is revealed when it meets significant milestones and investors take notice. However, there are times, like the present, when the margins between perceived and actual risk narrows a bit.

TGR: Or a lot.

CA: Indeed. Now is one of those times where perceived risk is moving close to actual risk. It's narrowed, even in some of my favorite jurisdictions, like Peru, which is a mining powerhouse and is No. 2 in the world in copper, No. 2 in silver and No. 6 in gold. Nevertheless, it's experiencing some problems with local unrest to the point where it's receiving international attention. It's brought a cloud over Newmont Mining Corp.'s (NEM:NYSE) Minas Conga project, which has the green light from government but is moving very slowly in the face of local opposition.

TGR: It's forced Peruvian President Ollanta Humala to change around his cabinet somewhat in order to try to appease both sides.

CA: That's right.

TGR: Humala is a former soldier. He's perceived as a leftist, but is he anti-mining?

CA: No, I don't believe he is. Prior to the election, we argued to our subscribers that if he won the presidency, given the nature of politics in Peru and the importance of mining to the economy, he would find it very difficult to enforce his platform overnight and would have to moderate it. In the lead up to the election we started to see him do exactly that.

After he was elected, he proceeded to raise royalties and taxes. The mining companies went along with that. He said he would distribute funds and enact social programs in the rural regions of Peru. It seemed to work out fairly well at first. The local unrest that developed almost immediately after he was elected took many, including me, by surprise. There has always been local unrest but it flared unexpectedly.

TGR: These communities feel that they've been left out of the boom that the country has participated in over the last 10 to 15 years.

CA: I think they felt that if they acted out their social displeasure, maybe they would have the backing of their leftist president, but he perhaps caught them by surprise as he proved unable or unwilling to offer that support.

TGR: Ultimately, is Peru is a good place to be investing?

CA: Will mining companies be able to execute projects in Peru and successfully move them from start to finish? Can that still happen logistically, politically, from a regulatory standpoint in Peru? Absolutely. Will investors get comfortable funding projects in a country where there is local unrest? That's the rub. Can companies raise financing in the capital markets in order to push projects through? That's the question mark.

In environments like Peru, where mining will continue robustly even under a cloud, it will be more and more important that investors be able to differentiate well-managed, well-capitalized companies, with sound projects.

TGR: Your model portfolio took somewhat of a beating in 2011, along with most portfolios with a focus on this particular sector. Your gold holdings included Lion One Metals Ltd. (LIO:TSX.V; LOMLF:OTCQX; LY1:FSE), Gran Colombia Gold Corp. (GCM:TSX.V), Mariana Resources Ltd. (MRY:TSX; MARL:LSE), Minera IRL Ltd. (IRL:TSX; MIRL:LSE; MIRL:BVL), Rio Novo Gold Inc. (RN:TSX), Sulliden Gold Corp. (SUE:TSX; SDDDF:OTCQX; SUE:BVL) and Azumah Resources Ltd. (AZM:ASX). Auryx Gold was in there too, but it was taken over by B2Gold Corp. (BTO:TSX; BGLPF:OTCQX).

CA: All of these companies except one are still in the portfolio.

TGR: A couple of those companies in there have projects in Peru, including Sulliden, which is suffering from the cloud hanging over Peru after Bear Creek Mining Corp.'s (BCM:TSX.V) license to mine the Santa Ana silver deposit was pulled. Does Sulliden simply wait it out or can it lift its share price by continuing to derisk its Shahuindo project?

CA: Sulliden has experienced management with a strong track record, is well capitalized with $44 million (M) in the bank and is far enough along to shepherd the project through to completion. The question is will the Peru cloud eventually lift and will markets begin to improve so that Sulliden can achieve its true value for shareholders? I believe so. As Shahuindo moves toward development over the next 18 months, its share price is likely to improve substantially. The company will release a definitive feasibility study in August, which will likely add ounces to what is already an impressive 3.4 million ounce (Moz) deposit. Sulliden is also ramping up for mine development. This company has done well for our subscribers and will likely, in our view, add more value in the near future.

TGR: What are you expecting from the feasibility study due later in August?

CA: I'm relatively certain the results will be positive. It will contain a resource estimate update to the existing 3.4 Moz deposit, which includes 66 Moz silver. The deposit remains open in all directions, including at depth, so there is excellent exploration upside. The update will likely add ounces and upgrade existing ounces that are currently in the Indicated and Inferred category. The initial production profile of the open-pit mine will be scaled down from 150,000 ounces/year (150 Koz/year)to 100 Koz/year. That will reduce the initially planned development cost of $200M by half.

With a definitive feasibility study and a smaller, simpler mine plan, the approval process will be easier to navigate as well. The definitive feasibility study will feed the all-important environmental impact assessment, which will be submitted in the fall. It should take 9–12 months to obtain approvals and Sulliden has recently hired a seasoned specialist to manage the process for them.

The Sulliden story has all the hallmarks of a management team that is thinking soberly and strategically with the wherewithal to get across the finish line.

TGR: Minera IRL also has significant assets in Peru. It has a mine in production, Corihuarmi, with about another three years of production left. Minera is counting on future production from its Ollachea project. Can Minera IRL bring it into production within that timeframe?

CA: Chances are very good. Corihuarmi, which may be exhausted by mid-2015, is currently producing 30+ Koz/year. When Ollachea comes on-line, it will have production of 117 Koz. It will be an underground mine and the access tunnel is currently under construction and progressing on schedule.

The deposit itself currently contains 2.6 Moz Indicated and Inferred with solid grades between 2.8 and 4 grams per tonne (g/t) with a higher-grade core within the resource envelope of 5.3 g/t. Ollachea also remains open in all directions.

Minera is currently in the middle of preparing a definitive feasibility study that is due by the end of the year and the company is already working on mine financing options. Permitting and financing are scheduled for 2013 with mine development in 2014 and production scheduled for 2015. So, yes, I think the schedule is reasonable.

In addition, Minera IRL is a very well-managed company with the venerable Courtney Chamberlain at the helm and roughly $25M in the bank. Finally, exercising tremendous foresight, the company has an excellent relationship with the local community through numerous programs, including an agreement that provides for a 5% ownership interest, and a recently signed 30-year surface rights agreement, which enjoyed wide spread local support.

The company should be able to weather the storm and continue advancing its projects in Peru, as well as its Don Nicolas project in Argentina.

TGR: Some of Argentina's oil and gas resources have been nationalized in recent months. Is Don Nicolas at risk?

CA: The country does not have a history of nationalization in the hard-rock mining industry, although it does in the oil and gas industry. The nationalization of the oil company, YPF SA (YPF:NYSE), has a lot to do with the fact that Argentina has gone from energy exporter to net energy importer in a massive way over the last few years. It used to provide all its own energy, but now it's suddenly importing large quantities of natural gas to keep the lights on and it's been draining the country's foreign exchange. As a result, the government has been reacting rather radically. However Argentina didn't try to nationalize the mining industry in the 2001 crisis and so far mining companies are soldiering on.

TGR: What about the move by President Cristina Fernández de Kirchner to restrict access to imported mining equipment?

CA: The government of Argentina is not necessarily targeting mining specifically. It is making policy decisions related to keeping foreign exchange in the country. It is impacting mining companies, but it hasn't shut things down for them. Is there added risk? Yes, especially with imposing capital controls and rules on the way dividends are repatriated and capital equipment purchases are made. It is having an impact on mines. But it hasn't shut down operations or exploration.

TGR: What are some other junior explorers that you believe have been unfairly punished by events beyond their control, or that are unusually undervalued due to perceived risk?

CA: Gran Colombia stands out in this regard. It sits in the junior ranks in the sense that it is continuing exploration on two very promising mining areas in Colombia. In reality, it has several legacy operating gold mines with large underlying deposits that are currently under development and hence is masquerading as a junior. The company's Marmato deposit has over 12 Moz gold and 75 Moz silver and yet it's valuation on an enterprise value per ounce level is around US$20 or 1.3% of the gold price. That's unbelievably low.

Marmato is in the heart of a historic mining district in the center of Colombia dating back to the centuries when the Spanish controlled it. The company is developing an open-pit mine, scheduled to begin production in 2015.

In the meantime, Gran Colombia is deriving cash flow from the existing underground mine, which produces about 30 Koz/year. The company has another well-known historic holding formerly known as the Frontino gold mine but recently renamed Segovia. Three or four underground mines are currently producing over 100 Koz/year. Segovia has 1.4 Moz so far, but it's going to get a lot bigger. So the company has cash flow from legacy operations, a world-class deposit at Marmato, lots of silver, a solid deposit at Segovia, with tremendous exploration upside.

TGR: The deposits tend to be high-grade underground vein deposits in Colombia, but they're difficult to exploit en masse. There are these smaller high-grade operations, but nothing at scale. That's what Gran Colombia is trying to do with the pit at Marmato. Do you think that it will prove successful?

CA: I do. Gran Colombia has a very experienced management team that has developed large gold deposits before. Although Marmato is operating a legacy underground mine, the massive deposit is being developed with a large open-pit bulk-mining design in mind. The drill results look good and I expect the company to be able to rationalize the pit dynamics and the grade.

TGR: These older operations that Gran Colombia is running have been grandfathered into the new mining act there. However, there have been very promising, much larger deposits that have not been green-lighted. What makes you think that this one will be?

CA: Because the management team has already accomplished what no other mining company would even attempt. Both Frontino (now Segovia) and Marmato had some significant legacy issues that had previously caused miners to shun them like the plague. Frontino had a $200M legacy pension problem from a bankruptcy in the '70s. Marmato was previously fragmented into dozens of different ownership interests. In addition, the historic town of Marmato, which sat right in the middle of the deposit, had been partially destroyed by a landslide, creating a humanitarian dilemma.

All of these issues have been completely resolved by Gran Colombia management. The company was able to raise the $200M in capital markets to resolve the pension issue in exchange for a 100% unfettered interest in Frontino. It consolidated all of the individual land holdings at Marmato so that it now has 100% ownership of the entire site. Gran Colombia has also aided the government in rebuilding the city of Marmato further down the hillside, which has been completed. All of this was considered impossible.

Atypically, the management team hails from the region and is well connected. Executive Co-Chairmen Serafino Iacono and Miguel de la Campa are from Venezuela and were responsible for finding and defining one of the larger deposits in South America. Their success with Bolivar Gold and later Pacific Rubiales established a tremendous reputation for them both and so they are able to open doors that few others can. In addition, the President and Chief Executive Maria Consuela Araujo is the former Minister of Foreign Relations and former Minister of Culture in Colombia. That gives you some idea of the pedigree of management.

TGR: Lion One appears to be sitting on the tip of an iceberg with its high-grade low-tonnage Tuvatu gold project in Fiji. How is their story coming along?

CA: Lion One is making good progress. It has become evident that the company is sitting at the periphery of a large volcanic system at one edge of a large caldera. In geologic and physical terms, it is very similar to the nearby historic and still-operating Vatukoula mine, which also sits in a caldera. For reference, Vatukoula has historic production and remaining resources totaling 11 Moz. In this context, Tuvatu has an initial existing deposit of roughly 650 Koz established in the early 2000s.

Over the last eight months, Lion One has established that consistent mineralization is extensive laterally and at depth from the existing deposit. In short, this deposit is going to grow. Another is that the company has a deep pool of local geo and mining talent to draw on from Vatukoula, who have lengthy first-hand experience with the above- and below-ground geology.

Thus, on the exploration front Lion One is working hard to nail down the geological system underpinning the deposit. At the same time, it is pushing to establish a commercially viable mine plan scenario that could support the long-term exploration and development of what is shaping up to be an extensive gold field. This is a project to keep an eye on. The company is well-managed by an experienced team and it has about $15M in the bank

TGR: Do you have some tips on how to hone our approach in order to take advantage of opportunities while mitigating risks in the junior resource space?

CA: As we alluded to earlier, on one side of the ledger, it's important to pick the right management, projects and jurisdictions. On the other side of the ledger, it is equally important to look at trading strategies and how much money to allocate to a particular company. The tried-and-true approach is not to invest more than you can afford to lose. I know everyone knows that, but I suspect a lot of retail investors lack the discipline to stick to it. Wait for the prices to come to you. Buy light in the beginning and buy in ever increasing amounts as the price declines. The rule is accumulation rather than chasing prices as they run away from you. The downside is far too high to chase prices like that.

TGR: Did we see the bottom for small-cap resource stocks in May?

CA: Indeed, they've come off the bottom a little bit—especially some of the more well known ones. I think they're still probably meandering along the bottom as a whole, but some of the more prominent names will bounce off the bottom.

With any good fortune, the buying season for gold, and potentially for mining stocks as well, is ahead of us in the fall of this year.

TGR: Hopefully, Carlos. Thanks for speaking with us.

Learn more about the companies mentioned in a special report at

Carlos Andres is the managing editor and chief analyst of the Frontier Research Report, a natural resource-oriented monthly investment newsletter focused on high-risk, high-reward junior exploration companies in emerging and frontier markets. Andres identifies countries and companies where "perceived" risk is much higher than "actual" risk, providing opportunities to profit significantly. Andres has been a natural resource analyst and investor for over 15 years.

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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/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: Lion One Metals Ltd., Sulliden Gold Corp. Ltd., B2Gold Corp. and Minera IRL Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Carlos Andres: I personally and/or my family own shares of the following companies mentioned in this interview: Lion One Metals Ltd., Sulliden Gold Corp., Minera IRL Ltd., Gran Colombia Gold Corp., Mariana Resources Ltd., Rio Novo Gold Inc. and Azumah Resources Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

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