The Gold Report: Michael, can you tell us why you believe we are at the psychological and valuation bottom of the trough in the junior mining sector?
Michael Ballanger: Using the TSX Venture Exchange (TSX.V) as a proxy for the junior mining sector, the TSX.V between 2003 and 2007 traded in a range of approximately 1.5 to 3.3 times the price of gold. In the 2008 crash, it went down to 0.8 times the price of gold. Going back 15, 20, 30, 40 years, the TSX.V had traded on a 1:1 correlation with either the oil price or the gold price. Since the 2008 crash, there has been an immense aversion to risk in the junior mining space. At the end of 2012, trading was around 0.71 times the gold price. We have never seen valuations like this in the junior mining sector.
"I am far more bullish on the senior producers and on the junior and intermediate developer/producers and explorers than I am on the physical gold price."
At the bottom of any bear market, sellers become exhausted so only survivors are left. If you accept that premise, it becomes important to see who has survived or who has the management capabilities, the financing and high-caliber projects to advance. Those are companies that will benefit from what I think will be a normalization of the Venture Exchange's ratio to the actual gold price. I think a realistic level would be 1.5–2.0 times the gold price.
Unlike most experts, I am far more bullish on the senior producers and on the junior and intermediate developer/producers and explorers than I am on the physical gold price. I think there is a lower-risk, higher-reward potential in the shares than in the metal right now.
TGR: Given the market performance in the junior precious metals sector and in the junior mining sector as a whole over the last couple of years, do you feel like the characters in the film "Groundhog Day," reliving the same events over and over?
MB: What is peculiar about this cycle is that we have not experienced the "mania phase" that typically happens at the end of a bull market. At the bottom in 2009, again in 2011 and all through 2012, despite near-record gold prices and very high energy prices, it felt as if we were in the post-Bre-X Minerals Ltd. period.
You need to remember that the symbol for crisis in the Chinese language is made up of two symbols: the first one is danger and the second is opportunity. I see tremendous opportunity, but not without challenges.
In my work, I have to be very good at identifying management teams and projects that will survive and will excel in most environments. With market valuations so low, I feel like a little child in a candy store with $10 in my pocket. There is so much to choose from.
Due diligence takes longer, yes, but when I find something, I can hand my clients an awfully big rate of return if they are prepared to take the risks associated with the sector.
TGR: We hear a lot about management teams at junior mining companies. You have said that you prefer management teams that incubate companies to preserve shareholder value. Can you expand on that concept?
MB: The perfect way to incubate a junior mining company requires, first, a private company with a very small group of shareholders who are looking three to five years down the line. The caliber of the shareholder base is paramount. The ideal shareholder is one who has been successful in his or her own business and knows how long it takes to start up, develop and eventually reap the rewards of owning a start-up. Having shareholders with a three-to-five-year timeframe eliminates frequent turnover in the shares, which makes it a lot easier for the management to raise capital for development at progressively higher prices.
"A well-incubated company keeps its financing strategic."
The second most important thing relates to raising money. If a company needs $3 million (M) for a project, it should not try to raise $10M. If a company raises only what it needs, it avoids diluting shareholders' equity. Do you remember the old expression "Friend or foe, take the dough"? In the last few years, junior mining companies have taken the dough, which is always associated with larger percentage fees charged by the investment industry, and companies have been trashed by the market. They have diluted shareholder equity.
A well-incubated company keeps its financing strategic, on a needs basis and at progressively higher levels. This minimizes dilution and enhances shareholder value. These companies can go to their shareholders first for financing. If they wrote a check at $0.10/share, they will write another check at $0.35 and another at $0.75 because they understand the business model.
TGR: How does an average retail investor find out who the shareholders are in a junior mining company?
MB: I wish I had a good answer to that. You might start by searching the company's press releases on its website or through SEDAR. You can cross-reference what the company financed at and measure that against how much it is spending on a month-to-month basis. If the company has executed its business plan and hit its benchmarks of estimated ounces, was that done on time and on budget?
That information will infer the caliber of the shareholder base and the kind of guidance the company is getting from its fiscal adviser. It will tell you how committed management is to preserving and enhancing shareholder value.
TGR: Can you give us a couple of examples of companies that have succeeded with that incubation strategy?
MB: Tinka Resources Ltd. (TK:TSX.V; TLD:FSE; TKRFF:OTCPK) is the best example. Its Colquipucro property in Peru is a great asset. I have been recommending Tinka to Gold Report readers since 2009.
In 2010, we raised a little over $1M and asked management to get the permits in place to develop the silver resource. Just before the meltdown in mid-2011, after the shares had hit a high of $0.75, there was a correction. We were set to do a $0.50/share financing to raise $5M. We scaled that back to $0.35/share to raise $2.25M. This minimized the dilution during a difficult period in the market.
In December 2012, Tinka moved its Zone 1 silver resource from 20.3 million ounces (Moz) to 32.7 Moz, under budget and in a very acceptable timeframe. The share price responded; the market went to $0.75–$0.80/share. The $2.25M raised was within the budget. If the company moves forward over the next 6–12 months to a level representative of fair value relative to its proven resource, it can do a much bigger financing at fair value. This gives the early shareholders a significant lift and, most important, a reason to hold the shares.
Another company that did not get hit in the downturn due to the caliber of its shareholder base is Kaminak Gold Corp. (KAM:TSX.V) in the Yukon, led by Rob Carpenter. It started off in 2009 at around $0.15/share. In 2011, when everybody thought the Yukon would become the next Northwest Territories diamond rush, it moved above $4.50/share. When the European meltdown hit, Kaminak executed beautifully. It minimized dilution and did not issue overly aggressive amounts of paper. The company still has less than 100M shares outstanding and 1.9 Moz or more.
Kaminak's shareholder base is primarily institutional. The people who run these portfolios are very capable and very sharp, but their hands are tied. If the retail public decides to redeem the fund, the portfolio manager has no choice but to liquidate to meet the redemptions. When they sold Kaminak, it was not because they wanted to, but because they were forced to. In the case of Tinka, no one was forced to sell through redemptions.
Both companies have executed beautifully. Both represent great shareholder value at current levels and have lots of blue-sky potential. Tinka closed at an all-time, 52-week high in 2012, while Kaminak closed at about 35% of its all-time high.
TGR: Tinka's share price has been trending higher since August. What is its next step? When can we expect a maiden resource estimate?
MB: Tinka has an Inferred, NI-43-101-compliant resource of 32.7 Moz. It has a permit and recently announced a villager agreement.
Tinka's management team in Lima has a done a superb job. The team has 30-odd years of experience in the mining industry in Peru. They negotiated both the government permits to drill the Zone 1 silver project and the Ayawilca base metal massive sulphide discovery. They also navigated relations with the local communities and what is called the "social contract" in Peru.
It took six months longer than expected to negotiate the villager agreement with the Pillao village, which is associated with the silver resource. It took longer than expected in Yanacocha, where Ayawilca is, as well. But if your shareholder base understands how politics and business co-mingle in Peru, they have the patience to let management do it right. Tinka's community relations staff used education and fairness to turn the villagers into advocates who are now running around wearing Tinka T-shirts and baseball caps.
TGR: What can you tell us about Tinka's two projects?
MB: Tinka's safety valve is its silver resource, Zone 1, which is being expanded rapidly. I expect the infill drilling has the potential to substantially move up that resource's 32.7 Moz; a resource of about 35–40 Moz is necessary to get on the radar screen and I am confident it will achieve that level in 2013.
The second thing that sets this resource apart is that it is all on the surface; it is in an oxide zone, amenable to leaching, and you get 97% recovery rates after 72 hours using bottle-roll technology. The feasibility of putting something like this into production with a very low capital expenditure is extremely high. This offers a level of security for Tinka's shareholders—you can get that valuation metric with very little risk.
Ayawilca is a new, massive zinc sulphide discovery made in late 2011. It is my passion. I am a base metal person and massive sulphides are the Holy Grail for me. When Tinka started hitting intercepts of massive sulphides containing economic-grade zinc, the hair on the back of my neck started turning up; this thing has structure. The geophysics say that Ayawilca has elephant capabilities. It is 70km down the road from Cerro de Pasco, one of the biggest zinc mines in Peru, owned by Volcan Compañia Minera SAA (LIN:PE:VOLCAAC1). The number-one marker mineral at Cerro de Pasco is rhodochrosite, and Tinka's discovery holes contain a lot of rhodochrosite. I am really excited about Tinka and its current share price objective has not factored in Ayawilca.
TGR: Kaminak put out a resource estimate in December of roughly 3.2 Moz Inferred at its Coffee project in the Yukon. What did you think of those numbers?
MB: Rob Carpenter has delivered more than people ever expected. I am bullish on the Yukon. I expect it will be the next major Canadian gold mining camp, not unlike Timmins or Kirkland Lake. And I think Kaminak has above-average potential for people willing to take the risk and have the patience to understand that these businesses take time to develop.
TGR: A lot of investors in this sector are employing strategies that worked in previous cycles in the junior mining sector, but seem ill-suited to today's market. Why is that?
MB: It dovetails with what we discussed about how you do your due diligence.
In 2000, coming off the Bre-X Minerals Ltd. disaster, junior mining companies could not raise money for any project regardless of its potential. It was easy to make money in the early part of that cycle because valuations were so depressed.
From February 2011 to the end of 2012, we were in what I call a "valuation compression cycle." Normally, you expect increased gold or silver prices to attract new investors when a company announces a discovery, and that demand will take a share price higher. In a compression period that does not happen. In a compression cycle, you have to make sure that your entry point is at a level that has already wrung out all the early or mid-range investors who bought it at the wrong price.
If you or your adviser has been investing only since 1991, 1998 or 2001, you may think that a company that has been in the range of $0.50 to $2/share, and that if you buy it at $1/share, the worst it can do is go back to $0.50/share. That is not the case; it can go back to zero.
There is an expression in this business, "there's no fever like gold fever." No one younger than 35 or 40 has any idea what a "mania phase" is like. And I maintain that we are heading into a mania phase for the junior mining sector.
I am not sitting here with a starter pistol, ready to tell you exactly when the mania will start, but there has never been a time when the gold price has advanced as it has over the last 12 years where the entire mining sector—junior, intermediate and senior—did not move to bubble valuations.
We may see gold at $10,000/ounce (oz) or $5,000/oz, but the lower-risk entry point now is into the abject, stark psychological depression that is the mining shares. That is the lower-risk transaction right now.
TGR: What are some other names you are high on now?
MB: In the Yukon I like Comstock Metals Ltd. (CSL:TSX.V). I have spoken to CEO Rasool Mohammad a number of times; I like his passion and commitment. Kinross Gold Corp.'s (K:TSX; KGC:NYSE) Golden Saddle project is across the Yukon River from Comstock, and Kinross needs to find more resource ounces to rationalize its infrastructure. If Comstock puts any ounces together in its 2013 campaign, it could be absorbed like a minnow in front of a shark because Kinross needs those ounces.
Bitterroot Resources Ltd. (BTT:TSX.V) has a nickel-copper, platinum group metals prospect in northern Michigan tied to Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCP). Bitterroot trades at $0.11-0.12/share. I am just in the due diligence process right now, but it certainly has my attention.
TGR: You follow the Chicago Board Options Exchange Market Volatility Index (VIX) and you track volatility. Should retail investors get used to more volatility as 2013 unfolds?
MB: They certainly should. Howard Marks wrote an article commenting on the high level of complacency in the market. People are buying into the equity markets because they see the Federal Reserve or the Treasury defending equity levels through interest rate policy or open market operations. That is why the VIX has come down so far.
I like seeing the VIX trade at a reasonable level—20 or 22—because it says to me that there is some fear in the market. A VIX under 15 tells me there is too much complacency. I would use VIX to hedge portfolio positions looking six to nine months out, particularly now that it is trading at a multiyear historical low, under 14.
TGR: What wisdom can you share with our readers from your 35 years in the business?
MB: A phrase I learned at the Wharton School has always served me well: "Never underestimate the replacement power of equities within an inflationary spiral."
All the central banks on the planet are doing their best to re-inflate their way out of their debt problems. When they all are doing their best to debase their currency, it is no different than a company trading on an exchange excessively diluting its shareholder capital. In the equity market, that is a negative for price. In the fiat currency world, currency dilution is punitive to the purchasing power, to the value of that currency. This makes currency the great short sale for 2013.
I recommend that people short sell or sell cash. The inverse of that is to buy assets. The integrity of the purchasing power of cash and cash equivalents is the greatest danger right now. People sitting on a pile of cash for retirement could wake up to a situation like Weimar Germany in 1921–22, instead of paying $1.20 for a loaf of bread, it suddenly costs $5 or $6. Inflation is like toothpaste, once it is out of the tube, it is impossible to get it back in.
Investors should be buying things, investing, taking their savings and making sure that they are selling or shorting cash. That includes owning companies that produce gold, silver, resources, farmland, anything that kicks out a rate of return on commodities and goods that people require.
In nominal terms, that means you could see a much higher equity market 12–18 months down the line without feeling it in the economy, because it is the currency that will have gone down, not the inherent value in the businesses or the shares.
TGR: Michael, thank you for your time and your insights.
Originally trained during the inflationary 1970s, Michael Ballanger, director of wealth management at Richardson GMP, is a graduate of Saint Louis University where he earned a Bachelor of Science in finance and a Bachelor of Art in marketing before completing post-graduate work at the Wharton School of the University of Pennsylvania. With more than 30 years of experience as a junior mining and exploration specialist, as well as a solid background in corporate finance, Ballanger's adherence to the concept of "Hard Assets" allows him to focus the practice on selecting opportunities in the global resource sector with emphasis on the precious metals exploration and development sector. Ballanger takes great pleasure in visiting mineral properties around the globe in the never-ending hunt for early-stage opportunities.
Want to read more Gold Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Interviews page.
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: Tinka Resources Ltd. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Michael Ballanger: I personally and/or my family own shares of the following company mentioned in this interview: Tinka Resources Ltd. I personally, Richardson GMP, and/or my family is paid by the following company mentioned in this interview: Tinka Resources Ltd. I was not paid by Streetwise Reports for participating in this interview.
4) The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results.
Richardson GMP Limited, Member Canadian Investor Protection Fund.
Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.