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Chris and Michael Berry: What the Boomers Got Wrong—and Right—About Natural Resource Investing

Source: JT Long of The Gold Report   (6/15/15)

Chris Berry Michael Berry What do Gen Xers not understand about value investing? What can Millennials learn from today's resource investors? In anticipation of Father's Day, The Gold Report, quizzed Chris and Dr. Michael Berry, authors of the Disruptive Discoveries Journal, on how investing has changed over the years in the gold, silver, niche metals and energy space, and what they are investing in today to make sure they survive to see the next cycle.

Natural Resources

The Gold Report: Mike, we often hear that the current generation doesn't realize how good they have it compared to when you had to walk uphill both ways through snow to make a trade. Is it easier to invest today with all the resources online and pundits around every corner or is it harder to cut through the noise and find the best opportunities?

Michael Berry: While the Internet makes it easier to do research and make a trade, that doesn't mean it is easier to make a good trade, or better still, a smart long-term investment. I think it's challenging today. It's easy to trade, but much more difficult to create real wealth. A P/E multiple used to have real meaning. Today, the pace of the market is so fast, there are so many flash traders, so many games being played and so many nickels being minted, that it is difficult to figure out what is real. There are debt and equity bubbles out there that have been being created for the past two decades. They can be difficult to take advantage of because investors have to go against the prevailing thinking.

"Quaterra Resources Inc.'s Yerington property could become a major world-class copper resource."

Hedge funds can't make it today; only the private equity players seem to be successful and they have tremendous advantages. Almost all central bankers are in the investment game now. The Federal Reserve owns 25% of the Treasury bond market. What do they plan to do with their investment? There is US$9 trillion sloshing around the world today and a global exchange rate devaluation. These issues make central bankers powerful new players and make the market more challenging for individual investors.

TGR: Chris, did the boomers and the flash traders wreck it for the rest of us?

Chris Berry: Algorithmic trading has raised many issues while at the same time solving others. Regarding the boomers wrecking it for us, I don't necessarily think so. True, debt and deficits must ultimately be reckoned with and its through debt that we in the West have been able to live beyond our means, but the cost of technology is declining so quickly and the opportunities that it brings paint a reasonably optimistic view of the future, in my eyes. There are clear structural challenges and inefficiencies in the markets today, but I have faith in human nature to confront and solve these.

TGR: Chris, you just spoke at the Cambridge House Investment Conference in Vancouver (See our story on the Vancouver conference takeaways here). What was your message to current resource investors looking to take advantage of the opportunities you see all over the world?

CB: I discussed the idea of disruption in energy markets and I laid out the case for why segments of the energy markets are ripe for disruption and offered some areas where I think opportunities exist. According to the World Bank, the urbanization rates in China (53%) and India (32%) are still far below those in the West. Most economists would consider a country "urbanized" when the rate hits 75% (the US and Canada are at about 81%). The percentage differences equate to over a billion people who live at a fraction of our quality of life. Data like this shows that there are opportunities to employ new development models that disrupt the old patterns.

TGR: Are energy metals—lithium and cobalt in particular—part of that disruption solution?

CB: Yes, but it may unfold differently than we are currently forecasting. I define an energy metal as any metal or mineral used in the generation or storage of electricity. That includes lithium and cobalt, but also copper and silver, which have much larger markets with a lot more price transparency. The real growth, however, will be in niche energy metals, including lithium, cobalt and scandium, for example. The demand side is positive for all of these metals over the next 5 to 10 years.

"One important thing Galaxy Resources Ltd. has now, relative to a lot of its peers, is cash."

Lithium demand is growing by 8–10% per year. As we sit here today, the potential for supply disruptions exists in lithium due to major producers having production issues and juniors facing difficulties accessing the major funding for production decisions. Cobalt demand is growing anywhere from 7–9% on a year-over-year basis.

TGR: What companies could move to fill that demand in the lithium, cobalt, copper and scandium space over that time?

CB: In the immediate term, the existing producers of these metals are going to handle the looming demand. Five years from now, we'll need additional supply and this is when the aspiring producers could benefit.

With cobalt, the large-caps are where I am focused. Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE), Glencore International Plc (GLEN:LSE) and First Quantum Minerals Ltd. (FM:TSX; FQM:LSE) are all examples. To be clear, cobalt is a very small part of their business—it's essentially a byproduct of copper and nickel mining. However, I think it's an important one, given the need for cobalt in battery growth. The cobalt value chain is not vertically integrated very well, with a majority of supply coming from one country (the Democratic Republic of Congo) and a majority of the refining taking place in another (China). Freeport-McMoRan is one of the largest refiners of cobalt outside of China, and so it's been a part of its business I pay close attention to. I have also begun looking at cobalt recycling. A company called Umicore Group (UMI:BRU) is a particular focus in that area.

I think a top-down approach is also the best method to evaluating the lithium sector. I've said in the past that lithium is really an oligopoly and when you look at the major producers, they're really chemical or agricultural companies with lithium as a side business. I suppose the opportunity lies in the fact the major producers are all facing different challenges. Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX; SQM-A:SSX) is facing political challenges in Chile and is effectively capped on what it can produce. FMC Lithium Corp. (FMC:NYSE), one of the other major lithium producers in the world, has had production and political challenges. That said, companies like those can produce lithium at a low cost, so any companies looking to compete will have to meet or beat their production costs. I think this requires leveraging technology to do so.

Albemarle Corp. (ALB:NYSE) looks particularly well placed given its acquisition of Rockwood Holdings, which was the number one producer of lithium compounds in the world before it was taken out in a $6.2 billion deal. Lithium production also emanates from China from the likes of Sichuan Tianqui Lithium Industries (002466:SHE) and Jianxi Gangfeng Lithium (002460:SHE), but the insane volatility of the share performance in the Chinese markets are not for the faint of heart.

On the junior side, Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX) and POSCO (PKX:NYSE) are in discussions to mutually pursue a commercialization strategy. If Lithium Americas and POSCO can put a deal together to leverage POSCO's proprietary lithium production technology, which can increase recovery rates, lower the time to market and lower the overall environmental footprint, that is a win-win all the way around. More importantly, it could serve as a model for other aspiring lithium producers on how to enter this rapidly growing space. There are a number of competing technologies in the lithium space that are focused on lowering costs, which I think is an exciting example of evolution in action in mining.

"Silver Wheaton Corp. is a great buy right now."

I also think that optionality is important in the mining sector. One company that's demonstrating this concept is Galaxy Resources Ltd. (GXY:ASX; GALXF:OTCMKTS). The company has a storied history in the lithium space, but one important thing it has now, relative to a lot of its peers, is cash. The company sold off its Jiangsu lithium plant in China, and struck a deal with General Mining, an Australian junior. The deal was recently revised, but will see Galaxy sell 50% of its Mt. Cattlin lithium mine for a total consideration of AU$25M. That gives management of both companies choices and flexibility. What it will probably do is focus on bringing its Sal de Vida lithium development play in Argentina closer to production.

TGR: What about copper?

MB: Today's announcement by Quaterra Resources Inc. (QTA:TSX.V; QTRRF:OTCQX) that Freeport-McMoRan Nevada has committed $7.1 million toward option payments over the next 12 months is certainly a welcome one for Quaterra investors. I have been associated with the company for the past 15 years and participated in its private placements. Two years ago I was elected to the Board of Directors. It appears that Yerington has the potential to become a world-class mine once again.

The Bear deposit, a large porphyry copper system on the Yerington property, will now be explored with Freeport's decision to move into phase two. This will be a $7.1 million program over the next 12 months run by Quaterra to explore the Bear. Of course Freeport, the world's largest copper producer, can opt out at any point in the future, but it can also spend up to $138 million over a period of several years to earn a 75% interest in the property.

How many companies with a market cap of $13 million have a direct investment of almost $10 million from a major mining company with little or no dilution to shareholders?

Hats off to Quaterra's CEO Steve Dischler and to Chairman Thomas Patton for their hard work in seeing this relationship with a major mining company begin to bloom. I own shares in Quaterra and in fact have never sold a share. From the viewpoint of the city of Yerington and state of Nevada, this agreement has benefits all round. Now it's time for Quaterra management to explore the Yerington property, which could become a major world-class copper resource.

TGR: Mike and Chris, you've both lived through a number of investing cycles. Where are we in terms of the rare earth (RE) cycle?

CB: We're close to the bottom. It's difficult to tell when the current down cycle will turn, as getting reliable data out of China is always challenging. It looks like China is serious about addressing its environmental challenges and demand for certain products that require REs continues to grow well above global GDP—two supportive factors for the market. Illegal mining has added excess supply to the marketplace and kept a lid on prices. Because of this, leveraging technology to ensure aspiring producers can compete with the "China price" is imperative.

I'm paying particularly close attention to advances in molecular recognition technology, ion exchange and solvent extraction, all of which are very promising. China is not going to give up its stranglehold on the market no matter what the World Trade Organization or anybody says. If you want market share in this space, you have to beat China on price. The Siemens AG (SI:NYSE) deal with Molycorp is a positive sign that major end users are looking to secure REs outside of China, despite the bleak future for Molycorp. We need to see more of that to reignite investor interest.

TGR: What is more important for a RE company, the resource, the processing chemistry or the agreements with the end users?

CB: If you don't have an offtake agreement, and I don't mean a letter of intent or a memorandum of understanding, I mean a binding offtake agreement, then nothing else matters. A binding offtake agreement is a vote of confidence that you can produce a product that an end user is certain it can integrate into its existing supply chain. Unfortunately for investors, the offtake is typically the last piece of the puzzle to fall into place. Usually, a mining company will need to establish positive economics for a project at a number of different pricing scenarios first. Unless the economics are robust, getting an offtake agreement is not likely, but without an offtake in place, the project is never going to move forward. So it's sort of a chicken-and-egg phenomenon. And it is not just with REs. It's the same thing with lithium, cobalt, graphite and some of these other niche metals.

TGR: Mike, are you seeing the producers stepping up and doing deals as they see explorers moving projects forward? Are you anticipating more mergers and acquisitions in the near future?

MB: Many explorers have stopped moving projects forward for a lack of capital infusion. Mergers are getting done. Unfortunately, because of the duration of this bear market, too many are being done for pennies on the dollar. Even the big gold companies are trimming marginal projects that they otherwise would have developed and kept in inventory. They will wish they had kept them. This bleak setting sets the stage for a massive renaissance in the price of these metals in two to three years. And we'll benefit from that when it comes. Inflationary expectations, when they arise, will tell us when this renaissance is in front of us.

TGR: What are some RE, silver or gold companies that you think are poised to be bought out?

MB: Almost all of them are struggling. One that's struggling with an extremely undervalued share price is Silver Wheaton Corp. (SLW:TSX; SLW:NYSE). It is a great buy right now. The stock has really been beaten up. It gets 25% of production from a number of different silver deposits at $4/oz or $5/oz, including Goldcorp Inc.'s (G:TSX; GG:NYSE) Penasquito project with 1 billion ounces of silver in reserve. The shares are presently trading down 33% from their 52-week high.

There are some really good plays out there that I think will eventually be taken out by their bigger brothers. Quite a few of them are cheap. I'm more interested now in silver and gold companies because they are such a bargain relative to the energy metals companies Chris has been watching. I am focusing on companies that are not in production, not likely to be in production and have enough cash to sustain themselves through the next couple of years. I like to invest in non-public companies at present. There are some great projects that will bloom by 2020 out there.

CB: On the niche metal side, I am not anticipating a lot of accretive M&A. The global RE market is too small for a major mining company to acquire a junior. It doesn't "move the needle" on the balance sheet. In lithium, I think the Albemarle-Rockwood deal was the last large deal we'll see for awhile. I would be extremely surprised if an auto manufacturer actually bought an equity stake in a lithium or graphite aspiring producer. Perhaps technology sharing or possibly a long-term offtake agreement that would act as a long-term call option, but that's it. The energy metals companies are going to have to manage their balance sheets appropriately, minimize dilution and survive until demand outstrips supply. That is why I am focusing on companies that can leverage technology to lower costs. Low-cost potential producers have a chance. The rest do not.

MB: I agree with Chris about the power of technology. Look at the oil industry. The Saudis came out last Thanksgiving and said, we're going to take the American oil industry's staggering new production, specifically the shale oil industry, off line. They did not reduce their production. In effect, the Saudis flooded the market with oil to drive oil prices from $100/barrel ($100/bbl) to $40/bbl. American shale drillers got technology hungry, and they learned how to be better, more cost-effective drillers. Now, the U.S. shale oil industry is absolutely the swing producer in the world. At $60–65/bbl oil, shale producers make money in spite of what the Saudis have tried to do.

The same thing is starting to happen with some of the geophysical techniques that are being used to locate ore bodies in the mining space. Recently, U.S. Precious Metals Inc. (USPR:OTCQB) used Russian satellite technology to map its large property in Michoacan, Mexico. The company has reported high-grade intercepts in its subsequent drilling.

We just used a helicopter technique called VTEM Plus to see several hundred meters deep on our privately held Nieves property. We may have identified a very large intrusive system. The cost? A little over $200,000 for the 55 square mile property. So technology is coming to mining, and it will separate the men from the boys.

TGR: Are you focused more on macroeconomic trends like whether oil prices are going up, or on specific stories and whether they're taking advantage of new technology?

MB: We have shifted a little to playing the royalty side of the equation more. Investors have established a royalty package in the Texas oil fields. They don't drill; they simply buy the property and lease it back to the drillers. Last year, this investment yielded 9.5%. It's just a different way of thinking about how to play the commodity market in a market that doesn't have a yield where the interest rate is negative. So we hope to win no matter what happens, and we do not have working interest risks. So far, it's worked pretty well.

There are some great companies, by the way, in the shale sector—EOG Resources Inc. (EOG:NYSE) and Chesapeake Energy Corp. (CHK:NYSE) to name two. Plus the survivors in the shale oil fields will be highly technology competent. But we don't invest in the companies. We buy properties and lease it back to the operator.

TGR: What about solar power? Are there some solar companies you like?

CB: I've spent a lot of time looking at the solar industry over the last three years. This is where the growth is, and both solar cell costs per watt and energy storage costs are falling precipitously. I think increased scale and distributed generation have the potential to remake our energy infrastructure in the coming decade.

The solar panel business has really become commoditized and today you see a great deal of research and development going toward increasing panel efficiency, which is the percentage of sunlight that gets converted into electricity. The best I've seen today are in the low 20% range, but this is slowly increasing, which helps the overall economics.

One area to think about in the solar space is with "yieldcos." Essentially, the yieldco is publicly traded and owns solar power projects with power purchase agreements that can provide long-term income. The yieldcos have one product, electricity, and they "pay" their investors with revenues generated from the sale of the electricity. The solar companies like this, as it provides a low-cost source of capital for expansion. Investors benefit in that there is an income stream and the risky parts of the business are separated. This concept is similar to the master limited partnership in oil and gas. The most recent example is a yieldco formed between First Solar Inc. (FSLR:NYSE) and SunPower Corp. (SPWR:NASDAQ), but the idea has been around since 1999.

TGR: Chris, you're a father. What will be the hot investing areas for your children?

CB: Everything is cyclical, particularly the commodity space, so I'm not sure if there's a specific area I'd tell them to focus on. I have begun to save money for my girls for college and I hope to be able to give them a choice: You can use the money for college, or you can use the money to start a business that can help address some of the societal issues we addressed earlier in the interview. Entrepreneurialism increases quality of life and creates wealth at the same time. That's a lesson I hope I can impart to my girls.

TGR: Mike, what advice do you have for investors just learning about the natural resource space?

MB: In a world with seven billion people seeking a higher quality of life, I think copper, gold and silver eventually will be more valuable than ever. Gold is constant. Gold is going to continue to be valuable because even now, China is buying as much gold as possible. It is rumored to have purchased the equivalent of the total mined gold production in 2014. The Chinese want their currency, the yuan, to be part of the reserve currency standard, and it will be eventually. They are going to have to have enough gold to back it. Silver, in addition to its monetary character, is used in so many industrial and health care products.

I think oil will bounce above $100/bbl again. Prices will go up and down, and you have to play it as it moves. But I think those liquid markets are easier to manage than smaller markets like graphite. But then again, I've been around for a while, so I could be wrong.

Chris Berry is a writer, speaker and analyst who is focused on the dynamism of energy metals—those metals or minerals used in the generation or storage of energy. He is a student of the theory of Convergence and believes it will have profound effects across the globe in the coming years as urbanization, innovation, and technology create multiple opportunities. He helped create a start up focused on computing with words. Active on the speaking circuit throughout the world and frequently quoted in the press, Berry spent 15 years working across various roles in sales and brokerage on Wall Street before shifting focus and taking control of his destiny. He is the co-author of The Disruptive Discoveries Journal. Berry holds a Master of Business Administration in finance with an international focus from Fordham University, and a Bachelor of Arts in International Studies from The Virginia Military Institute.

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 was the Wheat First Professor of Investments at James Madison University. 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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DISCLOSURE:
1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Galaxy Resources Ltd., Quaterra Resources Inc. and Silver Wheaton Corp. Goldcorp Inc. is not affiliated with Streetwise Reports. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Chris Berry: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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) Michael Berry: I own, or my family owns, shares of the following companies mentioned in this interview: Quaterra Resources Inc. and Goldcorp Inc. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. 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.
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