Well-known and highly regarded throughout the mining and exploration community, Mercenary Geologist Mickey Fulp returns to tell The Gold Report readers about his growing Primer for the Lay Investor, share his musings on the junior resource sector and even hand out a few nugget-shopping suggestions.
The Gold Report: The third installment in your A Primer for the Lay Investor series, “ The Good, the Bad, and the Butt Ugly ” appeared in The Gold Report on February 24. What’s the short story there?
Mickey Fulp: The piece deals with junior resource companies, metal commodities and flagship projects. The gist is that certain metal commodities are conducive to success for a junior resource company, and some metal commodities are not. Carrying that a bit further and bringing in the geology aspect, certain deposit types within these specific commodities are good, bad or ugly for juniors to have as flagship projects.
I then give examples of each: three examples of good types of projects and deposit types, three examples of what I consider bad commodities and/or deposit types, and three examples of the ugly (or the butt ugly as I say)—things I think juniors and investors should avoid at all cost.
TGR: When you’re qualifying the good, the bad, and the ugly, are you looking from a cost of mining point of view, a yield in the mine point of view or all of the above?
MF: All of the above. It’s based on the idea that juniors have limited financing capabilities and limited life spans. The average life of a junior resource stock is probably on the order of five to seven years. A junior needs to select projects that have a good chance of success within a time period of two to five years, it needs to look at something where the production costs are in the lowest quartile, ultimate capital expenditures are within its financing capabilities, and there are multiple exit strategies, whether it’s to develop a mine or get taken out, or even pay the exploration costs to get to the point that it can become a takeover candidate without diluting the share structure so much that it becomes a financial nightmare.
Many juniors select projects that are way too big for their britches. An example would be big porphyry copper deposits. It takes 10 years or more to explore, permit, and develop and you need a minimum of $2-$3 billion in debt and equity financing to put a mine into production. That is beyond the capability of any junior resource company. The exit strategy is limited too: Sell out to a multi-national integrated mining company or a sovereign company looking for smelter feed. So nearly all of these companies fail.
TGR: What do the first two installments in your Primer focus on?
MF: Bear in mind, there is no sequential nature to these things. Whatever I am inspired to write at a particular time becomes a chapter in this series. The first one (August 25, 2008) dealt with “Reserves and Resources,” and I was motivated to write that because it became very apparent to me that many investors, investment advisors, brokers—even geologists and engineers—did not understand the difference between reserves and resources. So this piece laid out the Canadian Institute of Metallurgy’s 43-101 definitions in layman’s terms.
The second in the series was “Share Structure, People and Projects” (December 15, 2008). Those are my three key criteria for evaluating companies. I have plans to do “What Do Drill Results Mean?” and actually posted a couple of others that will fit into this series.
It’s in the back of my mind that sometime this is going to be a book; so when I have 10 or 15 chapters, I may bundle them up and rework them to become less time-sensitive and perhaps publish a little book.
TGR: Your third one—“The Good, the Bad and the Butt Ugly”—deals with geology in a way that you are to be applauded for. It makes sense; even non-geologists can understand what you were saying. Would investors find all three installments on your website?
MF: First of all thanks for the compliment, the idea is to make them understandable to the average investor; and yes, they are available in Mercenary Musings, a tab on my website (MercenaryGeologist.com). All my newsletters appear on the Musings page. Just scroll down until you find the one you want to read.
TGR: In another recent Mercenary Musing (May 19, 2008), you wrote about your investing approach, which involves finding undervalued stocks and picking stocks that can double. You also note that in order to make a profit you need to sell the stocks, and so a key element in the junior sector is the need to move paper. Given that that hasn’t really been happening in the last six to nine months, what do you see as potential for investors in the junior sector? Is paper starting to move?
MF: Things are looking up in the junior sector, particularly in the gold business. Lots of money is being raised for good gold projects. As you point out, liquidity has been a problem in the junior resource sector since probably late spring. It was exacerbated by the usual summer doldrums and then the market crash. Paper just didn’t move.
One of the things I look at on an ongoing basis is volume on the Toronto Venture Exchange, and in November of ’07, up to 400 million shares a day were trading. It’s about half that now. Liquidity is always an issue with juniors. Some of them are very liquid; most are not; some are tightly held and illiquid for that reason.
TGR: Would you care to share any examples?
MF: Sure. Lydian International (TSX:LYD), a company I just wrote up “ Flying Under the Radar ,” February 16, is tightly held and has very low liquidity, and it’s sitting in the low 40s. I have been accumulating Lydian. I like this story. Their largest shareholders are the International Finance Corporation, which is a subsidiary of the World Bank, and Newmont. Insiders and family and friends hold most of the remaining stock. Maybe no one wants to sell at 40 cents because they also think it’s undervalued.
There is a lot of money being raised for good projects. It started with Kinross raising $400 million. Then Newmont raised $1.7 billion; Redback Mining raised $150 million. That happened in the first half of January, and then look at what happened in the second half of February: Osisko Mining Corp. (TSX:OSK), a junior mining company in the Abitibi area in Quebec, raised $403 million. Apollo Gold Corp. (TSX:APG) raised $88 million for its project on the other end of the Abitibi near Timmins, Ontario. We can even go further afar. Dynasty Metals & Mining (TSX:DMM), a potential gold-silver producer in Peru, raised $10 million. Alamos Gold Inc. (TSX:AGI) raised $83 million for their operations in northern Mexico.
When those private placements become free trading, along comes better liquidity. So I’m bullish on liquidity improvement in select juniors at this point. Juniors that don’t have good business models, share structures, projects, and cash on hand are going to fail in the next year or so, but there are still many good junior gold stocks.
TGR: You just gave us a couple examples of large gold companies—Kinross Gold Corporation (K.TO) (NYSE:KGC) and Newmont Mining Corp. (NYSE:NEM)—and several smaller ones—Apollo, Dynasty, Alamos, etc. Do you think the companies that are receiving funding will see liquidity in their stock? Or does the entire junior market have to rise up and get liquidity to see any of these individual ones start to take off?
MF: Oh, I think the individual ones will lead. Reaganomics is not my favorite economic system, but I am a trickle-down sort of guy in one sense. The mid-tier juniors are the ones raising big amounts of capital now, and eventually that will trickle down to some of the smaller players in the market thru mergers, acquisitions, joint ventures, and equity investments.
And indeed the smaller juniors are raising money right now. For instance, Lydian recently raised another $3 million. In Lydian’s case, they need liquidity; so we would hope that in four months, when these private placements become free trading, we will see more volume on the Venture Exchange. Of course, that’s predicated on a good gold price to drive the junior market. When stock becomes free trading, you want it in the right hands, and those right hands can be different groups for different companies. If you have a lot of liquidity, you want to put the stock in hands of people or institutions that will hold it for the long haul. But as I say, Lydian needs a North American marketing effort and a larger retail base. With positive exploration results and a continuing strong gold price, that should lead to a rising stock price and increased liquidity.
TGR: You said Lydian is tightly held. Why would those holders even begin to trade their stock at 40 cents? It seems as if it’s going to continue to be illiquid.
MF: Point well taken. If it stays at 40 cents, it will remain illiquid. I think we will see liquidity when the price rises. The catalyst is their flagship project. I’m very bullish on their Amulsar project in Armenia. Bear in mind, I haven’t looked at the project on the ground yet but will be there in the late spring when the snow clears and they start drilling. I know the geologists and worked with some of the group in the past. The Amulsar project is a joint venture with Newmont, and Newmont geologists really like it. Together they’re going to put somewhere between $5 million and $6 million into the project this year. There could be a biggie there. This summer’s program is important to determine how big it might grow. The old truth tool, the core drill, will tell.
TGR: When do you expect drill results to come back?
MF: They’ll probably start drilling around mid-May, so we could expect drill results to start coming in the mid-summer.
TGR: You were following Animas Resources (TSX.V:ANI) for a while. Are you keeping up with it still?
MF: Certainly, from a geological point of view, Animas Resources is an intriguing play, especially since they control the entire Santa Gertrudis district. Their first round of drilling hasn’t been especially successful in terms of gold numbers, but it is what we geologists like to call a “technical success.” They’ve drilled strong and large alteration systems. Animas is trading at 28-30 cents today.
TGR: Would you put it the category of a stock you’d expect to double?
MF: I don’t buy anything unless I expect it to double. It’s 30 cents; it could go lower. Who knows? But at that price Animas is certainly interesting. Historic resources in the district are over 700,000 ounces gold, so do a dollar per ounce in the ground peer comparison and see what you get. Near term catalysts could be a series of 43-101 resource estimates on the various deposits. They are being worked on now.
TGR: Do you have some other juniors that intrigue you as being undervalued?
MF: Well, I’m going to toot my horn a little bit and talk about one I’d told you about in mid-December, PDX Resources Inc. (TSX:PLG) (formerly Pelangio Exploration). If you remember, they were in the Detour Lake Camp and owned about 42% of Detour Gold (TSX:DGC). Those companies have since agreed to merge. When we talked, PLG was a 70-cent stock. Now, it’s trading at around $2.25. Soon I’m going to be a Detour Gold shareholder. The catalyst now for DGC is the pre-feasibility study expected in Q2 and a full-blown feasibility by year’s end. With positive results on these studies, Detour is going to get taken out. We need to look for some more companies like that.
At this stage, a few stocks are on my radar list. But because they are still just potential candidates for coverage, I’m reluctant to talk about them until I do more due diligence. Sorry to be vague, but I can’t throw names out there until I’ve done my homework. I would just say to stay tuned.
TGR: Another thing we talked about in our conversation in December was the gap between the prices of gold and silver, which was broader than it is now. At that time, you thought silver was a great play. What’s your feeling now that the gap is narrowing?
MF: When we spoke in December, the gold-to-silver ratio was 80. Today it is 70, so it’s not quite as compelling to buy physical silver as it was in late fall when I took possession of the big 1000-ounce silver bars. They’re quite a load. The historic ratio since our bull market started in 2003 has been somewhere around 55, so it’s still a little out of whack. I accumulate precious metals simply as a hedge against calamity. They’re my insurance policies.
TGR: So you take physical possession of both gold and silver?
MF: Yes, when I buy, I take physical possession. I am a firm believer in physical possession. Personally, I own no ETFs. I play the market through junior stocks, and I prefer physical possession of both gold and silver. Part of the problem with buying physical gold and silver now is that you might be at seasonal highs in the market and because of demand, markups are very high for the products that are available. Remember that gold hit its all-time high last March. I generally buy during the summer doldrums; late July until mid-August is the best time of the year to buy because you’re generally going to hit the yearly low. So, I find myself buying physical gold and/or silver in the summers.
I’d be a little reticent, personally, to buy at current levels because I think gold now is overbought. I’ve been saying this—I said it to my mainstream broker in the States a few weeks ago when it was up around $930 or $940. I thought we were due for a correction. Since then, it zoomed and touched a $1,000 three or four times but hasn’t held at that price and a correction has ensued.
TGR: We hear talk about buying gold because of the potential devaluation of the U.S. dollar. Is most of this rise in gold reflecting people’s concerns about that?
MF: I think so, the safe haven theory. I am never a gold bug but right now I am a gold bull. We have been pounding it into peoples’ psyches for so long that maybe the general populace is starting to wake up to the fact you go to gold in times of uncertainty. People with assets are choosing now to follow the advice of those in our business, which is to keep 10% to 20% of your net assets in physical gold and silver because they are hedges against calamity.
TGR: But if people are moving into gold as a safe haven, would we expect to see the seasonality you described this year?
MF: Good question; probably a question to debate over a beer in a bar. I don’t really have a strong opinion on that. But jewelry demand is way down and that’s usually 60% of the market. I will tell you what I’m doing lately, though. There are ways other than on the spot market to buy gold. I’m a nugget aficionado. The placer miners come out of the Yukon and Alaska and they hit the shows in Spokane in December and Vancouver in January. That’s a good time to buy gold nuggets, so I bought a few gold nuggets lately. They almost always trade at a premium to spot gold, but—
TGR: They trade at a premium?
MF: Yes. They’re specimen gold, so you pay for the mineral specimen quality of the nuggets. Generally, the bigger the nuggets, the more the premium over spot gold—maybe even one and a half to two times over spot. Sometimes it’s more for museum-grade, but often much less with artisanal miners in the third world. I’ve bought nuggets for as little as two-thirds of spot in Mexico. If you buy them in the retail market—at a gold and silver shop or a rocks and minerals place—you’ll probably pay three times the spot price of gold for the best specimen-grade nuggets.
TGR: What’s the advantage to nuggets over coins?
MF: The advantage over numismatic coins is that they are less speculative and therefore less risky. They have a base price worth the actual weight of contained gold. I’m an amateur mineral collector, so that’s part of what I do; I collect gold nuggets. But rather than going and buying in a retail store, I go directly to the miners who sell nuggets. That way, I can buy at a wholesale price and could turn around and sell those at retail if I chose, or keep the best and sell some of lesser quality to recoup my investment, or trade for other mineral specimens, or perhaps just hoard them, or all of the above.
TGR: But you have the expert knowledge to do that; some of us would be collecting big bags of Fool’s Gold.
MF: Oh, it’s not really that hard. Ask your friends, find a mineral collector, find a miner that you can get to know and trust. The North American placer miners I know are as honest as the day is long. It can be a bit dangerous in some parts of the world but you just need to be astute and careful, take a local friend or a business associate or maybe your bodyguard along. I carry a little digital scale and my geologist’s loupe with me everywhere on the road, so I’m always prepared. You’re looking for ones that are aesthetically pretty and pleasing to the eye. I’d be glad to show anybody at any time a little bit about how to buy gold nuggets.
In the interest of full disclosure, I am a shareholder of Lydian International, Animas Resources, and PDX Resources and, on occasion, a consultant to the first two companies.
A confirmed contrarian who invests solely in stocks he expects to at least double in value and considers himself a classically trained economic geologist, Michael S. "Mickey" Fulp is a Certified Professional Geologist who earned his bachelor’s degree in Earth Sciences at the University of Tulsa and his master’s in Geology from the University of New Mexico. Specializing in geological mapping and property evaluation, he brings more than 30 years of experience as an exploration geologist searching for economic deposits of base and precious metals, industrial minerals, coal, uranium, and water to his popular Mercenary Musings and other venues. Mickey launched MercenaryGeologist.com almost a year ago. You may contact him at [email protected] .
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