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Paul van Eeden: Finding Value Amidst Volatility
Source: Karen Roche of The Gold Report (2/23/11)
Despite the risks and volatility inherent in the natural resources sector, market frothiness and the absence of fundamentals to support current valuations, Cranberry Capital Inc. President Paul van Eeden says, "there are always opportunities in the market." Find out where those opportunities exist in the current market and how to profit from them in this exclusive interview with The Gold Report.
Paul van Eeden: A lot has changed in three years and the recession was not as deep or severe as I had expected. Many people have been adversely affected, no doubt, although it could've been much worse.
I'm not an apologist for central bankers or the Federal Reserve, and I don't believe in fiat money or that the Fed has a role to play in our economy. But in the context that they exist, and given Bernanke's job description, I think he did a good job during the crisis. Of course, what we really need is for the system to get flushed clean. But that would be far less attractive to the majority of the population to hold much hope for its occurrence. After all, a democracy is really nothing more than mob rule; and in this case, the Fed saved the mob.
TGR: Many people believe all the Fed did was kick a larger depression down the road.
PvE: I agree that it is merely postponing the inevitable, but that is the Fed's job. It's nothing new—it's what central bankers do. While central bankers are part of the banking system that debases our currency and, therefore, is partly to blame for some of our troubles, it certainly isn't solely to blame.
Part of the blame also lies with all of us—people who buy cars and houses they can't afford or go on shopping sprees with credit cards they cannot repay. Just because we have fiat money and people manipulating it doesn't mean we have to live above our means. It's very convenient to blame Bernanke for debasing our currency, banks for making us offers that sound too good to refuse and credit card companies for issuing cards to people who aren't creditworthy. But does that mean we have to partake in those activities? No. We have to take personal responsibility for our actions. Only by taking responsibility for our actions can we figure a way out of this. Stated another way, as long as we rely on others to solve our problems and live above our means with the expectation that somehow, someone will fix it for us later, we will never get out of this mess. It will only get worse.
TGR: You mentioned that you don't think the situation will get much worse. If it's not much worse, what are we postponing? The recovery?
PvE: Yes. The pain could've been worse, and I think we avoided that. But what we really postponed is the recovery. The way I see it, the central bank robs our future living standards in exchange for a higher living standard today by debasing our currency and reducing the value of our future savings and earning capacity. We do the same thing as individuals by taking on too much debt. When you borrow, all you're doing is spending today what you hope to earn in the future. You're trading a higher lifestyle today for a lower quality of life in the future.
TGR: So, if we avoided even greater downside against a more prolonged recovery, on balance isn't that better than having to dig out of an even greater depression?
PvE: No, because many problems creep in. The business cycle is like a lifecycle; you can't change it. People make mistakes with their money during periods of euphoria and optimism in the economy. There's malinvestment, gambling, speculation and misallocation of capital. In a depression or periods of conservatism, those misallocations of capital are corrected because those who were too speculative and perhaps took on too much debt go bankrupt. Production assets transfer from irresponsible people to more responsible people, who then build businesses back up, hire employees and increase our living standards. That's what we need. Keeping irresponsible people in business, forgiving their loans, debasing the money supply and/or reducing interest rates so they can make loan payments keeps the assets in the hands of irresponsible people who will continue to manage those assets in a sub-optimal fashion, until one day the party really comes to an end for good. That's not how to build wealth.
Misallocation of capital, speculation and malinvestment wastes both human and natural resources, including energy, on nonproductive enterprises. By enabling nonproductive enterprises and wasteful people to continue doing what they're doing, the Fed, governments and policymakers are postponing our ability to be more economically productive and thus are a hindrance to improving our standard of living. It gets much worse when you factor in the wasteful nature of government make-work programs (i.e., projects, such as digging holes and filling them up again, that have no useful purpose other than to make work).
TGR: Despite all that, the market has had an incredible rebound and seems to be continuing upward.
PvE: The market's rebound, in my opinion, is neither here nor there. We have to look at the structure of the economy to determine whether the improvement we're seeing is sustainable. Take the unemployment rate, for example. The authorities would have you believe it is stabilizing and showing signs of improvement. But a lot of those signs are statistical anomalies because they don't account for people who've abandoned their job searches. So, in reality, the labor situation hasn't improved—it's deteriorated. If you look at the U.S. economy fundamentally, it isn't actually getting better. We're just getting more used to the way it is. On that basis, the rally in equity markets perhaps has more to do with the decline in interest rates than fundamental improvements in the economy. So, I'm still very nervous and continue to see a lot of risk in both the equity markets and economy.
TGR: As an investor, how do you integrate that thinking into your investment strategies?
PvE: By being very scared. It's healthy to be scared when you're an investor because it helps you avoid some of the mistakes you might make otherwise. But being scared doesn't mean you can't be an investor and deploy capital in these markets. Despite tremendous rallies in both equity and commodity prices, every now and then I come across a business that's selling for an attractive price. In my investment business, that's what I'm looking for—value at an attractive price. You can still find instances of that in the market.
TGR: Even now?
PvE: They're always there. I used to work for Rick Rule and one of the first things he tried to teach me was that opportunities are like commuter trains. If you miss one, there's another one coming about five minutes behind it. Sometimes there are more opportunities than at other times, but there are always opportunities in the market.
TGR: So where do you find value?
PvE: If I can find a business with competent, trustworthy management at a price I would've paid for it in any market—good or bad—I'll buy it. That's where I'm focusing much more of my energy. My decision is based on the business, what I think of it and what I think it's worth—not on what the business is trading at relative to another. I try to find those opportunities in mineral exploration. They're there from time to time; you just have to recognize them. But the natural resource industry is very risky and, within it, mineral exploration is even more risky. I specialize in very early stage exploration, which is one of the riskiest areas of that business. It may sound a bit contradictory to say I'm a value investor at heart while investing in this high-risk area, but I think you can find good value there.
TGR: Can you share some of the companies that provide good value in the current market?
PvE: Yes. Last September, I was asked to join the Board of Miranda Gold Corp. (TSX.V:MAD). I've been a shareholder of Miranda on and off for the past eight years or so, and I know the company very well. It has an excellent management team and one of the best exploration teams in the business. When I agreed to become a director, I also bought shares in the company. I have confidence in Miranda's management team; and if I'm going to be involved personally, I will take the risks and rewards alongside my fellow shareholders. I would not have agreed to become a director nor would I have bought the stock if the company had not met all my investment criteria.
I look at a stock certificate as representing fractional ownership in a business. So, if I find a business like Miranda, of which I'm very happy to be a fractional owner at an acceptable price, those are the investment opportunities I look for.
TGR: You've created a variety of models. Some are related to the fair value of gold, some to inflation. Are you using any of those?
PvE: My gold and inflation models are very long-timescale macroeconomic models that don't necessarily help pick stocks. When I pick stocks, I look primarily at management. It doesn't matter which business or industry—all businesses are about people. Do I want to do business with these people? Do I trust these individuals with my money? Things like that. Then I start looking at what I'll be paying for the business, whether it has a proper business plan it's capable of executing, etc. It's a process. The more you go through the process of selecting business investments, the more accustomed you get to it.
TGR: You specialize in the riskiest area of a high-risk sector. Where's the appeal in taking such risks?
PvE: I've always liked the natural resources sector. The telephones we're talking on right now are made of plastic, which is a byproduct of the oil industry. Copper and other metals are inside this plastic, which is only possible because of mining. My computer's full of metal and I drive a car, which uses gasoline and is made of metal and other natural resources. My clothes come from the natural resources industry—cotton from farming, metal belt buckle from mining.
What would life look like without natural resources and the extractive industries that allow us to use those resources? We'd have nothing—no buildings, cars, furniture, televisions or telecommunications. So, natural resources and mining are absolutely central to our standard of living and the technological progress we've made.
TGR: This brings us back to understanding the underlying economic structure. If an economy really needs these resources for daily life, and the economy is not growing, how could we expect the value of natural resource companies to increase?
PvE: Natural resource companies can increase in value for reasons other than the economy. For example, if an exploration company makes a discovery, it creates substantial and real wealth that didn't exist before that discovery. So, it can grow and do well regardless of the economic conditions.
If you impose over the economy the speculative cycle, which just exacerbates the business cycle, you'll find natural resource stocks are some of the most volatile stocks in the universe. If you can learn to make that volatility work for you rather than being its victim, you can do extraordinarily well in this sector. That means you have to buy when other people are afraid to buy and sell when other people are exuberant about buying, which isn't easy.
TGR: Everyone's buying now. Should we sell, or will we miss out on more upside by selling too early?
PvE: You can look at investing from different elevations. From a very high elevation, this is the time to sell commodities, gold, stocks and bonds. The only thing that's likely undervalued right now—and I'm probably going to get hate mail for this—is cash. That paper money everyone's so afraid of is likely the oversold commodity. But that's if you're sitting at 30,000 feet looking down—a very, very high macro view.
TGR: And moving down the ladder?
PvE: As you come closer to the ground, you look for a business that represents good value or an attractive opportunity within a sector—be it long or short term. Last year, when equities and commodities were rising, Bob Quartermain brought Pretium Resources Inc. (TSX:PVG) or "Pretivm" public at $6/share. The company owns two large gold deposits in northern BC. The IPO wasn't inexpensive but if the market held together, the stock was sure to do well because it had huge resources to talk about, experienced management and a market cap at the low end of where the large institutions want to be. And we were in an environment where everybody and his dog wanted more gold and gold exposure. So you could've bought PVG for $6 at, or after, the IPO. It's now $10, and that's within just a couple of months.
I'm not saying you should run out and buy PVG right now. I'm saying you can sit at 30,000 feet and think you really should be selling gold, or you can come down to ground level and determine, in the context of overvalued gold and equity markets, that if things stay where they are for the next six months, a particular stock could do well.
TGR: Does that mean you are now invested in the market after selling most of your investments in 2008?
PvE: I have made a few investments over the past 18 months, but it has mostly been a very selective process. I am still very nervous about equity markets and commodity prices, so I am not heavily invested at all. What I look for are win-win opportunities, and for that you need a healthy cash reserve.
TGR: What do mean by that?
PvE: I bought Miranda stock late last year at $0.50/share. If the stock price increases, I make money—that's a win. But if the stock price goes down, I will have an opportunity to buy more shares in a business I like for less money. I will thus be able to increase my fractional ownership in the business and reduce my average cost basis at the same time—that's a win. As long as nothing from left field comes along and blows a hole in the company, it's a win-win situation.
This concept of looking for win-win situations is central to how I invest. I would be nervous owning a stock if the price went down, and then I sold it immediately. I don't wait for the price to go down to figure out whether I should sell or not.
TGR: You've spent more than 15 years looking at the mineral exploration sector. What do you recommend for new investors that lack such experience and time to learn about management teams and business plans? How do they find relatively undervalued companies and good businesses in which to invest?
PvE: I suggest they meet Brent Cook. I have known Brent for almost as long as I have been in the investment business. He and I used to work together at Rick Rule's firm in Carlsbad. Over the years, Brent has helped me make bundles; but perhaps more importantly, he has saved me from making some really big mistakes. Brent is an independent geologist with more than 30 years' experience in over 60 countries—and, not only is he a good geologist, he also understands the investment business. His research and opinions are top-notch and his Exploration Insights newsletter is the only one I read—and I always read it.
TGR: You went to the recent Cambridge House Resource Investment Conference and presumably you'll be going to PDAC 2011 in Toronto next month. What new trends in the exploration sector appeal to you? And, on the other hand, what do you find discouraging?
PvE: One trend I think is very good is that the standards and practices that explorers and miners employ are getting much better. For example, the attention they pay to community relations and environmental concerns is really world class. The whole industry has elevated itself. I think that trend is very positive.
The discouraging trend is that the bureaucracy and bull that explorers and miners have to deal with is literally adding years to the approval process to get work done, as well as exorbitant costs to the extractive industries. This additional time and money is, in a very real way, reducing our standard of living by raising the cost of the natural resources we use in everyday life.
It's a fine balance between nudging an industry to use best practices and pushing them over the edge. There was a time when extractive industries were abusive and deserved to get whipped. It worked and their standards and practices have improved. But now the pendulum has swung the other way and the extractive industries are being unreasonably targeted by special interest groups who don't really have any "interests" in these industries.
TGR: Well, this was very good, Paul—but certainly not too good to be true. Thank you very much.
Paul van Eeden is president of Cranberry Capital Inc., a private Canadian holding company. He began his career in the financial and resource sectors as a stockbroker with Rick Rule's Global Resource Investments Ltd. in 1996 and has actively financed mineral exploration companies and analyzed markets ever since. Paul is well known for his work on the interrelationship between the gold price, inflation and currency markets. He also created a measure called the Actual Money Supply (AMS) to monitor the real rate of inflation. AMS is crucial to analyzing real (inflation-adjusted) price changes and calculating the real return on investments.
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1) Karen Roche of The Gold Report conducted this interview. She personally and/or her 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: Miranda Gold.
3) Paul van Eeden: I personally and/or my family own shares of the following companies mentioned in this interview: Miranda Gold Corp. and Pretium Resources. I personally and/or my family am paid by the following companies mentioned in this interview: Miranda Gold for services as a director.