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.
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.
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.
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.
Morning Notes, analyzes emerging geopolitical, technological and
economic trends. He travels the world with his son, Chris, looking for
discovery opportunities for his readers.
