The Gold Report: Do you expect a broad market correction over the course of the next two years or so?
Björn Paffrath: Since the crisis in 2008, most of the well-known indexes, such as the Dow Jones Industrial Average or the German DAX, have almost doubled, and many individual companies have performed even better. Of course it is all liquidity driven, but it's at a level where we have to ask: Is it still justified or are we already in the next bubble?
On one side, indexes skyrocketed on the liquidity provided by the central banks. But interest rates and bond yields are so low that they are not keeping pace with inflation, so people put their excess cash in the stock market. And more money exited the underperforming mining sector as the general markets went up.
At some point we will have a painful correction of 30% or more. Maybe it started already, but it's tough to say because there is still a lot of liquidity in the market. There is a good chance that after the correction the bull market could run quite a bit longer. But we all know that we only bought time in Europe and the United States. A lot of Western countries have excessive debt. The painful end will definitely come at some point.
Outside events or black swans also could trigger it. Tension rises between Russia and the Ukraine almost daily now. In the Middle East there are uprisings in Turkey and Libya, Israel and Hamas are battling and there is a civil war in Syria. And Iraq is more and more lost to the IS-terrorists. Any of those events getting out of control could trigger further events on the market side.
TGR: Where should investors look for the first signs of problems?
BP: You have to first watch the U.S., then Europe and China. The U.S. made it out of the recession, but how sound is the foundation without the money that the U.S. Federal Reserve is pumping in? That money will probably stop this year, but my guess is that the Fed will find other opportunities to pump more money into the market. We have to watch the U.S. closely.
Europe came late to the bond-buying game and the peripheral countries—Spain, Portugal, Greece—are not in great financial shape. The Portuguese recently used bailout cash to shore up Banco Espirito Santo, and Greece will likely require a third bailout. Europe put a curtain on the debt crisis. Everybody is happy with the stock market, but we didn't solve any problems.
China, the future engine of the world, certainly of the mining industry, also has a problem. The central bank there recently warned about a real estate bubble. We never can really trust the economic numbers from China but if the Chinese volunteer information on some potential problems, we have to watch carefully. China could cause a lot of problems for the global economy.
TGR: How should investors plan ahead?
BP: Investors have to find a way to still participate in the buoyancy of the market, yet be hedged against trouble. How do you hedge yourself? If you made good money in stocks, you should buy a hedge like precious metals. It's insurance. You may lose a few percentage points a year but you sleep better knowing you have it. You have insurance for your house, your car. Why shouldn't you have insurance for your portfolio? Warren Buffett said: "Be greedy when others are fearful, and be fearful when others are greedy." We don't know where the Dow Jones or DAX will be in a year. At least take some of your big wins off the table and find a sector that is undervalued. In our case, that's mining.
TGR: You're a fund adviser based in Switzerland. Tell us about yourself.
BP: I am an adviser to Stabilitas GmbH, a group of resource funds in Germany. Also I consult to various Swiss or German portfolio managers on the institutional side with regard to mining investments. Smart money with deep pockets thought it is the right time now for investments into the mining sector, so we launched a new gold and silver equity fund for them in Lichtenstein. We plan to cap it at around $100 million ($100M) with a soft closing because we still want to play the junior and midtier stocks.
On top of that, we work with some wealthy private investors who look to invest not only in mining equities, but also in production streams. Therefore, we created a new loan fund to work with smaller companies to help them finance through to production. In most cases we have an 8–12% bond. Then we negotiate a royalty stream or financing fee for 10–15 years. Our money helps small companies with low share prices that can't raise sufficient funds in the equity market. Our latest investment is Inca One Resources Corp. (IO:TSX.V) in Peru.
I also write a subscriber-based newsletter called Cashkurs Gold, which mostly covers large-cap precious metals producers, $400–500M and up. Cashkurs roughly translates to "money direction." We educate mostly German and European retail investors on how the mining sector works and what constitutes a good investment. We also run a real portfolio there.
TGR: In an interview prior to the 2014 Prospectors and Developers Association of Canada (PDAC) conference in Toronto, you said the junior mining market had bottomed. Where is it now?
BP: In 2012, and especially in 2013, we saw one or two good breakout months. We all thought that maybe that could be the turnaround, but it wasn't. The biggest difference this time is that the volumes are picking up. Volumes on the Market Vectors Junior Gold Miners ETF (GDXJ:NYSE.MKT) are increasing and we know that people are bringing fresh capital back to the sector. It's not a lot but there is inflow. It might be traders or generalists seeking value in gold and silver stocks but I think we have seen the worst in the junior sector.
We focus on the small producers and near-term producers. Most of the exploration stocks still have liquidity problems. Last year, brokers and banks did a lot of bought deals. So money is still there and some people are taking advantage of undervalued assets.
TGR: Is that where the smart money is headed?
BP: It's still a small amount. The people who look for sector rotation see that the sector is beaten up. When we look at the long-term chart for the Philadelphia Gold/Silver Sector Index (XAU), there were buying opportunities in the early 2000s, and 2008, of course. We actually had a bottom-building phase here at similar levels. That means we really have a chance. Banks and other institutions, are investing into our new fund now in order to find the right investments. They want to get back into real assets; ultimately they know almost everything around us comes from mining. Before you own it, it's mined. So the smart money is starting to very carefully turn toward the mining sector. But if we combined the value of all the stocks in the Philadelphia Gold/Silver Sector Index and compared it to the market value of Apple Inc. (AAPL:NASDAQ), it's a tiny market. It doesn't need much capital to raise it 10–20%. Even this year we have seen nice gains already.
Source: Stockwatch.com
TGR: One of the common complaints among investors is that junior mining equities have little to no liquidity. How important is that?
BP: That is key. These companies need to have experienced management that earns the trust of investors and large institutions to fund their activities. Look at Detour Gold Corp. (DGC:TSX). It needed more and more money, but it is going to make it in the end. The latest quarter wasn't great, but that was expected.
If no one will give you more money, especially in the junior sector, someone will take you out or you will go in default and someone else will take your assets. The gold will still be in the ground. Liquidity is almost as important as management, geology and jurisdiction.
TGR: What's your pitch to investors?
BP: In general we tell people that mining is an important part of their lives. It's a great investment if you know how to play it, and if you do so at the right time.
We like gold and silver equities right now. That's why we launched a new gold and silver fund at what we believe is the bottom of the market. Even if the gold market drops a bit more, there are companies out there with all-in sustaining costs around or below $1,000 per ounce ($1,000/oz), which means they can still make good money and survive at $1,300/oz gold, and are well positioned if gold goes higher.
TGR: What are some gold and silver equities you're following?
BP: In the short run we like some large caps like Goldcorp Inc. (G:TSX; GG:NYSE), but we see the biggest potential in the junior market. We prefer the smaller producers that have been hammered down due to the market.
We like Rio Alto Mining Ltd. (RIO:TSX.V; RIO:BVL), and Timmins Gold Corp. (TMM:TSX; TGD:NYSE.MKT) and Lake Shore Gold Corp. (LSG:TSX) are some of our bigger positions.
Timmins had another great quarter. It recently fended off a move by Sentry Investments to take over the board. In my view, Sentry only wanted to sell it. CEO Bruce Bragagnolo did a fantastic job during that struggle. He does not come from a mining background but he runs that company better than most people I see in the mining industry. At around $2/share, Timmins either buys something else, which it needs, or gets taken out. On a pullback, it's a great buy, even if you only want to speculate on a takeout.
TGR: The rumor is that Argonaut Gold Inc. (AR:TSX) is going to make a bid for Timmins Gold. Your thoughts?
BP: I know the rumor, but I am not so sure about Argonaut, if I look at its stock price. Everybody's darling has fallen quite a bit. This may not be the right time for it. But of course there's a chance of a takeover by other companies. There are certainly a few sniffing around. In general, Timmins would be a nice fit at 120,000–130,000 ounces (120–130 Koz) gold annually. It would have to be a company where adding 120–130 Koz significantly increases its production profile and also the region has to make sense. Timmins probably can't lower its all-in costs much more but it has some healthy margins at the moment and even more if the gold price rises. Even at $1,300/oz gold, Timmins added another $11M to the cash balance last quarter. I think management is building up the cash to find a good takeover target itself; Timmins appears to be very selective, and that's probably because there are not many options out there that make sense.
TGR: You mentioned Lake Shore Gold. It's up 155% year-to-date. Is there any room left to climb?
BP: Good question. Maybe it's a little pricey right now, but it has some great assets. Lake Shore turned things around on the cost side at its Timmins West complex and now has free cash flow even after paying back some debt. It's sustainable at that level. It is building bullion and cash. President and CEO Anthony Makuch has done a great job. Of course, we were shareholders much earlier. You have to believe in management. It stumbled, but stood up and changed its course.
Lake Shore must eliminate its debt and it still has to prove in the next quarter and beyond that the expansions will continue to work. I would put it on a watch list and wait for a buying opportunity.
TGR: You mentioned that Inca One was the latest investment with your loan fund. Tell us more about that story.
BP: Years ago Dynacor Gold Mines Inc. (DNG:TSX) started the toll milling business in Peru because it is a country with a lot of high-grade ore and small miners who need a processor for that. We own Dynacore and like it a lot. It's a good model, if you have the right people and connections. We were looking for the next play there and came across Inca One. We liked the management—CEO Ed Kelly, COO George Moen. They are not mining people, but they found the right partners in Peru. We have been to Peru a couple of times to check everything out. We liked what we saw so we made sure it does not have to worry about any financing in the near term so that it can build the plant.
TGR: Inca One says it wants to be the processor of choice in Peru. Is there much competition?
BP: There are lots of small miners but Peru recently changed its laws because it lost a lot of revenue on gold that was being smuggled out of the country. Since then a lot of small processing plants were shut down by the military. We have followed the Inca One story for more than a year. We wanted to be involved, learn about the process and make sure our investment was sound. The business is about how you treat the miner—how quickly you process the ore, pay him back and what the discount is to the spot price. But first Inca One has to build a 300-ton-per-day (300 tpd) refinery. The company started with a pilot plant to make sure everything was formalized and that it had the right team. Hopefully, it is at 100 tpd by Q1/15. Once it's there, it should have no problem getting access to more capital. The stock already went up to $0.17/share but the price will follow operational performance. We're happy with what we see so far.
TGR: What are some other miners that you have positions in?
BP: We like to find sweet spots in the gold space. About six months ago we took a position in Caledonia Mining Corp. (CAL:TSX), which owns 49% of the Blanket gold mine in Zimbabwe. I met the management in London and I was convinced that these people were doing a great job. The stock was about $0.70/share with a great dividend, and nice, steady small gold production. Now, it is above $1/share. At some point we probably have to think about a sell but right now there is lots of room to grow, so we're quite happy.
TGR: There is incredible value across the junior gold and silver space. Why would you willingly take on exposure to Zimbabwe and Robert Mugabe's regime?
BP: As we listen to the company and checked out the setting of the mine and how it fully indigenized, we got a very good and positive feeling for the investment. It's one of the opportunities most of the people miss. We always like to learn, right? Also the mine brings a lot of value to the locals and it treats the miners very well. This mine helps the local community. We watch the company closely, but so far it always has delivered and that builds trust in the management.
TGR: What about some other smaller gold plays?
BP: With the recent success Osisko Mining Corp. CEO Sean Roosen had with the takeout by Yamana Gold Inc. (YRI:TSX; AUY:NYSE; YAU:LSE) and Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE), Quebec's Abitibi region started getting more traction. We like Falco Resources Ltd. (FPC:TSX.V), with its huge project database. Also we think that a few big names bought into the stock through a transaction from QMX Gold Corp. (QMX:TSX.V), which had to sell a block of 7M Falco shares. A privately owned Ontario company took it. No names where disclosed, but I think we have a pretty good idea who is behind it. There's absolutely a chance this company could be taken out sooner than later. It's certainly a great buy at these levels.
Balmoral Resources Ltd. (BAR:TSX; BAMLF:OTCQX) President and CEO Darin Wagner is on the Falco board, too. Balmoral itself had a huge run. It was presenting in Europe at $0.50–0.60/share; now it is around $1.90. You never really lose money with Darin. I like him very much. He's not overpromising or underdelivering. He has a good nose for the right asset. The latest high-grade discoveries are very promising and also the nickel deposit was a nice add on. Let’s see how long the company will be around.
TGR: Parting thoughts?
BP: For an investor who looks for a good opportunity, the mining sector is the place to be. You have to have patience so that you don't get shaken out on the pullbacks, but I would be quite surprised if you are not making a lot of money in this sector within the next two or three years.
TGR: Thank you for your insights, Björn.
Cashkurs*Gold.
