As we head into the last quarter of the year, James
West questions how important macroeconomic trends are for individual
investors. But he does believe stock catalysts in the energy space are easier
to understand than precious metals market forces. In this interview with The Energy Report,
West updates us on some possible top performers in the space and what they're
with the U.S. election behind us, we are currently looking at a couple of
looming and significant issues. One of these is QE3. You're not a fan of
easing; tell me why.
Quantitative easing is just the issuance of more money. Since the onset of
the crisis, two episodes of stimulus/quantitative easing injected $2.3
trillion into the economy between 2008 and 2011. Real gross domestic product
(GDP) numbers in that timeframe show GDP grew by roughly a net of $2.3
trillion, demonstrating that the "recovery" GDP growth rate of 1.2%
was not in fact growth at all, but was merely the addition of 2.3 trillion
newly fabricated dollars to the weak and stagnant GDP number. By distributing
free money to the top layer of the financial food chain, Obama and Bernanke
get healthy numbers. In other words, they are focused most intently on
maintaining a delusion, and expend no effort on tackling the real problem,
which is income and opportunity disparity.
TER: You have cited the practice of dividend
recapitalization as a consequence of near-zero rates. You've written that it
leads to a doubled rate of bankruptcies in companies undertaking that
strategy. But shouldn't easing promote higher rates?
JW: Dividend recaps are the exclusive domain of private
equity-owned corporations. The private equity owner causes the company to
borrow so that the owners can be paid a dividend by the company. With such
low interest rates, they can completely destroy the company over time, while
paying themselves large dividends until the company goes bankrupt, and then
they just walk away. They know that the United States can absolutely not
withstand a rise in interest rates, or else it would have to declare
bankruptcy as the cost of servicing debt would then rise to truly
unsustainable levels. Super-low interest rates create the illusion of
sustainable debt service levels to persist.
TER: Do you see this practice of dividend recap
occurring in energy companies?
JW: Not necessarily. For private equity-owned energy
companies, it's possible. But that would only happen if the earnings from
energy sales were insufficient to provide income to the private equity owner.
If the board of a public company tried that, they would be voted out, as the
self-destructive nature of dividend recaps is obvious. The key requirement
that makes a dividend recap possible is a strong balance sheet that throws
enough cash flow to service a debt, which disqualifies 99% of the juniors.
And again, it's not an option for a public company.
TER: Let me ask this counterintuitive question: Do you
believe higher rates are important to the health of the economy?
JW: Interest rates are essentially the value of money.
If you have interest rates at zero, and money is being created arbitrarily,
then what does that tell you about the value of money? Zero interest rates
mean banks don't make anything lending or investing money, so why should
they? Meaningful and stable interest rates are absolutely characteristics of
a robust and healthy economy. Zero interest rates are likely signals of
impending economic collapse.
TER: The other major issue looming over the U.S. right
now is a threatening fiscal cliff. What could be the upshot of this issue if
it is not resolved between the president and Congress?
JW: There's all kinds of
posturing by both sides to suggest there won't be a problem resolving the
issue, and there won't be! It will likely go to the eleventh hour of course,
as each side tries to exact concessions from the other, but at the end of the
day, there's no choice. The bigger issue ahead of the fiscal cliff is the debt
ceiling. Watch how quickly that gets raised. The U.S. can't afford another
TER: How do investors play your general economic theory?
Back in the summer you told us you favored energy over gold. Is that still
the case? Why?
JW: I don't think individual investors play economic
theories so much. I don't think there are anywhere near the number of
investors right now that there were in 2007. Yes, I favor the energy sector
over the precious metals sector generally because it's easier to understand
the market catalysts, which in energy are a little less controlled than in
precious metals. The precious metals markets make no sense, unless you
subscribe to the theory that the U.S. cannot permit higher gold prices,
because a suppressed gold price is critical for maintaining the illusion that
all is well in the United States Treasury and Federal Reserve.
disparity in gas prices between east and west hemispheres is creating massive
opportunity, and the rapid increase in North American shale-borne production
is changing world energy dynamics by the day. In precious metals, you've got
all the same fundamentals, but they're castrated by government-sponsored
price suppression in futures markets.
TER: What about junior companies?
JW: Junior explorers are divided into two camps, as far
as I'm concerned. Two years of severe underperformance have capped any
possible upside in a lot of these older companies. They're practically
pariahs, just waiting for the inevitable day when they run right out of
money, and can't raise it at any price. There are many such
"zombie" companies out there, but there will be a lot fewer this
time next year.
viable are companies that match strong management with solid structures where
the share price can still respond to success without battling through a wall
of cheap paper from past financings. These are generally newer companies.
specific ideas in junior explorers, my favorite companies now are Atico Mining Corp. (ATY:TSX.V), which we own in the fund. The Ganoza
family is essentially recreating the winning recipe that they applied to Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), though this time in Colombia. The company is
acquiring a producing mine with plenty of exploration upside, and so you're
buying into cash flow.
Graphite (LLG:TSX.V) is a new graphite deal in which I own shares. I've
been familiar with its graphite project for many years and I've spent time
traipsing all over it. It's called Lac Guéret,
and this was a hot graphite property in 2006, when it was owned by Quinto Mining, which was sold to Consolidated Thompson
Iron Mines Ltd., which then was bought by Cliffs Natural Resources Inc.
importantly in the graphite game, however, is not so much grade and purity,
both of which you need, but end users. Who are you going to sell it to?
Graphite is not scarce. It's common. But CEO Benoit Gascon
built the entire graphite sales channel at his former employer, Stratmin Graphite, from nothing to the point where it was
bought by Imerys (NK:PA), one of the world's
largest graphite vendors. In my mind, that is a critical differentiator that
will make Mason Graphite one of, if not the graphite company of this
lithium, I like Critical
Elements Corp. (CRE:TSX.V), again not so much because it's the biggest lithium
deposit, but because management is making all the right moves to put the
deposit into production on a fast track. Ron MacDonald, the company's
executive chairman, has a high profile within the alternative energy
materials space, and serves several companies among whom synergies exist.
Critical Elements is working to secure non-dilutive, commodity-based financing
that could see it leapfrog ahead of other, more apparently advanced
companies. Production I think will happen as soon as the company can find a
buyer who wants to secure a supply of lithium, and will advance the funds to
go to production on that basis. I know discussions are under way with a few
groups, though nothing concrete has emerged yet.
TER: Do you have some other ideas you could share?
JW: I own the most shares in a stock I think is a
billion-dollar company in the making. It's an OTC-traded company called Abakan Inc. (ABKI:OTCQB). It has now filed for a NASDAQ listing, and it has
received investment from and is working with Petrobras,
the world's fifth-largest petroleum producer, to supply Petrobras
with a continuous supply of its nano-composite
coatings for pipelines. Petrobras is producing
highly corrosive oil from very deep fields, which creates stress for pipes
gathering and transporting oil from offshore Brazil. Without Abakan's
pipeline coating, much of the oil that Petrobras
owns would be uneconomical to produce. And Petrobras
is the tip of the iceberg for Abakan. Seventy percent of the world's
remaining oil and gas supplies are "sour," meaning highly
corrosive, and so that means demand for Abakan's MesoCoat
pipelines should keep ramping up for decades to come. The company is looking
at building plants in Indonesia, Bahrain, Brazil and Canada, besides its
first plant, which comes onstream
soon in Euclid, Ohio. The company recently won the Wall Street Journal's Technology
Innovation Award in the manufacturing category.
TER: James, I'd like to get some updates on some of your
picks from past interviews with us. To start, Aroway Energy Inc. (ARW:TSX.V; ARWJF:OTCQX) announced that it had acquired an additional 265
barrels per day (bbl/d) of immediate production.
That's a runrate of about $1.3M per year just on
this addition. The company has now increased production six fold this fiscal
year. Shouldn't these additions be significant for a $27M cap company? When
is this company going to get noticed?
JW: All the junior producers in the patch are in a
state of suspension pending the outcome of Industry Canada's rulings on the
two big mergers currently underway, yet not yet done deals. I'm referring to China National Offshore Oil
Corp.'s (883:HKSE; CEO:NYSE) acquisition of Nexen Inc. (NXY:TSX; NXY:NYSE), and Petronas (PETRONAS) acquisition of Progress Energy (PGN:NYSE), which was initially turned down. This arbitrary
move has put a big question mark over the valuations of the whole patch, from
seniors to juniors, because the possibility of a buyout from a bigger company
is one of the key price drivers in the sector. With the denial of the Petronas-Progress deal, global investors don't know who
qualifies and who doesn't as far as purchasers go.
story starts to resolve itself, I think Aroway will
start to see more of a lift in its share price. These days, if you don't
produce 1,000 bbl/d,
you're not even on the radar. So the company is technically already over that
hurdle because it will exit 2012 with 1,200 bbl/d.
TER: EFLO Energy Inc. (EFLO:OTCQB) has recoverable access to 1.8–3.3 trillion
cubic feet of natural gas. Gas may be cheap, but this stock is cheaper.
Clearly the company suffers from being so small in market valuation where
small-cap funds can't participate. But is it just a matter of time before the
company is discovered by small hedge funds and investors? What catalyst can
JW: EFLO is owned by the Midas Letter Opportunity Fund,
and has already been a double and then some for us. That's certainly
one to watch, though it's early days for the company at this point. The big
picture for EFLO is the development of pipeline capacity and a liquefied
natural gas (LNG) plant on the west coast, which still has a lot of hurdles to
clear. But it's going to happen. Canada needs the addition to the GDP. When
the company starts drilling and bringing wells onstream,
it will be able to move its gas to market—that's going to be the
ongoing catalyzing event for the company's shares. That and getting a listing
on a senior exchange, which I understand is in process.
TER: Prophecy Coal Corp. (PCY:TSX; PRPCF:OTCQX; 1P2:FSE) shares have had a rough time. It seems like the stock
began to turn south when the company announced it was going into the power
generation business in Mongolia. Did investors hate this deal because it took
focus off of its core business?
JW: Not at all. Its horrible
share price performance is attributable exclusively, I would say, to the
political situation in Mongolia, which is still uncertain, especially with
the passage of the Strategic Entities Foreign Investment Law, passed in May
2012. This document has created more uncertainty than it has assuaged, and
that's why Prophecy shareholders are suffering right now. Unofficially, there
is basically a sense of optimism for the long term,
and pessimism for the short term.
at Oyu Tolgoi—no
investment hesitation there on the part of Rio Tinto. Obviously, Prophecy
Coal isn't Rio Tinto, and that's probably the main roadblock to reversing the
share price performance. When it becomes apparent that Mongolia is not going
to make a grab for the power plant, and clear investment and power offtake agreements are in place, the share price should
start to appreciate. At this level, I think it's attractive.
TER: Recently the company announced a preliminary
economic assessment on its Chandgana Tal coal
mining licenses in central Mongolia, reporting 124 million metric tons of
measured coal with a mine life of 30 years. How significant will this be?
JW: Well this was a big cloud put over the company by
the Ontario Securities Commission, which has now been quite thoroughly
addressed. In any other market, that should have been sufficient to attract
buyers in the company's shares, but there just aren't a lot of those around
right now, thanks to the overall weakness in mining companies for the last
two years. Add to that a dose of political uncertainty, and you get the share
price Prophecy has right now. But there's certainly no longer any question of
there being sufficient coal to supply the power plant.
TER: James, thank you for your time today.
JW: My pleasure.
James West is publisher and editor of The Midas Letter, an independent capital markets
entrepreneur and investor. He has spent more than 20 years working as a
corporate finance advisor, corporate development officer, investor relations
officer, and media relations and business development officer for companies
involved in mining, oil and gas, alternative fuels, healthcare, Internet
technology, transportation, manufacturing and housing construction.
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1) The following companies mentioned in the interview are sponsors of
Streetwise Reports: Aroway Energy Inc., EFLO Energy
Inc., Fortuna Silver Mines Inc. and Prophecy Coal Corp. Streetwise Reports does not accept stock in exchange for services. Interviews
are edited for clarity.
2) James West: I personally and/or my family own shares of the following
companies mentioned in this interview: Abakan Inc., Mason Graphite and
Critical Elements Corp. I personally and/or my family am
paid by the following companies mentioned in this interview: None. I was not
paid by Streetwise Reports for participating in this interview.