The Gold Report: In a recent article, you argued that investors in the West will find
their way to gold when the new reality dawns on them that losing a bit of
money to preserve the rest is "a good deal." Please explain
further.
Jayant Bhandari: What has to happen does not have to happen right
away. Everyone in the world is flocking to the U.S. dollar. It offers
liquidity, but eventually the U.S. dollar will become too expensive. When
that starts happening people will look for other opportunities to safeguard
what they own, and gold is something that will become increasingly visible.
TGR: How long is the U.S. dollar going to continue its ride?
JB: The U.S. dollar could do well for quite a period of time
because while the U.S. is sinking, everything else is sinking faster. The
European Union is in worse shape. Most of the developing countries, apart
from China, are in horrible shape. They consume pretty much everything that
they create. The U.S. dollar, despite all that is going on, remains one of
the better currencies.
TGR: You also relate gold buying to how in India people buy gold
and cattle—not necessarily because these are excellent investments but rather
that these things will ultimately lose less value than other investments.
JB: A lot of people buy gold because of inflation but I don't think
that's the reason why Indians, people in the Middle East and people
historically in China have bought gold. As I mentioned in that article, the
return from 300 million cattle in India is about minus 50–70%, depending on
the kind of cattle. People invest in negative yield investments because they
have few options in these societies. But that is what's increasingly
happening in the West. It started with the European bond market. This morning
I see Swiss bonds trading at a negative yield, which tells me that this
society is no longer offering people opportunities to make money by
investing. When that starts happening people do what they have to do to
safeguard whatever they can safeguard.
TGR: You present a rational argument for buying and holding gold.
Yet you buy and sell precious metals equities, mostly small-cap gold and
silver equities, which carry more risk than owning gold. Why are you active
in this space?
JB: The reason I'm in the junior gold equity market has almost
nothing to do with gold per se. These are two different beasts: gold
is gold and gold equities and gold mining is a business. When I invest in a
mining company or a junior mining company, I assume a very low gold price,
something generally lower than the spot price, and then I do a valuation
based on that price. Now, when I enter the gold market I presume that gold
will go up and if gold actually goes up it will trigger a higher valuation of
these equities. I am increasingly more optimistic about gold and as a result
I think this will underpin an increase in buying volume and investment in the
junior mining space.
TGR: Is the junior mining market largely undervalued given current
metal prices or is it fairly valued?
JB: There are still lots of useless companies in the junior market,
most of which are "lifestyle" companies. Yet the market fall has
resulted in the fall in the share prices of some very good companies, too.
That's where the future value is and where money will be made.
TGR: What do you mean by lifestyle companies?
JB: Junior mining companies exist in an interesting space. The CEO
often decides his salary, expenses and what kind of accountability he wants.
If he chooses, he essentially has a company credit card to live the life that
he wants, and regulations cannot help you there because as long as they are
expenses, and the CEO signs off on those, they are legally legitimate. This
is a lifestyle company.
TGR: In a different opinion piece on JayantBhandari.com
you wrote, "The real problem with the junior mining
industry is that investors have lost faith in those who run these
companies." Are you willing to name some management personnel that you
still have faith in?
JB: The mining industry as a whole has done a horrendous job of
creating value for investors. Over the last 15 years the gold price has gone
up four or five times, but the share prices of most of these companies is
lower than it was when gold was $250 an ounce. However, some management teams
have done a good job. One name is Ross Beaty, who has consistently created
value for investors. Osisko Gold Royalties Ltd. (OR:TSX) is working on an
entity called Oban
Mining Corp. (OBM:TSX), which is in the process of merging with Eagle
Hill Exploration Corp. (EAG:TSX.V), Ryan Gold Corp. (RYG:TSX.V), and Corona
Gold Corp. (CRG:TSX). I have known Oban President and CEO Jose Vizquerra for
a long time. Oban has a fabulous group of competent people who can easily
raise money, even in this market. The new company will have about $65–75
million ($65–75M) in cash. This is an ideal marriage of companies with
projects and technical skills with companies with cash. Corona Gold and Ryan
Gold are cash-rich companies. Oban, meanwhile, is backed by some of the best
technically qualified people in Canada.
Another company is Callinex Mines Inc. (CNX:TSX.V; CLLXF:OTCQX), which is
run by President and CEO Max Porterfield and Chairman Mike Muzylowski. The
company is backed by some good financiers and recently raised about $3.4M for
a drill program.
First
Majestic Silver Corp. (FR:TSX; AG:NYSE; FMV:FSE), which has made a
friendly takeover bid for SilverCrest Mines Inc. (SVL:TSX; SVLC:NYSE.MKT), is run
by President and CEO Keith Neumeyer, who also helped found the company. He's
done a great job and has started another company called First Mining Finance
Corp. (FF:TSX.V).
Novo
Resources Corp. (NVO:TSX.V; NSRPF:OTCQX) is a company in Australia with a
very small but high-margin gold deposit run by President and CEO Quinton
Hennigh. And Minaurum
Gold Inc. (MGG:TSX.V), run by President and CEO Darrell Rader, has raised
about $2.875M and is about to start exploration drilling. There are lots of
good companies in the space, even today.
TGR: What are some red flags for you when you're working out junior
mining company valuations?
JB: I usually spend one or two hours talking face to face with
management. I have seen again and again that a lot of decent people managing
junior mining companies are essentially financially illiterate. You want
people who understand the business but who are also decent people. It takes a
while to get an understanding of how they process information. I want to see
if they are rational people. If they talk rational things with me, I'm prone
to assuming that they are honest people. Honesty is usually the best way to
create a name for yourself and make money. I have confidence giving my money
to such management people in the hope that they will do a good job with it.
TGR: Most people don't have the opportunity to sit and talk with
management. How do they get this information?
JB: You don't always have to sit with the management or visit the
property, but you should only buy these companies using a worst-case
valuation. For example, if my worst-case valuation of a company is $1/share
and I can buy shares in that company for about $0.20, then perhaps I have
enough margin of safety not to have to visit the project or meet the
management. But I still need to be reasonably sure about the public profile
of such management teams.
TGR: What are some common errors made by junior mining investors?
JB: People invest without really knowing what they are doing. They
think that a $0.05 stock is cheaper than a $0.50 stock. That's completely
irrational. You have to multiply the share price by the shares outstanding,
and that is assuming that the two companies have exactly the same kind of
projects. Other people over-glorify company management. Do not expect
management to turn around the impossible. Try to rationally value these
projects. Try to understand where these projects are situated, whether they
are economic, and whether the locals approve of a project in that area. I was
looking at a project in Argentina. It's a fabulous project with fabulous
grade but the locals are completely against it, so it will likely never be a
mine. There's a series of things you should understand and connect and then
make a worst-case valuation on these companies before you invest.
TGR: Anything else?
JB: Patience is big. Don't chase a stock. I have seen feeding
frenzies in this market and that sort of activity will eventually return.
When the feeding frenzy starts people don't think in terms of valuations.
They ignore things like jurisdictions, which are also important. A project in
the Democratic Republic of Congo (DRC) versus a similar project in Canada
would have completely different risk profiles and thus completely different
valuations. Investors should always try to understand what is underpinning
the valuations of these stocks, royalty structure, tax structure and how much
money will go to local governments. All these costs should be factored into
the valuation.
TGR: What discount do you use for a high-risk country like the DRC
versus a low-risk country like Canada or the United States?
JB: I typically use a 20% discount rate and use metals prices that
are lower than spot prices.
TGR: Did you use a 20% discount rate when the markets were better
in, say, 2010?
JB: No, but by not doing that I stayed vested in the market when I
should have left the market in 2011. We all make mistakes but if the industry
is trading at a discount rate of 5% or even in the future, I will no longer
be invested in the junior mining space.
TGR: In different articles you have said you expect 20% returns
from your junior mining equity investments. How did you determine that
number?
JB: It's a very risky business. Unfortunately, investing in any
kind of stock market is risky because you're handing your money to someone
you don't necessarily know. My overall return in a portfolio will be much
less than 20%, but the 20% leads to a buying decision for me. That's how I
built my portfolio.
TGR: Once a company has appreciated 20%, do you sell?
JB: No, I might not sell until much later. My selling is decided by
the kind of discount rate the market is using to value projects. I'm going to
buy based on a 20% discount rate, but I intend to sell using a valuation
based on a 5% discount rate—if the market is using a 5% discount rate to
value projects.
TGR: You have written that 5th grade math skills are sufficient to
be a successful investor in the junior mining space. You even suggest taking
a spreadsheet and plugging in some numbers to help investors figure things
out. Please take us through that process.
JB: It's amazing how simple math can make you a lot of money in the
junior mining industry. There are two shells that are arbitrage situations
based on cash. One is Kobex Capital Corp. (KXM:TSX.V). It's trading at
$0.54/share but has about $0.70/share in cash. Another shell company is Probe Metals
Inc. (PRB:TSX.V), which is trading at $0.36/share but has $0.51/share in
cash.
There is also an interesting arbitrage situation in the acquisition of CB Gold Inc.
(CBJ:TSX.V) by Batero Gold Corp. (BAT:TSX.V). CB Gold is trading at
$0.045. For each share of CB Gold you will get $0.0275 in cash and 0.3056
shares of Batero Gold. Remember, at $0.075/share, Batero is trading at nearly
a 50% discount to its cash value, providing an early investor another phase
of upside based on cash value. Just be mindful that CB Gold is very illiquid
and I prefer to give only limit orders. If you miss a trade, there will
always be more opportunities coming up to be exploited.
Another arbitrage opportunity is First Majestic Silver merging with SilverCrest
Mines. At the current share prices there's a 4% arbitrage opportunity, but if
you buy SilverCrest there's a possibility that a better takeover offer might
come for SilverCrest, in which case you'll not only position yourself to
benefit from the arbitrage opportunity, but perhaps benefit from a sweetened
takeover bid for SilverCrest.
TGR: Do you think First Majestic CEO Keith Neumeyer would get into
a bidding war?
JB: He might actually, but as a SilverCrest shareholder I have
nothing to lose either way. My guess is that the merger will go through and
I'll make 4% in arbitrage, but this is truly another ideal marriage. First
Majestic needs cash and SilverCrest has excess cash. This is a case where two
plus two is more than four.
TGR: Are there others?
JB: PNO
Resources Ltd. (PNOPF:OTCMKTS) and Sandspring
Resources Ltd. (SSP:TSX.V) are merging. Sandspring's share price is
$0.07. The value of PNO Resources based on the merger ratio is $0.195.
However, PNO is trading at $0.15/share, so there is about 30% arbitrage
upside. This is truly primary school math. People should be doing this.
Alpha
Exploration Inc. (AEX:TSX.V) is merging with Lakeland
Resources Inc. (LK:TSX.V). The arbitrage upside is close to 50%. The risk
is that the arbitrage upside might get dissolved by the time the merger is
over and you can't short either entity. My clients are interested in these
kinds of situations. That's how I am surviving.
TGR: Are there any arbitrage situations outside the precious metals
equities space?
JB: Sprott Asset Management has made a hostile takeover move via
its Sprott
Physical Gold Trust (PHYS:NYSE.MKT; PHY.U:TSX) and Sprott Physical
Silver Trust (PSLV:NYSE.MKT; PHS.U:TSX) to acquire Central Gold
Trust (GTU:NYSE; GTU.UN:TSX) and Silver Bullion
Trust (SBT.U:TSX). Sprott Physical Gold Trust is trading close to its net
present value (NPV) whereas Central Gold Trust and Silver Bullion Trust are
trading at about 6.5% discounts to their respective NPVs. There's another
fund held by the same group called Central Fund of
Canada Ltd. (CEF:NYSE.MKT; CEF.A:TSX), and that is trading at an 11%
discount to NPV. By investing in these three funds you get gold and silver at
about a 7–11% discount to the spot prices for these metals.
These funds usually trade at a premium to spot metals prices in a bullish
market, so you might even make money when a bullish environment returns.
TGR: You mentioned Callinex and Minaurum earlier. Those are not
arbitrage situations. What do you see in those names?
JB: Callinex is run by CEO Max Porterfield, whom I have known for
almost 10 years. The company just raised $3.4M in an equity financing. Its
Flin Flon and Pine Bay projects are close to HudBay Mineral Inc.'s (HBM:TSX;
HBM:NYSE) 777 mine in northern Manitoba. There is a historical resource not
updated to current standards and the rock could be trucked to HudBay's 777
processing plant. That is where I see the upside in owning Callinex Mines—it
has good projects right next to HudBay's 777 mine. Callinex Mines has already
started exploration drilling with the money it raised.
Similarly, Minaurum Gold is another small company. It has raised $2.875M,
backed by directors David Jones and Peter Megaw, who are well known in
Mexican mining circles. I have known CEO Darrell Rader for a long time. He
runs things from a small office in Vancouver, so it has low general and
administrative expenses. Minaurum will soon start drilling its properties in
the Guerrero Gold Belt in central Mexico.
TGR: Minaurum is trading at around $0.075/share. What would you say
to shareholders who might be frightened by the low share price?
JB: Unfortunately this has been the problem with early-stage
exploration companies. Their share prices have fallen a lot. Minaurum was
trading at more than $0.60/share but that doesn't necessarily change the
valuations of its projects. When other people are disinterested in a stock, I
get more excited about the stock because I should be buying when others are
selling.
TGR: Are there other companies you would like to talk about today?
JB: I am on the board of a company called Gold Canyon
Resources Inc. (GCU:TSX.V). Gold Canyon has 4.4 million ounce (4.4 Moz)
Indicated gold deposit in Canada. Another 0.7 Moz is in the Inferred
category. At the share price of $0.115, my view is that it's one of the
cheapest gold companies in the mining space today, but as I'm a non-executive
director of the company, take my view with a pinch of salt.
TGR: Please leave us with one piece of junior mining market wisdom.
JB: The quality of management is extremely important. In the past I
have owned companies that had cash value three, four or five times more than
the share price of those companies, and over a period of time the financially
illiterate management team destroyed its cash advantage. I no longer tempt
myself by investing in companies that offer me very good valuations unless
the management is exceptional. That is truly the key.
TGR: Thank you for talking with us today, Jayant.
