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An
investment executive at Sprott Global Resource
Investments Ltd., Michael Kosowan is working by
three sayings these days: "Well bought is half sold," "Small
is beautiful" and "Necessity is the mother of invention." In
this Gold Report
interview, Kosowan talks about the challenges
mining companies face and shares some jurisdictions that offer outsized
returns.
The Gold Report: Are you
mostly involved in mining investments, or are you also involved in oil and
gas?
Michael Kosowan: If it
comes out of the ground and has value in a commodity sense, we're looking at
it for investment ideas. My background is as a mining engineer, so what I'm
often looking at are mineral-style investments along the precious metals
space, because a lot of my clients are speculators. They're looking for the
high-return, high-potential rewards that we can get from a discovery. We're
coming into a market where there's been a lot of work that's gone into the
ground and a lot of dollars spent, some misspent. Either way it sets the
table for a strong exploration market.
TGR: A lot of these junior mining
companies are struggling because they're running out of money for
exploration. Yet you say it's a strong exploration market—could you
explain that?
MK: Strong because there have been a lot
of dollars put in the ground over the last decade that are going to prove up
some real buyable deposits. Also, the economic metrics that we're working
under are much stiffer than in the past.
We're in a marketplace that has very tight financial constraints. It's
also not particularly forgiving—the markets have been lousy over the
last 18 months and we are seeing low stock prices. But it's important to make
the distinction between the market and the businesses. From a business
perspective, I see quite a bit of good work going on.
TGR: Over the past 12 to 18 months, many
senior mining companies are spending a lot of time justifying to their
shareholders reasons to stay in the stock even though their share prices have
not performed, costs have increased and senior management has been fired and
replaced. Do you see a pathway for the seniors to retain investor confidence,
and do you see them being successful in drawing money away from the
exchange-traded funds (ETFs) and back into the equities over the next three
to six months?
MK: The senior mining companies are
starting from a very low base relative to the prevailing gold price. I'm a
big proponent of the slogan "well bought is half sold." From that
perspective I see good valuations among the seniors for investors with a
bullish view toward the gold price.
The senior gold stocks have to compete with three new elements in the
marketplace with which they're not entirely familiar:
"There
have been a lot of dollars put in the ground over the last decade that are
going to prove up some real buyable deposits."
First,
precious metal proxies or ETFs have had a significant impact on the
investment flows into the sector, which didn't really exist before the advent
of the ETFs. Aside from the direct relativity to the gold price, the metal
proxies have had the added benefit of removing the investor from the equity
arena.
Second, skepticism has grown toward corporate governance. There are
some management changes at the top of some of these companies, and investors
are starting to ask if management groups are making the best investment
choices for shareholders and economically growing the mining enterprise. When
the price of gold was moving up strongly, the message seemed to be to grow at
all costs. Now that inflation, taxes, regulatory hurdles and labor costs are
seen as cutting into the profit margins of the seniors, the seniors are
acutely aware of fine-tuning their operations and becoming more economically
efficient.
Third, there had been a lack of leverage to the gold price. The price
of gold has increased more than fourfold over the last 10 years. Meanwhile
the major gold producers have enjoyed a mere 8% annualized return. The low
return can be accounted for in part by the attempts made to develop marginal
assets. The market was rewarding the industry for ounces in the ground
irrespective of what that meant to the bottom line. The concept of leverage
to gold got confused in the context of a greatly increasing gold price. Now
that reality has set in, in the form of tighter financial markets, inflation
playing catch-up with costs, higher taxes and operational constraints, the
earning outlook does not seem as pretty as was originally hoped, and the end
result is the weak share prices.
TGR: Do you think it's true that extremely
high capital expenditure (capex) projects aren't viable anymore?
MK: High capex and low grade have been
the death knell of many a project and will continue to be real. The market
has changed and is becoming more focused on the economic viability of
projects. The market has developed a sweet spot for the "small is beautiful"
idea. Smaller gold producers may be in a real window of opportunity where the
higher gold prices that we're experiencing go directly to their bottom lines
or their margins and are allowing them to be quite profitable because they
never really had an aggressive growth strategy to begin with. If you're a 2
million ounce gold producer, you've got a real problem. Your problem is
finding more economic reserves to rely on, and that's become a challenge now
that we've removed a lot of the low-grade opportunities that were once
apparent in the marketplace and financeable in better economic times.
"The
market has changed and is becoming more focused on the economic viability of
projects."
We've seen the senior names diversifying their asset portfolios to
include metals that they hadn't focused on before—for instance with the
Barrick Gold Corp. (ABX:TSX; ABX:NYSE)–Equinox
Resources Ltd. (EQN:TSX; EQN:ASX) deal that we saw earlier last year. The
huge companies are trying to find ways to replace ounces through other metals
or acquisition. Going back to my illustration about the gold price going up
fourfold, or even fivefold, in a relatively short period, the supply response
from gold production has been pretty muted. If you think about the margin
that would expand under that scenario for any other commodity, then you would
start to see real supply coming onstream, and we just haven't seen it. That
speaks to the challenges of finding these good, high-grade, economically
viable deposits. They haven't been found at the rate that the industry
requires, which is why what we are looking at could develop into a strong
exploration cycle.
TGR: Given the backdrop of resource
nationalism, increasing cost inputs, exploration risk and the other factors
that go into exploration, how do you decide what projects you're going to
investigate for your clients? Let's talk about some of your favorite
jurisdictions right now.
MK: I like to find jurisdictions that are
generally misunderstood, especially if that misconception is further emphasized
by the media. I'm a contrarian and find investments at a discount. It's, of
course, critical to back up that with concrete, objective facts; however,
finding well-valued or cheap speculations involves building up the intestinal
fortitude to go against the crowd. I hearken back to what my friend Rick Rule
has often said, which is there are many who call themselves contrarians so
long as it's fashionable.
"I
like to find jurisdictions that are generally misunderstood."
I have looked at areas such as the Yukon, about eight years ago, when
it was a frontier market that really lacked infrastructure. I then moved on
to West Africa in the wake of the Red Back Mining Inc. (RBI:TSX)
acquisition, with the idea that the senior mining companies would see this as
a very attractive area because the types of deposit matched their style. They
were large, low-grade projects that required high capital and in a sense
created a moat around their investment thesis. You couldn't be a little
junior company who hopped in there with a rake and a shovel and started going
to work and producing gold. It was much more capital intensive and that
created the moat, the barrier of entry. With the market developing the way
that it has lately, the high-capex projects are nonstarters. I've been
looking at heap-leach oxide, near-surface projects. That's where your capex
is nicely controlled and infrastructure is readily available.
I think Mexico is a great place. I visited the Guerrero Gold Belt this
year with a team of geologists, and I concluded that it was very appealing to
the sociopolitical contrarian in me. The drug wars were quite heated, and
there was the idea that Mexico is just a terrible place to go, which I didn't
see as true. There are certain places in Mexico that are certainly dangerous,
but you shouldn't use a broad brush and wipe out the potential or the
stability of the entire country based upon what is in the news media. The
Guerrero Gold Belt is an old new gold belt. Even though it is an area that
has been mined for decades, there is still much to learn from the
prospectivity of the geological controls.
This concept of a renaissance is exciting because it gives an air of
familiarity with the region, enough to make you comfortable with the geology
while opening the door to modeling and interpreting these new gold-bearing
structures.
TGR: Do you see Mexico continuing with its
support of the mining industry? Could the Mexican government do anything
similar to what we've seen in Argentina or Peru, where there is increased
resource nationalism, or a more difficult permitting environment?
MK: In Peru, which is a country I worked
in with a junior exploration company, the community where the mining activity
occurs doesn't share in the social take that is generated in the region. Lima
is gaining most of the benefit. Argentina is going down the route of currency
controls. But let's face it: the idea that countries worldwide are going to
increase their social take is very much on the rise. Part of that problem
stems from the mining industry itself, which has simply been announcing
operating costs and not taking into account the additional costs of
sustaining capital or exploration in finding more ounces. As a consequence,
the jurisdictional governments have been saying, "Well, if their margin
is that thick, 100%, then they can certainly cut us in for twice the kind of
taxes that we have historically achieved."
TGR: That is a problem of a mining company
not effectively reporting what its true costs are. Maybe that's part of the
better transparency that we might see going forward.
MK: I think we will because they have to.
The senior mining companies were rewarded for offering leverage to gold; as a
consequence the market misrewarded them, in a sense, for finding marginal
ounces, and that's what they gave us in spades. It was very easy for them to
deliver on that promise, and now they're sitting with a series of assets that
they really can't develop due to the economics of hard times.
TGR: Are there other jurisdictions you
like besides Mexico?
MK: I like Serbia. I traveled there two
years ago. There are a series of companies along the Tethyan Belt, which
really offers a lot of potential. Serbia was closed off largely because of
Kosovo and the war. Now that they want to get the economy humming again, it's
really looking at these other mineral-type developments.
TGR: Do you have any other parting
thoughts for investors in terms of how to navigate 2013, when we have a gold
price today at $1,700/oz.
MK: A large part of my investment theory
is geared toward discovery. My clients hire me to seek out the high-return
speculations available in this market. These markets, while challenging, are
still rewarding exploration success. The discoveries are starting to come to
the forefront because there has been a fair amount of activity that's gone
into plays, or dollars spent to develop geological concepts and ideas that
are starting to bear fruit. Speculators often like the idea of getting rich
quick, but the exploration process realistically takes time, and it takes a
mature view to see how these projects are developing.
TGR: Rick Rule has been famous for saying
that the chances of success in the discovery business are extremely slim. Are your clients patient with this process, knowing the
odds are not great?
MK: Yes, my clients have developed this
discipline over time. I've been working as an investment adviser for over 12
years, and a lot of my clients have been with me through thick and thin.
We've been through the 2008 market. We've been through this market over the
last 18 months, which I've typified as death by paper cut—it's been a
long process. I've been able to educate my clients. If you want to be happy
with your stock portfolio over the last two months, that's simple: lower your
expectations. You've got to expect that there's going to be times in the race
where you're at the back of the pack. It's more important to stay with it on
a good trend in a good investment and to know when you're positioned to make
a move at the appropriate time.
TGR: That's the whole idea of being a
contrarian. That's why it takes a lot of moxie and guts.
MK: It does.
TGR: Thanks for your insights.
Michael Kosowan is an
investment executive at Sprott Global Resource
Investments Ltd. Originally from Canada, Kosowan holds a master's degree in mining engineering and
is a licensed professional engineer. He is also a registered representative,
having completed the Series 7, Series 24 and Series 63 in the U.S. and the
Canadian Securities Commission course. He also holds a diploma in Regulatory
Law. Prior to working for Global Resources, Kosowan was a project engineer at
Placer Dome (now Barrick Gold) and the exploration manager for Atapa Minerals
in Indonesia.
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DISCLOSURE:
1) Sally Lowder 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: None. Streetwise Reports does not accept stock in exchange
for services. Interviews are edited for clarity.
3) Michael Kosowan: I personally and/or my family own shares of the following
companies mentioned in this interview: None. 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.
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