Michael Ballanger: There's Still Money in the Juniors
Source: Tim McLaughlin and Karen Roche of The Gold Report 4/12/10
While Union Securities, Ltd. Investment Advisor Michael Ballanger says we're still in a vintage bear market situation, he sees opportunities for investors in the junior mining sector. In this exclusive interview with The Gold Report, Michael explains the rule of thumb he uses when investing in the juniors.
The Gold Report: Back in March of 2009, you said we were seeing a vintage bear market rally at that point. What's your opinion of the market a year later?
Michael Ballanger: We're still in a vintage bear market rally, but there have been some mitigating events that have shaped my opinion. I did not, and I don't think anybody realized the extent to which the printing press would be turned on by central banks globally.
If you can accept the premise that we're in a massive global bear market in purchasing power of cash, then everything else that is denominated in cash is going to be in an inverse of that which is a bull market.
You're not necessarily going to get price-to-earnings multiple contraction, which you should've seen by now, given the overbought status of the S&P 500 and many other industrial markets globally. Because the replacement power of equities within a reflationary spiral can only be higher.
I'm not doom and gloom driven right now. I still maintain that in all senses it's a bear market rally. But I think the re-flation effect will largely offset the P/E multiple contraction that I had forecast a year ago. You may just have a sideways market, 10% swings either way. It's going to be a lot like the '70s. You trade very straight-line, flat line, little rallies up, little declines downward. The big bull market won't be seen in the major averages like the S&P and the Dow.
TGR: Do you see a scenario where we will get back to those bull markets?
MB: What is happening right now is that you've got, to coin the phrase, the potential for a conflagration of stock prices upward. Everything is in place right now for a massive return of inflation. I don't buy the hyperinflation route, but the seeds are sown for inflation. What's missing right now is money velocity. The only way I see the S&P and the Dow moving to record highs is if money velocity kicks in. Money velocity is the match that ignites the inflationary tinderbox.
TGR: Last year you described a valuation gap in the TSX. Do you still see that there a year later?
MB: Oh, very much so. A lot of junior mining companies that survived the bad times, let's say from 1997 until 2002, issued a lot more stock than they did in the past.
In the 1990s, many of these companies would start their exploration campaign from a market float of 10 million shares. By the time they'd raised money and done all their exploration work, they might have gotten to 30 million. Many of these companies have gone from 30 million to 100 million shares outstanding. So the leverage, based on the smaller capital structure of a lot of these companies, may not be quite as dynamic as it was in the late 1970s.
A lot of the institutional money is managed by younger people who were probably in kindergarten when share prices were exploding in the late 1970s. I don't think they have the experience or the knowledge to understand that this mania is coming and that we may be in it right now.
A great degree of trepidation is still being shown toward the venture capital sector and the Canadian junior mining sector particularly. There hasn't been that propensity by the larger institutional funds to buy that sector yet. The retail investor has got a huge advantage right now over the larger professional or mutual fund/hedge fund investor because they have the ability to buy these things. Later on in the cycle, perhaps a year down the line, these larger professional and institutional investors will return to the Venture Exchange. When they do, that's going to be the driving impetus that takes the exchange to 4,000 or 5,000.
TGR: You have a rule of thumb for pricing junior exploration companies. Would you explain that for our readers?
MB: A company makes an initial discovery of gold. Through the drilling and exploration process, they come to a 43-101 compliant resource base of, let's say, 10 million ounces in the ground. Take the gold price, for example $1,000 an ounce, and multiply it by 10 million ounces. That gives you a $10 billion in situ metal value.
My recommendation is that investors can pay up to 10% of in situ metal value. In this instance, if you had a $10 billion asset, you wouldn't let your clients or investors pay over a billion dollars of market valuation.
Here's the reason. The location of a discovery is critical to what the mergers and acquisitions departments of the major mining companies are willing to pay based on in situ metal value. For example, if it's in northern Siberia, they will probably be willing to pay 12% or 13% of in situ metal value to take over a company. If it's in Timmins, Ontario, which is the heart of the Abitibi Greenstone belt, major mining companies might be more willing to pay up to 40% of in situ metal value. If my clients have been advised to pay no greater than 10% of in situ metal value, then if the exploration and the delineation of that discovery pans out and a major does come to take it out or take it over, you're going to get a lift.
TGR: Now if this is a standard method that's used to value junior exploration companies, what causes some explorers to trade at a substantial discount and some over that?
MB: One of the reasons, obviously, is political jurisdiction. We've seen what's happened in various parts of the world, where confiscatory regimes will arbitrarily come in and confiscate a discovery made by a foreign national. You've seen it in Venezuela. You've seen it in some parts of Africa. When I'm trying to evaluate a junior, after looking at management, I look for where they are exploring. Does the country in which they're exploring have great respect for and protection of the rule of law, the rule of contract law, primarily?
The provinces of Ontario and Quebec have the models for mining law. Canada is a commodity-driven country, but the two provinces of Quebec and Ontario are the most mining- and exploration-friendly provinces anywhere in the world.
Outside of Canada, I would think Mexico, which is heavily reliant on its mining business and mining industry, has been a place where they've actually respected the rule of contract law admirably.
TGR: You've said the underlying commodity is your third criteria in looking at companies. Where do you see the price of gold headed for the remainder of this year and into the next couple?
MB: I'm pretty run of the mill, like everybody else. I hate putting dollar numbers on it. However, as I said, if money velocity catches all this freshly printed money globally, and becomes the spark that ignites the inflationary bonfire, then you can just pick any number you want for gold prices north of $3,000 an ounce. Who knows?
For 2,000 years we've known that gold is money. The people that are in charge of central banks and treasuries globally have illustrated to us that they have no respect for fiat currency. They have proven it because they have, without any consideration of the ramifications for the average citizen, elected to debauch the currency. That's not just the U.S. That's everywhere. The inverse of that is gold. Gold is money. There's no counterparty risk associated with it. The same stuff we've read a thousand times by anybody that likes gold is what I believe. Gold is money. Fiat currency is paper with a promise.
Therefore, I certainly think it's going to see a new high here in the next two quarters, above $1,220. More so if the so-called Green Shoots recovery does actually prove to be an actual recovery rather than a money-printing exercise. Then demand, which will be the money velocity, will force people's hands and they will have to underpin their currency. That applies particularly to the central banks. The central banks have to find some way to maintain the integrity of their banking system.
The bottom line is that gold can go up for another five to eight years, and still not be considered to be a spike or bubble like all the anti-gold people talk about.
While I like gold, what interests me even more in the near term is silver. I think that silver is the poor man's gold. I don't want to get into any sort of great conspiracy theory, but I do think there's been some funny business that's been going on in the reporting methods of the Commodity Futures Trading Commission (CFTC). I don't think silver is trading where it would rightfully be if there wasn't funny business going on. Every study of global supply versus global demand on silver would suggest that we would have sharply higher prices than where we are today. Just to be really conservative, a 50-to-1 ratio of 50 ounces of silver being worth 1 ounce of gold would be normal. That would take us to a very conservative number of around $24. If the CFTC looked at position limits that are largely held by a couple of big investment banks in New York and perhaps one in London, you would see some legislation that would restrict position limits.
Silver, therefore, represents my favorite of all the metals right now. One of the reasons that junior silver explorers and junior silver companies are so attractive in my world is it's hard to find one. You know the names Pan American Silver Corp. (TSX:PAA;NASDAQ:PAASO) and Silver Standard Resources Inc. (TSX:SSO;NASDAQ:SSRI). There are very few companies right now that are actually pure silver producers, or certainly very few that are pure silver explorers. That's a very attractive area to get involved with. If you can find the right management and the right location, it's going to be a funnel effect. I think that when people start moving to try to find a pure silver equity there's only going to be handful. So Econ 101 dictates that when you have big demand against finite supply, the price variable is going to go up. The pricing variable on a lot of these junior silver explorers and producers I think has really elastic potential behind it. I think it'll be quite explosive.
TGR: Michael, what are some of undervalued companies that you think fit into this good management/right properties model?
MB: I will use three different types of juniors in my examples: gold and base metals exploration, gold development and one silver explorer/developer. The one exploration junior that has met all the criteria above is Explor Resources Inc. (TSX.V:EXS). In the interest of fairness and full disclosure, I am a shareholder. Also, our firm and I have been corporate finance and investment banking representatives for this company since May 2007. Explor is in the heart of the Abitibi Greenstone belt, which is a geological environment that stretches from north of Duluth, Minnesota, right across the tops of the provinces of Ontario and into northern Quebec. The Abitibi Greenstone belt has produced 180 million ounces of gold and 450 million tons of copper-zinc ore over the last 120 years.
In Explor's exploration model they are searching for what can be called an elephant. An elephant in the junior exploration game is an ore body that takes on just like it sounds-elephant status, elephant size. Explor's put together the biggest quality land package of any junior I've ever seen in and it is largely within the Abitibi Greenstone Belt.
The one that is the most exciting in the gold arena right now is an acquisition they made last year in the Timmins, Porcupine. It's actually west of the Mattagomi River in Timmins, Ontario. Over the last 100 years, 70 million ounces of gold have been produced out of Timmins.
Last June 25th, in an area west of Timmins, a junior called Lake Shore Gold Corp. (TSX:LSG) made a discovery at 83 meters of 12 ¾ grams at an elevation of 865 meters of depth, which was the first of its kind west of the Mattagami. In fact, it was one of the best drill holes in Canadian gold mining and exploration history. Explor has a 1,900-hectare parcel of ground called The Timmins Porcupine West Gold Property, which has had around $25 million of shallow exploration work completed over the years. Explor is executing a deep exploration program following the Hollinger-McIntyre model, which is significant because those two mines (located about ten kilometers to the east) produced over 30 million ounces and, like Explor's land, were associated with a major porphyry unit.
The second major package is the first serious land package assembled in over 40 years, located next to the world's largest and richest volcanogenic massive sulfide deposit-Xstrata PLC's (LSE:XTA) Kidd Creek Mine, which was a 140 million ton copper-zinc-lead-silver deposit that would have an in situ metal value of over $70 billion at today's metal prices. The most recent addition to that assemblage is a four-claim block located 600 meters from the Kidd open pit.
The third property is located in the Duparquet region in the province of Quebec, tied on to the Clifton Star-Osisko joint venture. It's called the East Bay property. November 3rd of last year Clifton Star Resources Inc. (TSX.V:CFO) announced a joint venture with Osisko Mining Corp. (TSX:OSK). That was at around $2.35 a share. Within three months of that particular joint venture announcement, the stock traded as high as $8.25 a share. They have a low-grade, big-tonnage, big-ounce deposit in that area. The biggest land package surrounding that deposit is Explor's.
Explor's CEO and President, Chris Dupont, is a seasoned ex-Inco, ex-Noranda mining engineer born in the heart of the Abitibi, and with our help now has a $5 million cash position and is currently drilling with two rigs on the Timmins Porcupine West prospect.
TGR: Now, Michael, in addition to Explor, are there other companies that excite you nearly as much?
MB: There's another one called Ely Gold & Minerals Inc. (TSX.V:ELY). It is based on a fairly attractive area of real estate in Nevada. It's a 43-101 compliant, 400,000-ounce deposit. John Brownlie is the geologist. He's been successful in putting one of Castle Gold Corp.'s (purchased by Argonaut Gold Ltd. (TSX:AR) in Feb. 2010) gold properties into production in Mexico as well.
Nevada is a mining-friendly jurisdiction within the United States. Ely has ounces in the ground. It trades at a reasonable market capital structure. If you take the 400,000 ounces at today's market value and you start working on the metric of gold at $1,100, it's got half a billion dollars in the ground, but the whole value of the company's more like $16 million.
The last one I'll mention takes us down to Peru and it's a interesting little company by the name of Tinka Resources Ltd. (TSX.V:TK; Fkft:TLD; Pksheets:TKRFF), which is run by Andrew Carter out of Vancouver. He and his team have had extensive operating experience in Peru. So in terms of Mother Nature, the geology's right, but what they have is really interesting. They have a 43-101-compliant silver resource of approximately 20.3 million ounces that could grow dramatically with continued exploration. Again, in the interest of full disclosure, we financed the company at $.10 per share. It trades at about $.23 right now. That financing closed in January of 2010.
TGR: Michael, any final thoughts on the junior mining sector?
MB: There was a reason why investors took the Venture Exchange to 3,300 in '07. You had $150 oil. You had gold approaching $1,000 an ounce. Copper was nearly $4. They weren't mispricing it, but what happened was the Venture Exchange got over-owned by all the highly levered hedge funds. When Lehman Brothers went down during the meltdown, these guys got redeemed and they had to blow out and just liquidate en masse. Around 80% of the juniors got nailed with forced redemptions. So that's where the opportunities arose.
I don't see that this time around. It's a different breed, a longer-term kind of investor class that owns the juniors now. They're not gapping up. It doesn't feel like hot money is in it. In terms of risk in the Canadian junior sector, I don't see it as being anywhere near what it was two years ago, because you don't have that hot money in it now. It's sort of a more seasoned long-term investment approach to it. But if we get the move in the metals I'm looking for in the next year-and-a-half, I think that you're going to see 4,000 to 5,000 for the Venture Exchange. If you've had somebody picking the right issues and you do your own due diligence to find those issues, I think you'll make yourself a pile of money.
TGR: Well, our readers will like that. Thank you for your time.
Michael Ballanger completed his undergraduate studies at Saint Louis University, where he earned a B.Sc. in Finance and a B.A. in Marketing. He joined the investment industry in 1977 with McLeod Young Weir, Ltd., and currently serves as an Investment Advisor at Union Securities, Ltd. His substantial background in corporate financing is further informed by his 30 years of experience as a junior mining and exploration specialist.
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1) Tim McLaughlin of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None
2) The following company mentioned in the interview is a sponsor of The Energy Report or The Gold Report: Explor Resources
3) Michael Ballanger: The views and estimates expressed in this article are those of Michael Ballanger and not of Union Securities Ltd.'s research department or its analysts. This article is not to be construed as an offer to sell or the solicitation of an offer to buy any securities mentioned in this article. Union Securities Ltd. does not assume any responsibility or liability for the accuracy or completeness of information contained in this article.
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