Well-known and highly regarded throughout the mining and exploration community, Mercenary Geologist Mickey Fulp returns to tell The Energy Report readers about his growing Primer for the Lay Investor and share his musings on plays taking shape in uranium (Athabasca, Wyoming and New Mexico) and natural gas (southern U.S. and central Texas).
The Energy Report: The third installment in your Primer for the Lay Investor series, The Good, the Bad, and the Butt Ugly appeared in our precious metals website, The Gold Report, on February 24. What's the short story there?
Mickey Fulp: The piece deals with junior resource companies, metal commodities and flagship projects. The gist is that certain metal commodities are conducive to success for a junior resource company, and some metal commodities are not. Carrying that a bit further and bringing in the geology aspect, certain deposit types within these specific commodities are good, bad or ugly for juniors to have as flagship projects.
I then give examples of each: three examples of good types of projects and deposit types, three examples of what I consider bad commodities and/or deposit types, and three examples of the ugly (or the butt ugly as I say)–commodities and projects I think juniors and investors should avoid at all cost.
TER: When you're qualifying the good, the bad, and the ugly, are you looking from a cost of mining point of view, a yield in the mine point of view or all of the above?
MF: All of the above. It's based on the idea that juniors have limited financing capabilities and limited life spans. The average life of a junior resource stock is probably on the order of five to seven years. A junior needs to select projects that have a good chance of success within a time period of three to five years, it needs to look at something where the production costs are in the lowest quartile, ultimate capital expenditures are within its financing capabilities, and there are multiple exit strategies, whether it's to develop a mine or get taken out, or even pay the exploration costs to get to the point that it can become a takeover candidate without diluting the share structure so much that it becomes a financial nightmare.
Many juniors select projects that are way too big for their britches. An example would be big porphyry copper deposits. It takes 10 years or more to explore, permit, and develop and you need a minimum of $2-$3 billion in debt and equity financing to put a mine into production. That is beyond the capability of any junior resource company. The exit strategy is limited too: Sell out to a multi-national integrated mining company or a sovereign company looking for smelter feed. So nearly all of these companies fail.
TER: What do the first two installments in your Primer focus on?
MF: Bear in mind, there is no sequential nature to these things. Whatever I am inspired to write at a particular time becomes a chapter in this series. The first one (August 25, 2008) dealt with Reserves and Resources, and I was motivated to write that because it became very apparent to me that many investors, investment advisors, brokers–even geologists and engineers–did not understand the difference between reserves and resources. So this piece laid out the Canadian Institute of Metallurgy's 43-101 definitions in layman's terms.
The second in the series was Share Structure, People and Projects (December 15, 2008). Those are my three key criteria for evaluating companies. I have plans to do What Do Drill Results Mean? and actually posted a couple of others that will fit into this series.
It's in the back of my mind that sometime this is going to be a book; so when I have 10 or 15 chapters, I may bundle them up and rework them to become less time-sensitive and perhaps publish a little book.
TER: Your third one–The Good, the Bad and the Butt Ugly–deals with geology in a way that you are to be applauded for. It makes sense; even non-geologists can understand what you were saying. Would investors find all three installments on your website?
MF: First of all thanks for the compliment, the idea is to make them understandable to the average investor; and yes, they are available in Mercenary Musings, a tab on my website (MercenaryGeologist.com). All my newsletters appear on the Musings page. Just scroll down until you find the one you want to read.
TER: You're a fan of the uranium sector, which we discussed in our last interview a few months ago. At the time, you called uranium the canary in the coal mine for the commodities collapse but also noted that it had recovered fairly well. What is your thinking nowadays?
MF: I like certain segments of the uranium industry for speculation in junior resource stocks. I like the Athabasca Basin, which we have talked about before and where Hathor (November 24, 2008) made its discovery. I also like the Western U.S., specifically areas that have had significant historic production. For me that would be Wyoming and New Mexico, particularly the in situ recovery (ISR) techniques being employed in Wyoming. Several juniors have projects in the permit stage right now. The ISR deposits are basically solution mining. They establish well fields, inject oxygen, baking soda, and club soda down the holes, dissolve the uranium and then recover it in small extraction plants. In some ways–in that you're developing well fields–it's analogous to coal-bed methane. It's relatively cheap to do and environmentally benign. So yes, I'm bullish on uranium in the mid-term, for say, the next 10 years. I see a supply crunch in the uranium business.
TER: It's interesting that Obama never seems mention nuclear when he talks about energy.
MF: I think that's a mistake.
TER: So should we expect any government funding to be advancing nuclear facilities, either building, expanding or upgrading them?
MF: I don't care to predict what the government might do. The U.S. has expanded its nuclear power plant capabilities significantly since Three Mile Island. It's been under the radar screen, but we are consuming many, many more pounds of uranium than in the 1980s when the bottom fell out of the U.S. uranium business. We currently consume about 55 million pounds a year, and we're producing about four million. About half of that supply shortfall is presently being filled by the Russians in their Megatons to Megawatts Program, but that's all going to end in 2013.
U.S. nuclear power plants are going to continue to use 55 to 60 million pounds of uranium a year, and that supply has to come from somewhere. Whether government supports the expansion of nuclear power plants or not, that supply shortfall still exists.
TER: And what about Hathor Exploration Ltd. (TSX.V:HAT)? Many people are talking about Hathor, and the Athabasca region has a lot of fans. Is it group-think or do we really have a play there?
MF: It's group-think, and it scares me because it is group-think. By nature, I'm a contrarian; but all my buddies and all the analysts in the business–we're all onto this, and we're all into this play. So, although it makes me a little bit uncomfortable to be in a crowd, Hathor is a very good play, an interesting play.
I recently crunched some numbers on Hathor and will run you through my simple scenario: There are 95 million shares fully diluted–86 million outstanding, but we'll use the fully diluted because the warrants were in the money until recently. I haven't calculated numbers on the resource because I don't think there's enough drilling to put good numbers on it, but lots of analysts have played around with it and have come out with about 35-40 million pounds U3O8. Using current peer valuations for, let's say Forsys Metals Corp. (TSX:FSY), which operates in Namibia and is being taken over by a Belgian company or the Uranium One (TSX:UUU) sale of half of Honeymoon in South Australia, we're looking at $7–$9.50 per pound in the ground. Based on that comparison, you have somewhere between a $245 to $380 million market cap for a resource of 35-40 million pounds.
That adds up to a fair market value somewhere between $2.60 and $4.00 a share. With recent weakness in the uranium sector and Hathor's first results from this winter's drilling, which for some reason that I don't understand were negatively received by the market, it is currently trading at about $1.90. I would say it's undervalued at that price. The thing about Hathor is that it trades a lot of shares. And it's cyclical, too, so people play both the liquid nature and the cyclical nature. I know players in Hathor who have a core position they don't trade, and then a portion of their Hathor ownings that they trade between $2.50 and $3.50. You can see a cyclical pattern to Hathor's price over the past three months, ranging somewhere from $2.50 to $3.50 per share. It's now broken thru on the downside of that trading range.
With current guess-timates of pounds in the ground–say that 35 million or 40 million pounds–and in a previous trading range of $2.50 to $3.50, it was not undervalued. The play, and why analysts are so bullish, is premised on growing this resource.
TER: And what's the basis for that expectation?
MF: Analysts think that the resource is going to be much bigger than it is currently. There are good geologic reasons to think that, because they have yet to hit mineralization where the structure hits the unconformity. I know this is geology speak, but let me try to explain.
These deposits are fed by basement faults, the basement being the underlying rocks. A series of flat-lying sedimentary rocks lies atop that basement at the so-called unconformity. Where the basement faults, i.e., the feeder zones hit the unconformity, is where bonanza-grade uranium ore bodies occur. Hathor has yet to announce results from current drilling that test that unconformity.
So the deposit could grow much bigger; there is also good geophysical evidence that it could grow bigger. Everybody has analyzed and recommended Hathor based on the theory that it's going to get much bigger than it is. That's really a crapshoot; all drilling is a crapshoot, so we'll see.
TER: But as a geologist, you see nothing arguing against high potential for a much larger find?
MF: The geological evidence says it has a chance of growing bigger, and I think that's what the market is expecting. If it grows to 100 million pounds–which is pure speculation–do the numbers; you're looking at a legitimate market cap of somewhere between $700 million and perhaps $ 1 billion. That would translate more or less into a stock price of $7 to $10; but that's solely based on speculation and exploration risk and that makes me nervous.
TER: When should we expect drill results that will prove or disprove a much larger find?
MF: They will trickle in over the next two or three months. Four rigs are currently drilling around the clock up there. The first round of results didn't really tell us anything about the ultimate potential since they are grid drilling the Rough Rider Zone, so we can expect lots of misses in with a few really good hits. Last winter and summer seasons, they drilled 28 holes in Rough Rider, and hit on 21. That's a 75% success rate, which is phenomenal. I do not expect that sort of success rate to continue. It can't happen, because investors should realize that lots of misses are required in a grid-drilling scenario. Not only are you defining the mineralized body, you are also testing its limits and that demands deliberately stepping out until you miss.
But as long as they get a few big hits again, and once this drill program is done, Hathor geologists will have a very good understanding of the geology and can start putting real numbers on this. We would expect a 43-101-qualified resource estimate by the end of Q2.
TER: Are there some other interesting uranium plays up in the Athabasca region?
MF: There certainly are, and I wrote one of them up not long ago in a musing called Fission Energy: Splitting from the Herd (January 14). Fission holds ground that adjoins Hathor and AREVA (ARVCF:OTO) on the Midwest trend and called the Waterbury Lake project. They have some of the key areas, and I very much like their prospects. When I wrote it up, it was trading at about 34 cents. It immediately ran to 60 cents, and then settled back down. It's been badly hit along with Hathor and is now as low as 17c.
For a speculative uranium play and the chances for a double- or even the proverbial five- or 10-bagger, Fission Energy Corp. (TSX.V:FIS) looks good to me. The geology is compelling in that they have a good chance at some pounds in the ground within their extensive land package at Waterbury Lake. And because their claims are as close as 30-40 meters from Hathor's intercepts at Roughrider. So if Hathor gets taken over, Fission's adjacent Waterbury Lake ground would be required, too. It's kind of an insurance policy on exploration risk. This scenario is of course predicated on Hathor's success.
TER: Beyond Athabasca, you say that Wyoming and New Mexico may have some interesting plays?
MF: Yes, especially Wyoming. Deposits are in permitting now for conventional open-pit uranium mining in Wyoming's Gas Hills District. Historically, the Gas Hills produced over 100 million pounds of uranium. Cameco is in production with in situ mining and recovery in the Powder River Basin. AREVA's plant there is currently dormant, but some mid-tier juniors in the Powder River Basin are well-financed with lots of pounds in the ground. We can expect the first new uranium production from the U.S. to come out of the Powder River Basin sometime within the next two years.
TER: And New Mexico? You live in Albuquerque.
MF: Yes, I like New Mexico. I live about 70 minutes from the heart of the Grants Mineral Belt, where a couple of really nice deposits may be mined before too long–conventional, underground uranium mining and ISR. The Grants Mineral Belt produced 340 million pounds of uranium from the 1950s through the early 1980s. It has not produced significant amounts since then, but remains the world's second-largest uranium district, exceeded only by the Athabasca in 2005.
The key in New Mexico now is to get a mill permitted. There is opposition but hopefully we're mid-term away from having an up-and-running custom uranium toll mill in the Grants Mineral Belt. Once that happens, lots and lots of uranium will be coming from multiple deposits in northwestern New Mexico.
TER: Any specific companies there that would interest investors?
MF: Check out my recent musing (March 9, 2009) to learn more about Strathmore Minerals Corp. (TSX.V:STM) (OTC:STHJF), a sister company of Fission Energy that has combined resources of 163 million pounds of uranium, that's both historic and 43-101-qualified in all categories, measured, indicated, and inferred.
TER: Strathmore is in New Mexico?
MF: New Mexico and Wyoming.
TER: Both of your favorite areas.
MF: Strathmore is the largest junior pounds-in-the-ground holder in the Gas Hills. They are the largest pounds-in-the-ground holder in New Mexico, and have significant pounds in the ground in the Powder River Basin. This is the true super uranium junior in my opinion. It was trading somewhere around the 22-cent range and has jumped to 30 over the past three days on increasing volume, very undervalued considering the resources. In terms of peer comparisons, they're much lower than any other company out there, and they have many, many more pounds in the ground than most other juniors.
TER: Why is their stock trading so low? Is it just market conditions for uranium juniors?
MF: Partly market conditions but Strathmore historically has traded at a low peer-group comparison. I've been grasping at straws; I've been a Strathmore shareholder for well over a year and a half, and I can't really put my finger on it. Perhaps marketing perception, overly optimistic timelines in the past, so many projects with resources that the market thinks the company lacks focus, no U.S. listing whereas most of the mid-tier uranium juniors have AMEX listings, etc. There are not a lot of insider holdings, so they're at the mercy of the market. I just know they are undervalued. I recognize that, and I think they're a buy. I've been accumulating Strathmore.
TER: Another sector you've been following and commenting on is natural gas.
MF: Yes, I follow natural gas a bit. I own a couple of Canadian natural gas producers. Gas is interesting right now; we're in the high demand season in the winter. To my knowledge, it's been a very harsh winter this year, so gas should be at its yearly high price. It's trading at somewhere around $4.25 for the benchmark Henry Hub, though, which is a ridiculously low price, especially in the winter. Industrial demand is down because of the economic crisis, and as the spring comes and consumer demand eases off, we can expect natural gas prices to fall even lower thru the spring and summer months.
We have also been hit by a glut of gas–shale gas. There are a couple of very successful plays in the southern U.S.; specifically the biggie is the Barnett Shale play in central Texas, near Fort Worth. In early 2008, oilmen in Texas were saying the U.S. could become a net exporter of natural gas in the next few years. So with more supply and lower demand, I expect lower gas prices.
A bubble in shale gas started back in April of last year. Natural gas prices were high, oil prices were high; but at the time, through May and June, I recognized this as a bubble, especially in the junior stocks, and wrote about it. A big to-do was made about the Utica shale gas play in eastern Quebec, which has not turned out especially well. Basically, production is nowhere near what was predicted. That's not why I saw this stock bubble coming though. It was just the flavor of the month, much like the quick-lived potash boom and Saskatchewan coal area play. Quebec shale gas stocks ran to ridiculous values. Now with the downturn in natural gas prices, financing is nearly impossible, drill rigs are not turning, and many of these shale gas plays are not economic.
TER: But for the time being and given where you think gas prices are going, it sounds as if there really aren't any natural gas plays unless you want to be speculative and buy during the low summer months.
MF: Your point's well taken and a contrarian may buy when nobody else likes these stocks. At some point, some of these beaten-up gas plays become buys. I have no idea when that is. It's not now, but when gas prices hit their yearly lows, you might want to start looking at some natural gas plays.
There's been a double whammy, too; Alberta's new royalties took effect at the beginning of 2009. So lots of Alberta gas plays are beaten up right now. For me, natural gas is on my radar screen; I'm not going in yet, but some compelling gas buys may surface later this year. Don't get me wrong–these will be high-risk, speculative plays; but if you can pick them up for a few pennies, your upside is good, you get your double and maybe move on. Don't you wish you would have bought your 10 favorite gold stocks in mid to late December?
TER: We'll have another conversation in the spring to see what comes to fruition.
MF: I look forward to that.
In the interest of full disclosure, I should say that I am a shareholder of Hathor Exploration, Fission Energy, and Strathmore Minerals and on occasion, a paid consultant to the latter two companies.
A confirmed contrarian who invests solely in stocks he expects to at least double in value and considers himself a classically trained economic geologist, Michael S. Mickey Fulp is a Certified Professional Geologist who earned his bachelor's degree in Earth Sciences at the University of Tulsa and his master's in Geology from the University of New Mexico. Specializing in geological mapping and property evaluation, he brings more than 30 years of experience as an exploration geologist searching for economic deposits of base and precious metals, industrial minerals, coal, uranium, and water to his popular Mercenary Musings and other venues. Mickey launched MercenaryGeologist.com almost a year ago. You may contact him at Mickey@MercenaryGeologist.com .