A professional investor with Boy Scout genes in his DNA, Mercenary Geologist Mickey Fulp picks winners in the junior resource sector based on three criteria: share structure, people and projects. In this exclusive Gold Report interview, Mickey touches on how he studies up on such key factors as insider holdings that indicate management's skin in the game and the public float necessary for liquidity. He also suggests that the summer slump-with low volumes and low prices-is a good time for some homework on equities that could double within 12 months.
The Gold Report: So far in 2010, there's been both positive and negative economic news. We now have health reform, about to have financial reform and stimulus money is still working its way through the system. The markets are bumpy. What's your view for the second half of 2010?
Mickey Fulp: We always see volumes take a nosedive in the summertime, as everybody in the business goes on vacation. We're in the summer doldrums right now, and so I think we would hope for a better market after Labor Day. Amongst the juniors, liquidity has been the real problem. Volumes have been way down on the Toronto Venture Exchange; that's one of the criteria I always look at for the health of the market. We're down to around 150 million per day; you want to see something on the order of 250 million in a robust market. There's not been wholesale divestiture, though, so after Labor Day I think we'd expect higher volumes for the juniors and, hopefully, a better market. I even saw some Canadian analysts the other day talking about how the World Cup has affected volumes in that country.
TGR: You've talked about junior resources as a very high-risk, high-reward sector where people must be prepared to lose, as well as win. If they consider this gambling money, your Power of Two concept helps them improve their odds. Could you explain this concept?
MF: It's actually simple: The Power of Two is the idea that you take your money off the table when a stock doubles, so you're playing with somebody else's money. Let's take an example: Say you invest $10,000 in a junior stock that costs $0.20 per share. When it reaches $0.20, sell half; take all your initial investment off the table. Then take your $10,000 and find another stock that will double within 12 months and do exactly the same thing. It's an iterative process. You're accumulating positions in a basket of juniors and preserving your initial capital. If you do it five times, you still have your $10,000 ready to go into stock number six; and 25,000 shares each of the five investments with a zero cost basis. It's an infallible way to make money in a bull market.
TGR: What if the stock halves instead of doubles?
MF: There's only one reason to buy a stock-because you think it's going to go up, or if it's a blue chip, to generate cash flow through a dividend. There are myriads of reasons to sell a stock. If the reason you bought has changed, sell it; if not, hold it or average down on weakness, because you still think it will double within the original 12-month period. Part of the Power of Two concept is to buy stocks you think will double within 12 months, and nearly all active exploration juniors will have a low-to-high in any 52-week period of at least a double. In other words, during any given year, the stock's high will be at least double its low. The key is to buy at low volumes at low prices and sell at high volumes and high prices.
TGR: And when do you sell?
MF: If the reason you bought the stock has changed, when do you sell? It depends on many things. Perhaps it becomes deadwood and doesn't perform. You hang on to break even. Perhaps there are better opportunities, so you sell at a loss and move money elsewhere. Perhaps you sell it at the end of the year for a tax loss, because if you're doing your homework-and doing it right-you will have profits so you can take tax losses and write off against your capital gains. If it was a bad investment decision, just take your lumps and move on.
TGR: If the key is to buy at low volumes at low prices and sell at high volumes and high prices, does it make sense to buy now, during the summer doldrums?
MF: Yes, the summer doldrums always present buying opportunities. But make sure you don't buy too early. If you buy stocks with underlying good fundamentals and value, you will be rewarded at some point.
TGR: Aside from juniors, what would you advise investors?
MF: It's important to have a nest egg, and I have that outside of the money I have in the junior equity market. It's important to spread your assets and, therefore, your risk. I'm a bit of a Boy Scout, so I'm prepared. It's necessary to own your own shelter, and hopefully you don't have a mortgage on that. I have some farmland, keep some cash on hand and own large market cap equities, mainly in a managed IRA. I own gold, guns, gas and goods. I'm a bit of a survivalist. It's important to be prepared.
TGR: You say you look for three critical components in any public company: Share structure, people and projects. Tell us what you want to see in share structure and why that is important to you?
MF: You want a low number of shares outstanding, but it's a floating target that depends on the stage of the flagship project. I have some rules of thumb that I use for what constitutes a low number of shares. If it's a startup company, you want a low number of shares-10 million to 20 million-that are tightly held. If it has an advanced project, the acceptable number of shares would be higher, perhaps in the range of 40 million to 60 million. For a company going into the development stage, I like to see no more than 100 million shares outstanding. You want insider holdings to be significant, and you want insiders to participate in their company's private placements. They need to have skin in the game.
Institutions can be good or bad. Companies with advanced projects often have a large institutional fund holding. I am very particular about seeing a spread of institutions, and not one institution controlling a significant number of shares, because management then becomes beholden to that institution.
The Achilles heel for most of the juniors is the lack of liquidity, or trading at low volumes. Volume is generated in the market by a healthy retail public float, so although you want companies that are relatively tightly held by insiders, families and friends, you also want a significant retail public float because that's what generates liquidity.
TGR: What do you consider significant?
MF: 50% or more. Retail investors are the ones that provide trading volume.
TGR: What percentage of insider holdings do you like to see as opposed to, say, institutional holdings?
MF: I certainly prefer at least 10% to 20% insider holdings, sometimes more. I don't have strong feelings about institutional holdings. Oftentimes, it depends on the institutions and how committed they are to the junior resource market. Institutional funds need to make money, so they often do not have the company's best interest in mind. If any institution holds 10%, 15% or 20%, you want to make sure they are pros and committed to the company business.
TGR: Any other share structure factors that you consider important?
MF: You want to be wary of overhanging warrants, especially if they're marginally in or out of the money, because that can cap the share price. A company can go on a run but, in times of low news flow, drift back toward the price of overhanging warrants.
I always run working capital in with share structure. You want to make sure the company has sufficient working capital for a year or the ability to raise money-at non-dilutive share prices-when necessary.
The other thing I very much watch is insider selling. As a general rule, I want insiders not to sell. They should make their money on options and not huge salaries. If they sell into positive news or front-run, that raises a big red flag as does selling before or during bad news I've dropped coverage of three companies in my two-year newsletter history; two because of insider selling. It's very easy to find out about insider selling, assuming those people file transactions on time. There's a website called CanadianInsider.com that shows the last 10 insider transactions for every listed company, and sedi.com lists all the insider transactions in the history of a company. It's all available but no different: I look a lot of people pay attention to it. They absolutely should.
TGR: You mentioned startups vs. advanced projects in the share structure context. Along the spectrum from prospect generators and exploration plays to early development to near-production, do you have any preferences?
MF: I tend to favor advanced explorers because I think that's where real upside value can come in share price at relatively low risk. For instance, I like Amarillo Gold Corp. (TSX.V:AGC), which is an advanced explorer in Brazil with two projects. A resource estimate pending on one (the Butia Prospect, the most advanced of the numerous prospects that fall within the Lavras do Sul Project) and bids for a prefeasibility study going out soon for the second one (Mara Rosa).
Presently, I cover one small miner, an explorer in Mexico, one prospect generator and I'm adding another in the near future and one development generator. I currently hold more than 20 stocks, and I publicly cover 10. I am not averse to early on plays, and I especially like prospect generators. To evaluate a prospect generator is a little different. I look first at geological potential of the area they're working in and then consider very seriously the geopolitical risk; I look at their previous success and their JV partners. If the partners are mid-tier to major mining companies or top-tier juniors, that indicates the projects are especially good.
TER: Before we get to the prospect generators, which is the small miner you mentioned?
MF: The small miner I just added to my coverage list is Goldgroup Mining Inc. (TSX:GGA), which will produce about 25,000 ounces of gold this year from its operating mine in Mexico. Goldgroup has been cash-flow positive in 14 of the last 15 quarters. The real excitement is their exploration plays, especially the Caballo Blanco Project near Veracruz. It has a moderate-size resource presently, but excellent exploration potential. Goldgroup is earning in on another resource project and a third was recently sold for $20 million.
TER: And how about those prospect generators?
MF: Eurasian Minerals Inc. (TSX.V:EMX) is one of my favorites. It's a rapidly growing prospect generator. It completed a recent private placement of more than $5 million with the IFC (a member of the World Bank Group) and Newmont Mining Corp. (NYSE:NEM). That was done at 10% above market with no warrant. Presently, Newmont is drilling in Haiti.
And I'm going to be covering Almaden Minerals Ltd. (TSX:AMM; NYSE:AAU) soon. It's a venerable prospect generator-one of the most successful and long-lived prospect generators in the market-with significant projects in western Canada, Nevada and especially in Mexico. They are the underlying owner and a 30% holder of Goldgroup's Caballo Blanco Project.
TER: Any other juniors on your list?
MF: Animas Resources (TSX.V:ANI) is drilling at its flagship property in Mexico, Santa Gertrudis. Rumors on the street are that their consulting geologists like the look of the rocks. It doesn't mean they have a lot of metals in them, but they're seeing good alteration. Recently they've done two joint ventures in Nevada, drilling this year on a Round Mountain-type target with a current small resource; and for me a very exciting play is Kinsley Mountain in eastern Nevada. I first looked at this in 1978. It eventually became a small gold producer. The geology is very similar to AuEx Ventures, Inc.'s (TSX:XAU) Long Canyon deposit. Animas has been brutalized in the market of late and is perhaps a buying opportunity at these levels.
Otis Gold Corp. (TSX:OOO; OTCBB:OGLDF) is a small company that has the Kilgore deposit in Idaho, with a qualified resource and 6,000 meters of drilling going on. I'm bullish on the idea that they will increase and upgrade that resource this summer and fall.
The chart's kind of broken down on Pediment Gold Corp. (TSX:PEZ; OTCBB:PEZGF; FSE:P5E). It will become a buying opportunity at some point. They just initiated a 40,000-meter drill program at their flagship San Antonio Project in the Baja.
TGR: Do you know why their chart broke down?
MF: Low volumes amid a relative dormant period. They're not the only one; lots of charts have broken down over the last couple of months. It's not only the summer doldrums, but the overall markets are nervous and people are not putting risk money on the table. I think it's an overall trend in the business right now.
TGR: You've called the rare earth element sector one of your favorites. Do you still feel that way?
MF: I do. But as we've seen, the sector is very dependent on the health of the world economy. I have several core positions in the REE sector that I hold for the long term.
TGR: Who do you like, and why?
MF: Avalon Rare Metals Inc. (TSX:AVL; OTCQX:AVARF) just put out the first economic study of any junior in the sector, a prefeasibility study. The market reacted negatively because of high capex and relatively low internal rate of return (IRR). I spent a long time talking with CEO Don Bubar about it. There are lots of positive tweaks available in the mining, processing and marketing. For instance, a 1% increase in metallurgical recovery results in a 1% increase in IRR. After talking with Don, I was very pleased and had somewhat of a different idea about what this prefeasibility study means. This is a mine-to-market sector, and those of us who cover it have been saying from the get-go that offtake contracts will be paramount. Western world consumers of rare earth elements are very worried about mid-term supplies, and are positioning themselves for product now for the next three to five years. I think that's all behind the scenes, but I expect some movement in this regard in the short term.
TGR: So you're seeing production in the short term?
MF: Not production, that's five years away in North America, but I mean commitment to product flow from mines. Consumers will line themselves up and make sure they have a secure source. They're concerned about where their raw materials will come from.
TGR: If consumers are lining up to buy, why, then, would the prefeasibility IRR cause a decrease in share price?
MF: The market doesn't understand that. The market looks at a very large capex and a 12% IRR and says it's a marginally economic deposit. That may be, but the Western world requires rare earths, and they'll have to come from somewhere other than China.
TGR: What companies do you see lined up to take advantage of these offtake agreements?
MF: Avalon will likely be the first in North America. Quest Rare Minerals, Ltd. (TSX.V:QRM) is one of my favorites. They are trading somewhere around 50% of their yearly highs, just initiating a 15,000-meter drill program, with four rigs at their flagship Strange Lake heavy rare earth Project. They'll delineate the west half of the deposit, drill the east half-which has never been drilled-and their metallurgical results probably will come out in early August.
I particularly like Rare Element Resources Ltd. (TSX.V:RES), with their Bear Lodge Light REE Project. Their new resource estimate is 50% larger than the previous one, and they are drilling now. They're also drilling on the adjacent Sundance Gold Project and will follow that with a resource estimate. I can speculate that eventually this will be a two-for-one; there will be a gold company spinout.
My other favorite is Tasman Metals Ltd. (TSX.V:TSM), a European REE play. Since we last talked, they've raised $3 million, completed a drilling program with positive results at their Norra Kärr Project in Sweden and acquired the Bastnäs Project. That's particularly interesting, because Bastnäs is where rare earths were first discovered in the early 1800s. The mineral bastnäsite is named for this locale. Tasman also has acquired an advanced deposit in Finland (Korsnäs), and I think you'll be seeing a pipeline of additional projects coming in the door. This play is especially important because the European Union has stated they want to become more self-sufficient in critical and strategic metals, and Tasman is well-positioned for that.
Dacha Capital Inc. (TSX.V:DAC; OTCQX:DCHAF) has an interesting business model. It's the only rare earth element ETF.
TGR: Can you describe Dacha Capital's approach?
MF: Their corporate strategy is to buy REE metals, alloys and oxides in China, take them out of China and presently they're storing them in Singapore and South Korea. They can monetize that various ways, for example in the net asset value of the stock, so with increasing REE prices-which we've been seeing-Dacha Capital's stock price will go up, and if things go up very rapidly they can always sell these REE stores to consumers.
TGR: How are you feeling about the future for silver?
MF: I call silver the bipolar metal. In good economic times, it functions as an industrial metal, which makes sense because the majority of the world's silver is produced as a byproduct of lead, zinc and copper mining. So when base metal is in high demand, silver producers do very well. In times of economic crisis and duress, it acts as a precious metal. For me, silver is a hedge against calamity, the same as gold is but to a lesser extent. I own silver-bars and so-called junk silver, which is silver-bearing U.S. coins minted prior to 1965. When I buy precious metals, I look at the gold-silver ratio. It's currently in the upper 60s, which is not attractive to me. When the ratio was in the low 80s, in October and November of 2008, I bought silver. So I buy silver when that ratio is high, meaning the price of silver is relatively depressed. Otherwise, I default to gold.
TGR: Mickey, you are a big proponent of investors doing their own due diligence. What conferences, books, seminars or newsletters would you recommend to those who might be new to the gold sector?
MF: There are numerous investment conferences every year, and I personally speak at about 10 or 12 of them. They're held in various large cities-Vancouver, Toronto, Calgary, Chicago, Phoenix, New York City, New Orleans, San Francisco. I encourage investors to go to these. Most of them are free to the investing public. At the upcoming San Francisco show (Hard Assets Conference, November 21-22), there are educational workshops, some of which are free and some requiring small fees.
TGR: You'll be there?
MF: Yes. I will be presenting my educational workshop called Geology for Lay Investors. Probably the most difficult thing for lay investors to get a handle on is the geology of these junior resource companies' projects. We geologists tend to speak our own language. We understand the jargon but it's probably puzzling to the investing public who has no background in the science. So in an hour-long seminar, and however long I stay for questions-which tends to be quite a while-I try to boil it down into the basics of geology. Geology is a science, but the best geologists are artists. So through these educational seminars, my mentoring of investors and a book I'm writing on resource investing for the lay investor.
TGR: When is that coming out?
MF: I keep saying a year, but it keeps getting put off as I keep adding more chapters, kind of like most juniors' Gantt Charts. I'm chipping away at it but then I get busy with other things. I'm writing it chapter by chapter, so it's a work-in-progress. Stay tuned.
TGR: Any final thoughts you'd like to share today, Mickey?
MF: Yeah, I've got one. There ain't no cure for the summertime blues. Except that. . .Time is on my side, yes it is.
TGR: You ought to set that to music.
MF: I think that's already been done.
The Mercenary Geologist, Michael S. Mickey Fulp is a Certified Professional Geologist with a bachelor's degree in Earth Sciences with honors from the University of Tulsa (1975), and a master's degree in Geology from the University of New Mexico (1982). He has more than 30 years' experience as an exploration geologist searching for economic deposits of base and precious metals and other resources. Mickey has worked for junior explorers, major mining companies, private firms and investors as a consulting economic geologist for the past 22 years, specializing in geological mapping, property evaluation and business development. Respected throughout the mining and exploration community due to his ongoing work as an analyst, newsletter writer and speaker, Mickey can be reached at Contact@MercenaryGeologist.com.
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DISCLOSURE: 1) The Gold Report Publisher Karen Roche and Barbara Templeton conducted this interview. They personally and/or their families own the following companies mentioned in this interview: None. 2) The following companies mentioned in the interview are sponsors of The Gold Report: Avalon, Rare Element Resources, Pediment, Otis, Dacha, Quest Rare Minerals, AuEx and Animas. 3) Mickey Fulp: I personally own shares of the following companies mentioned in this interview: Amarillo Gold Corp., Animas, Avalon, Almaden Minerals, Goldgroup Mining, Otis Gold, Rare Element Resources, Quest Uranium and Tasman Metals. I personally am paid by the following companies mentioned in this interview: Amarillo Gold, Avalon, Almaden Minerals, Eurasian Minerals, Goldgroup Mining, Otis Gold, Pediment, Quest Rare Minerals and Tasman Metals.
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