Annual Review: Natural Resources, Metals & Mining

by Travis Johnson, Stock Gumshoe | January 6, 2017 5:54 pm

Each year I check in on every company that I own and cover for the Irregulars, even those where my opinion doesn’t change much from month to month (or even from year to year, in some cases)… but we’re going to do it a little differently this year. This is all part of what will be a transition over the next few weeks in how I write to you about my favorite ideas and about my portfolio.

As I noted a few weeks ago while we were coming to the end of the year, I’ve long gotten questions about my personal portfolio and about the performance of my “picks” and about why I own some stocks in the “Irregulars” listing and don’t own others. I don’t offer a portfolio for other folks to follow, we’re not trying to provide an advisory that directs you to make trades each month, but I do hope to help other investors by sharing my thought process and, since you’re a kind and generous soul and are willing to pay up as an Irregular to keep Stock Gumshoe going, I want to provide you with, well, more.

And it has, I’m sad to say, gotten a little confusing over the years as my special coverage for the Irregulars has evolved — we’ve had core stocks that I write about a lot, and I’ve profiled interesting investments for you most months, and sometimes I own those stocks and sometimes I don’t… and sometimes I cover them a lot going forward, and sometimes I don’t.

So I’m going to revamp what I write and share with you to make it a bit more clear, and will be changing up those Irregulars spreadsheets and “performance” measures to reflect that.

The end result? The Friday File commentary will still include teaser solutions sometimes, and I’ll still write to you once a week about something that I find interesting — but from now on, the Irregulars-only “non-teaser” coverage in pieces like my “Idea of the Month” articles will be much closer to being just the coverage of my personal real-money portfolio and the stocks I’m making decisions about throughout the year.

I will disclose the rough portfolio weightings in the stocks I write about and own, and publish updated summaries of those holdings at least once a month in some form (I’m still hammering out the details)… and other stocks that I find interesting enough to write about for you but don’t own will just sit on a “watchlist” until I decide to either buy them or stop watching them.

That should give me a chance to write more about sector weightings as well, and about risks and concentrated portfolios, and I hope it will help my coverage to become more even… as you’ve probably noticed, I’ve always written more about and followed more ardently the investments I actually own.

So to begin this fresh start and reset, in my annual review I’ll spend the next few weeks going through everything I own right now by looking at them in rough sector groupings, with my thoughts on those holdings… and today we begin with Natural Resources — which includes crazy gold miner speculations as well as energy, farming, and whatever else comes out of the earth as a raw material. Mostly my holdings in the sector are in mining and just a little in energy, but that won’t always be the case. I often like to have some exposure to timber and have held agriculture stocks like little Input Capital (INP.V, INPCF) in the recent past, for example, though those aren’t in my holdings at the moment.

I was browsing through the Global Mining Observer recently, and what struck me were comments by Franco-Nevada CEO David Harquail about royalties, land banks and the end of the ‘big freeze’ in mining finance[1], and by Altius CEO Brian Dalton on patience and counter-cyclical investing[2] in cyclical natural resource markets. And those pieces reminded me of why I don’t really like investing in mines… I want to invest in smart people who are taking advantage of the booms and busts in mining and getting steadier returns by financing explorers and miners.

Harquail has been around much longer, building Franco-Nevada (FNV) with Pierre Lassonde as the first big gold royalty portfolio that gave them a way to “skim the cream” from some big mineral deposits without having to do any work, and his perspective on his history in mining finance provides some good counter to our urges to invest in the next hot mineral discovery — he talks about how open-ended financial vehicles (like mutual funds in the 1980s, or ETFs now) were the ultimate vehicles for buy high, sell low investors as money rushed in to chase a trend and flooded out at the bottom of the cycle. Here’s a bit more from him that I thought was interesting (this is from a speech that the Global Mining Observer folks excerpted — the full speech is here[3]):

“The gold industry was very accommodative to what investors wanted. Easier money came with the bull market, but mining boards felt more obliged to be responsive to shareholder pressure. In the last decade, I have seen four successive investment themes applied to the gold industry by investors: ‘ounces’, ‘maximise NPV’, ‘growth’ and ‘maximise free cash flow’. None of these themes work well through the cycle and waste a lot of capital.

“Mining has been around for millennia. There is a lot of wisdom with the old timers who knew mining would always be a highly cyclical business. It was why the industry would use debt sparingly and be willing to accumulate capital in the good times. It was why mining companies focused on developing only low quartile cost projects with long lives. The industry veterans knew they could never time the commodity cycle. But if they managed their risks, they could manage their business to be around long enough to profit from the up-cycles. The mining industry lost its way when it started to cater to the wrong type of investors. Own your strategy and make it relevant to the investors that matter.”

Altius’ (ALS.TO, ATUSF) Dalton similarly says what many mining executives will not: that mining is an awful business. It’s expensive, driven by wild cycles of boom and bust, and rife with failure. Here’s a quote from that article:

“The only way it is really interesting is because of the volatility, the difference in valuation that occurs from the bottom of the cycle to the top. Other than that, it’s pretty much a horrible business.”

And that’s from a guy who has been staking lands and spinning off mining projects for more than 20 years. He also sounds very Buffett-like in his “outside the mainstream” life, with most of his time spent far from the go-go markets of Vancouver, Toronto, London and New York… and with his ho-hum description of why Altius has been successful for a long time while so many junior miners fail:

“Our job is not to be predictive of where the markets are going. Our job is to recognise where they are. And act accordingly.”

“We’ve got a lot of growing to do. We study what we did before, what we did good and did bad, and all the peers around us that did the opposite. We stuck with the sector in the ugly times, when everybody else jumped ship and became tech stories. Then tech went bust and they became mining stocks again.

“I don’t know why everyone doesn’t do it.”

I think I know why everyone doesn’t do it — everyone doesn’t act thoughtfully and think long term, everyone wants to look smart by making the next great trade, everyone is terrified of missing out on the latest go-go market.

The genius of Warren Buffett is not in some preternatural ability to skillfully trade stocks, though he’s certainly good at buying and selling, it is largely in his ability to focus on what is important to long term success and not get distracted by trying to be fashionable or ride exciting trends… long-term investment success largely comes down to psychology, not math or the things you learn while getting your MBA. If you can keep your head straight while those around you are doing crazy things, your odds improve markedly. Hopefully Brian Dalton will continue to build his company with that mindset, and hopefully I’ll be smart enough to stick with him as he does.

That, really, is a pretty good summation of why I try to put most of my natural resources (particularly mining, but also sometimes energy and others) investment capital into companies that can survive and thrive for a long time with upside exposure to mining booms but not so much exposure to the downside risks that destroy so many explorers and mine developers.

For me, Franco-Nevada and Sandstorm Gold (SAND) and Altius Minerals are the prime picks in this area, with FNV being the blue chip that I just recently started to buy and Sandstorm the junior upstart that wants to become the next Franco-Nevada… and Altius the oddball trying to expand that precious metals royalty strategy into base metals and other natural resources. All three are core positions now, and I expect them to remain in my portfolio for a long time.

Valuations are reasonable for all three of those, my most recent purchase was of Franco-Nevada, which was my December “Idea of the Month,”[4] because I think that’s one that’s easiest to buy whenever there’s a sharp dip or sentiment shift in gold equities, and the most likely to hold up reasonably well if there’s a market panic or another sharp drop in gold prices — it has a far longer record and a far stronger portfolio than Sandstorm Gold right now, given its age.

Sandstorm is much more volatile, so there will almost certainly be better opportunities to add to that one when gold dips — the valuation is about in the middle of where it has traded over the past five years in relation to the price of gold (market cap divided by gold price), and given the greater leverage that SAND has to gold prices I’d rather pick this one up when sentiment is uglier… it’s getting there, but for me right now the edge in gold royalties goes to the much more solid Franco-Nevada.

Altius I wrote about in some detail just a few weeks ago[5], it is reasonably priced now, with potential catalysts if zinc, iron ore or copper take off in a meaningful way (or if Alberta loosens up on their recent anti-coal regulatory changes) and I’d be willing to add… but it’s not really in a heavy pessimism mode right now, big positive catalysts in the near future seem unlikely, and it has mostly been in this same $10-15 trading range for five years, so I’m just continuing to hold and watch.

What else do I own in the natural resources space?

First Mining Finance (FF.V, FFMGF) is another company that’s trying to be a counter-cyclical “land bank” for mining, though it’s nowhere near as quiet and subtle as Altius was in its early days. I’ve long been uncomfortable with First Mining (and with the somewhat similar Brazil Resources, which renamed itself GoldMining (GOLD.V, GLDLF) a little while back — I no longer own any of that one) because of the focus on promotion, including paid stock promotion that has enabled them to boost their share prices and use those higher-priced shares as currency to acquire new assets… but promotion is a big part of building a junior miner, and to some extent that’s the taciturn and judgmental New Englander in me.

The reason to bet on these kinds of highly speculative project acquirers, like Keith Neumeyer’s First Mining or Amir Adnani’s GoldMining, is that they are designed to be extremely levered to gold prices. Their goal is to acquire lots of not-that-great junior mining prospects at low prices when their owners are in dire financial straits or unable to get financing… then just hold them until gold prices go manic again and suddenly those not-that-great projects look a lot better and some big, dumb large cap miner buys them out or does a joint-venture deal to get the projects developed.

Sometimes that works really well, and there is a growing portfolio of assets at both of those companies, but we do fall into the trap of starting to imagine the value of the “ounces in the ground” that these companies are acquiring and thinking that those ounces are real and particularly valuable. That’s not necessarily true — sometimes exciting things fall into your lap, particularly if you’re well-connected like Keith Neumeyer, and it’s not unusual for a mineral discovery that’s not all that exciting at first to turn into something dramatically more fantastic after years of (expensive) drilling… but it seems awfully likely to me that many ho-hum discoveries that can’t get financing during lean times and get sold for pennies on the dollar to the likes of First Mining or GoldMining aren’t ever going to be worth more than those pennies.

These stocks are arbitrage — they are well-known and loved by investors partly because their CEOs are connected to investment newsletter folks and generate a lot of attention, and they use attention from individual investors to drive their share prices up, and having more highly valued shares lets them buy up other companies more cheaply (since they’re using their stock, not cash, to make acquisitions)… so that makes their acquisitions “accretive” in at least a theoretical way because the potential ounces they buy when they acquire little junior miners are instantly more valuable under Neumeyer’s more celebrated stewardship than they were as underfollowed and underfunded little exploration projects, but it also means that it could all come crashing down if the market suddenly starts to hate junior miners again or loses faith in Keith Neumeyer’s ability to build another billion-dollar company.

So First Mining, which I wrote to you first about a couple years ago and which has certainly been a profitable speculation so far (I sold half of my shares after the gold boom this year, but the remainder is still in my portfolio and happily in the green), is still a worthy speculation on a wild gold boom… and unlike some speculations (like warrants or options), it’s a bit evergreen. This is just equity in a company that has Hoovered up a dozen or so gold mining prospects, and they probably won’t spend much money developing those prospects, so you get to just sit and wait as they keep issuing more shares to acquire more prospects and look for the day when big mine operators are throwing money around to rebuild their reserves and get their development pipeline restocked (or, alternatively, when animal spirits get so frantic in Vancouver that you can spin projects back out to the public markets when individual investors are rabid for junior gold IPOs).

It’s not the pretty, smooth and intellectual sheen that you get from Franco-Nevada and Sandstorm and Altius, and it will be far more volatile, but it can sure be interesting. I have as big a position in First Mining Finance as I want right now, and they have been fairly quiet of late — there haven’t been any new acquisitions in the past six months, and the news from their larger potential assets has been pretty light… their biggest assets, in terms of measured, indicated or inferred resources, are still their Springpole and Pickle Crow projects that they bought back in the Fall of 2015, and Springpole is the farthest along of their larger projects with an updated Preliminary Economic Assessment (PEA) expected this year. You never know when a promotional campaign or newsletter enthusiasm or another big acquisition will drive more attention to these shares, but with gold prices fairly tepid we’re not going to see most of First Mining’s smaller projects advanced at all so there’s no rush. I’d think about a small position here if you find the potential interesting, but keep it small because of the high risk — and think about adding if and when gold sentiment gets much worse again. All of these non-operating gold companies get access to better deals when gold is weak and junior miners are hurting and can’t find financing, so that’s often when real “buy low” opportunities hit — whether we see a time like that again in the next six months or year, I have no idea.

And, of course, I write about stocks all the time and I get sucked into speculations and fun stories beyond these more substantial investments… some of those stories are in mining, so I keep a little section of my portfolio bracketed off for what I’ve often called “dumb speculations”. My thinking is, this keeps me from going to Vegas too often and I can get a little adrenaline rush (and, who knows, maybe the occasional 1,000% return) from a chunk of my portfolio that I’m willing to put at real risk of 100% loss.

So what’s in the “Dumb Speculations” section of the portfolio right now, assuming that we give First Mining Finance a pass and think of it as a less-dumb speculation?

The biggest one is Northern Dynasty Minerals (NDM.TO, NAK in the US), on which I hold some warrants (both 2020 and 2021 expirations).

I’ve written about Northern Dynasty a few times, most recently because Doug Casey and his resource investing folks have been chatting it up and promoting the idea (the latest ad is all about “Executive Order 0001,” which anticipates President Trump immediately cutting the EPA back and restoring the path to possible permitting for Northern Dynasty’s Pebble Mine near Bristol Bay in Alaska — I wrote in more detail on that here[6]). This is not even really a speculation on gold, though higher gold prices would help — the potential mine is so incredibly, absurdly large that it can probably be profitably operated, even with huge environmental protection costs build in, with gold and copper prices much lower than they are today.

No, this is really a speculation on legal and regulatory outcomes… and if that doesn’t make you think that you’re risking 100% of your investment, then you’re using your biases to assume a much higher degree of certainty than anyone should have about any governmental or legal decision (or, frankly, the permitting process for any mine). The current status is that the mediation and possible settlement talk between the EPA and Northern Dynasty is ongoing and the lawsuit is on hold until at least March 30 to let the parties continue their settlement talks. (The lawsuit is not over permitting the mine, we’re still a long way from getting to that point — it’s over the EPA’s aggressive block of the Pebble permitting process using the “Waters of the US” act, which meant the project was effectively killed before they could apply for permits. The goal for Northern Dynasty is to get that block removed and to be allowed to enter the permitting process, environmental and otherwise… with the assumption that permitting will be far easier under a Trump presidency and what is expected to be a much less active EPA).

And, of course, I’ve made it even a bit more speculative by using warrants, which can amplify my returns if things work out in Northern Dynasty’s favor. I probably won’t hold those warrants through to expiration in 3-4 years, but my speculation is that a resumption of the permitting process for Pebble will bring in another joint venture partner to help push permitting and development, which will make the project seem “real” again, and Northern Dynasty shares could easily surge if that happens. The size of the deposit is so remarkable, with this potentially being one of the largest gold and copper mines in the world, that a return to the pre-EPA block levels of $8-10 a share isn’t completely ridiculous, and perhaps if that comes at the same time that gold prices are surging again we could see a return to all-time highs of about $20. I’m not at all counting on that, but my investment effectively gives me possible exposure to a return as high as 1,000% (or more, if we’re getting greedy) while risking only 100%.

Beyond that I have a few other positions that I can explain more briefly:

eCobalt Solutions (ECS.TO, ECSIF) and LiCo Energy Metals (LI.V, WCTXF) are my speculations on a possible surge of interest in cobalt. There aren’t many “pure play” cobalt juniors, and these are companies with at least a shred of “real” to their operations… but I’m not holding these because I have a deep-seated urge to own cobalt miners for a long time, I’m holding these because I think there’s a decent chance that we could see a little speculative mania in cobalt stocks that parallels the sometimes manic moves in lithium stocks (cobalt is a key battery ingredient as well). Who knows whether it will work, but, as you can see below, the two together are less than half a percent of my portfolio — I wrote in more detail about these back in October when I first added these stocks to my portfolio as small speculations, and nothing of substance has changed (and no manic bull market has emerged, of course — the stocks are both down a little bit).

I also have some LEAP options on Cameco (CCJ), which is the only real “blue chip” stock in the uranium business — Cameco has the biggest uranium reserves, a real market leadership position, and significant leverage to uranium prices even though it’s the biggest and most stable company in the business. This is my bet that uranium will at some point recover — and, to be fair, I should admit that I’ve been expecting uranium to recover for several years. It was too cheap when it was at $45, it was too cheap at $35, and too cheap at $30… and now that uranium is down below $20 it is even more foolishly cheap. Uranium is priced so low on the spot market right now that it’s not worth it to explore for more uranium, and even big and high-grade miners like Cameco won’t expand their production at these levels… but nuclear power is still a substantial part of the world’s energy, and there are still large numbers of nuclear plants being used in some countries (the US, France) and built in others (China, India, among others), and the demand should outstrip supply at some point and drive prices back up.

The reason I’ve speculated on Cameco options (and on some other uranium ideas in the past couple years that did not work out) is that uranium has had two crazy manic bull markets in the past decade… and I think there’s a reasonable chance that they will have another. Cameco will keep chugging along as one of the world’s preeminent uranium producers whether uranium is at $20 or $40 a pound, and it will be profitable at the top end of that range, but if we see uranium go back to $100 CCJ shares could easily skyrocket (they were above $40 during both the 2007 and 2011 uranium spikes). They won’t go up as much as the crazy little uranium juniors… but they also likely won’t disappear in the next year, and some of the uranium juniors might if there’s no price improvement. I’ve got two years of speculation potential with these options, if Cameco gets to, say, $25 over the next two years — a reasonable possibility if uranium prices finally do get some traction — then the options I paid roughly a dollar for would be worth $10, so I’m essentially risking a 100% loss in order to get the potential of a 1,000% gain. That doesn’t work for a big chunk of a portfolio, since the risk is too high that Cameco will not rise by 50% in the next two years and the option will expire worthless, but I’m still stubbornly expecting uranium to recover from these ridiculously low prices at some point… so for a small (one third of one percent) portion of my portfolio I like the potential.

And in the more conventional energy space, I have two positions right now — Blackbird Energy (BBI.V, BKBEF) is focused on producing natural gas liquids in the Montney and they’re building up their production capacity as they drill new wells. I picked up a small warrant position while I was covering a Marin Katusa teaser that looked to me like it pointed at Blackbird back in October[7], and the warrants have more than four years to expiration so I’m going to let them ride for a while — this provides me with some levered exposure to natural gas without committing much capital, and the company’s use of technology is interesting enough to make me want to follow them. The warrants are in the money now, they have a 30 cent strike price (Canadian) and expire on. May 19, 2021, the shares are currently at C$0.56 in Canada so the warrants at C$0.33 don’t incur much of a premium price to get a bit of leverage… though if you’re interested in the stock long term, certainly the warrants will do much worse than the common stock if the shares fall in a meaningful way.

And Africa Oil (AOI.V, AOIFF) is the stub I still hold from a very profitable position that was inspired by, again, a lot of newsletter promotion of the stock about five years ago, before they drilled their first well in Kenya. That first well was a big hit, and they’ve built on that and defined a meaningful and large potential oil field and continue to have exposure to other exploration blocks in East Africa… which they’ve also derisked by partnering all of their blocks and selling large chunks of their discoveries to Maersk, Tullow and other partners. Africa Oil surged by several hundred percent back in 2012, I sold half and took some profits, and the rest I’ll keep holding until we see either enough infrastructure development in Kenya to get these wells into production or we see enough of an oil price spike to make the shares get overvalued again.

I like their large cash position (almost C$650 million) and the fact that they won’t have to raise money or spend a lot anytime soon, though there is some risk that they could use that cash to make a large and risky investment to expand somewhere else and start the exploration process over again, which could hurt the share price depending on what that acquisition is… but they’ve done well operationally so far despite a couple of years of sleep stock price, and large undeveloped on-shore oil fields are still a rarity and worth owning, so I’m willing to be patient — it’s not a stock that I’d necessarily be excited about buying right now for any short-term potential, but the assets are valuable and I like what management has done to derisk their operations and I wouldn’t try to talk you out of a small position below C$2.50 or so if you want some exposure to frontier oil prospects.

To sum up this portion of my portfolio, these are the positions I hold right now in natural resources, including the weighting they have in my portfolio today:

Substantial Equity Holdings, likely long-term:
Altius Minerals (ALS.TO, ATUSF) (5.8% of equity portfolio)
Sandstorm Gold (SSL.TO, SAND) (2% of equity portfolio)
Franco-Nevada (FNV) (1.5% of equity portfolio)
First Mining Finance (FF.V, FFMGF) (1.5% of equity portfolio)

Dumb Speculations and Stubs:
NDM Warrants B 2021 (NDM.WT.B) (0.75% of equity portfolio)
NDM Warrants 2020 (NDMWF) (0.75% of equity portfolio)
Blackbird Energy warrants (BKBFF) (0.3% of equity portfolio)
Ecobalt Solutions (ECSIF) (0.15% of equity portfolio)
LiCo Energy Metals (WCTXF) (0.3% of equity portfolio)
Cameco (CCJ) 2019 LEAP options $15 call (0.3% of equity portfolio)
Africa Oil (AOI.V, AOIFF) (0.75% of equity portfolio)

Total weighting for natural resources equities (and warrants and options) in my individual stock portfolio today: 14%

To be clear, that doesn’t represent my entire investment portfolio, just the portion that I invest in individual stocks and speculations and write about — so that’s roughly half of my investable assets. The balance is mostly in mutual funds that I rarely write about, most of which are very diversified and will end up probably returning something similar to the broad market. This is in no way a recommended sector allocation for a full portfolio, but I’ll go into more detail after we’ve looked at all the stocks in the weeks to come and I can share a fuller picture of my personal investments.

For what it’s worth, before we get into my full portfolio weightings, I should let you know that within this “natural resources” space broadly conceived I also hold gold and silver bullion, mostly in coins. That bullion is not reflected in my portfolio totals, since I consider that to be a form of savings, not investment, but if it were it would be roughly a 9% position. Pretty similar in size to the cash position in my investment portfolio at this point, coincidentally enough.

So that’s step one — we’ll move on to the other sectors represented in my portfolio next week, from REITs to insurance stocks to technology and whatever else is hiding in there, and I’ll see how far I can get before I lose your attention… thanks for reading!

Endnotes:
  1. Franco-Nevada CEO David Harquail about royalties, land banks and the end of the ‘big freeze’ in mining finance: http://www.globalminingobserver.com/david-harquail-franco-nevada-mmc-160
  2. Altius CEO Brian Dalton on patience and counter-cyclical investing: http://www.globalminingobserver.com/brian-dalton-altius-minerals-st-johns-newfoundland-172
  3. full speech is here: https://static1.squarespace.com/static/52483801e4b0cd3b08465542/t/571384c6555986fb1e0b8371/1460897028096/2016+Melbourne+Mining+Club.pdf
  4. most recent purchase was of Franco-Nevada, which was my December “Idea of the Month,”: http://www.stockgumshoe.com/2016/12/december-idea-of-the-month-what-to-buy-during-complacency/
  5. wrote about in some detail just a few weeks ago: http://www.stockgumshoe.com/2016/12/friday-file-the-third-most-important-base-metal-is-about-to-rally/
  6. wrote in more detail on that here: http://www.stockgumshoe.com/2016/12/friday-file-last-of-the-year/
  7. back in October: http://www.stockgumshoe.com/2016/10/friday-file-ligand-apple-junior-miners-and-katusas-montney/

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