“Box” Your Gold Stocks … and find “an extremely rare opportunity”

By Travis Johnson, Stock Gumshoe, December 21, 2010

After several years of touting (and sometimes teasing) microcap mining stocks for subscribers of Stansberry’s super-expensive Phase 1 newsletter, Matt Badiali is launching a new letter that focuses on these small stocks, picks that he says are too small and volatile for his inexpensive S&A Resource Report letter.

This letter is called the S&A Junior Resource Trader and, as you might have guessed, it’s an “upgrade” subscription — in this case, the price is $1,450. And though it sounds from the letter like they’ll be picking junior mining stocks for the most part, they’ve got more of a “trick” than that — they’re also teasing a trading system that focuses on these picks and (this is the part that got me interested), one particular “extremely rare opportunity” to buy a particular stock.

So I’ll try to figure out what that stock is for you in a minute — but first, I should briefly share their tease about this trading “system.”

They say that over the last year or two, as Badiali and his colleague Brian Hunt sniffed out a few picks for a variety of other newsletters in the Stansberry stable using this system, they’ve developed a technical screening and trading tool that they think identifies winners. Here’s how they briefly describe it:

“Well, most resource analysts concentrate on one or two factors they think might indicate that a stock is about to go up.

“In the resource sector, that means most analysts choose to focus on either drill results… new ore grade samples… feasibility studies… permit approvals… new joint ventures… or the announcement of big new discoveries…

“But my colleagues, Matt and Brian look at a totally different set of data… one that blows the lid off conventional resource stock analysis.

“You see, this little known strategy has its origins in the 1950s Canadian penny stock mining boom, when a guy named Nicolas Darvas discovered that upcoming events about a resource stock (whether it be new drill results… permit approvals… mergers, etc.) actually show up in one place BEFORE it’s announced in the market.

“It’s called a ‘Box Chart.'”

And they go on to say how they’ve refined this system from Nicolas Darvas, setting their own data points and time period to help chart the best boxes to use to indicate buying points for junior resource stocks. And, of course, they have a fundamental aspect of this — they say that they only do this to the best stocks that they know have real potential anyway, thanks to their knowledge of the firm and their prospects and their industry connections — so this technical indicator only applies to stocks they already would have liked anyway, they don’t just “believe the chart” like many market technicians.

So what are they talking about? Well, I’m not a chartist or a technical trader, but the basic concept of the Darvas Box was developed, as you might imagine by that Nicolas Darvas mentioned. It is in its most basic form just a way of charting stocks that are breaking out of a trading range. If you set the time frame at eight weeks as Badiali and Hunt do, for example (that’s 40 days), then you look for stocks that trade in a fairly defined range for that time period and then break out of that range to the upside and make new highs (either 52-week highs or all-time highs, depending on how you read it). If they break out of the top of the “box” that you can draw on the chart of their short term trading range, then you buy (I hear a lot more about people using Darvas Boxes to find buys than to identify sells — from what little I know, Darvas used stop losses instead of a precise box to sell).

That’s an extremely simplistic explanation, and I think Darvas also looked for an increase in trading volume when he went searching for “boxes” (he did it using stale weekly Barron’s listings and searching for new highs in daily tickers, I think — this was more than 50 years ago, and he was a touring professional dancer, he wasn’t sitting at a tickertape machine in a Wall Street office. What he “discovered” and explained with his box theory of stock selection was basically the same kind of momentum trading that so many people use today — he wrote it up in a book titled “How I Made $2,000,000 in the Stock Market” that you can still buy (it was reprinted last year), though I haven’t read it.

So briefly put, the Stansberry guys have apparently developed some data-chewing version of a momentum screener that uses the Darvas Box to identify breakout resource stocks that are presumably indicating, through the speculative magic of the stock market and the considerably less magic mechanism of information leaking out of a company before it’s public, a future likelihood of big positive fundamental news (new drill results, reserves improvements, etc.)

I can’t share any particular wisdom about the Darvas Box or about the Stansberry version of it — if you like momentum trading as a sort of intermediate term thing (eight week indicators, holding periods usually under a year), then it may well appeal to you, but if you’re already doing that kind of momentum and breakout trading than you probably also understand it better than I do.

So let’s get to the part that I found more enticing: the “extremely rare opportunity” that they tease, albeit briefly, in this letter. Here are the clues:

“An extremely rare opportunity just hit Matt and Brian’s radar.

“You see, every 10 years or so, a new type of equity emerges in the resources sector.

“The interesting thing about this particular kind of company is that it has very little do with exploration or mining, but is actually one of the most profitable kinds of resource stocks in the world.

“This unique business model has come into existence in the resource sector only a handful of times in modern financial history. But on almost every occasion, it’s resulted in an explosion of wealth so incredible, the numbers almost seem like they were made up:
The first one came about in 1982 and has handed investors gains totaling more than 20,614%…

“The next appeared in 1992 handing investors as much as 179,900% gains…

“And the last one we of came about in 2004, handing investors as much as 17,610% gains…”

I know what you’re going to say: “but Gumshoe, how can you possibly identify this stock? Those clues are crap!”

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And I have to agree. But still, we can probably get you a little further down the line and make a guess.

Since they’re talking about a company that has “little to do with exploration or mining” and that has been profitable in resources, has a unique business model, and those specific dates, I’m going to hazard a guess that they’re talking about royalty companies.

1982 was the year that Franco-Nevada (FNV in Toronto, FNNVF on the pink sheets), the first modern royalty company was founded, and it did generate massive gains (though it was owned by a big miner for a few years in the middle).

1992 is roughly the time that Royal Gold (RGLD) became principally a gold royalty company — they existed for about a decade before that, first as an oil explorer then as a gold miner and finally, with their royalty on the Cortez Pipeline property (that’s one of Barrick’s huge gold mines now), they began to refocus on royalties.

And 2004 is when International Royalty (ROY, since acquired by Royal Gold) started building up, culminating with their IPO in February of 2005 that was used to fund their flagship acquisition (a big royalty on the massive Voisey’s Bay nickel mine).

So that’s my speculation: we’re talking royalty companies, and some kind of new one that’s developing and looking good in Matt and Brian’s charting model. These companies aren’t quite so rare as it appears from that list — those are by far the biggest ones to have gotten attention in recent decades, but there are lots of smaller companies and private firms that also hold royalties, often as a result of being early owners of the land or doing initial discovery or exploration work.

There are a small handful of other mining royalty companies that are conceivably big enough and fundamentally sound enough to have made their top list, and also a couple “streaming” companies that are a little bit different (instead of getting a royalty, they pay up front and buy the right to a portion of the output of a specific metal or other resource, and get silver or gold or whatever at a set price forever into the future) — and as long as we’re talking “resource” stocks there are also quite a few energy royalty and trust companies, most of them focused on natural gas, but those seem unlikely matches (I talked about a few of them when I discussed Badiali’s “Mainz Income” teaser a few months ago if you’re curious).

But which one are Badiali and Hunt pitching now? My short list would include several stocks (I own some of these), including:

Silver Wheaton (SLW) — silver “streamer” and a fair candidate for any momentum breakout given their dramatic performance lately, though I know Badiali has been recommending this stock to his Resource Report for ages (quite profitably), so it would be odd if he re-recommended it to subscribers of this more expensive service. SLW is looking pretty expensive to me at 36X sales, but it’s true that they get more efficient as they grow and if silver keeps climbing dramatically I assume they’d do quite well. Gold Wheaton, a sibling of SLW, is being bought by Franco-Nevada so is no longer really an option.

Sandstorm Resources (SSL in Canada, SNDXF on the pink sheets) — I like this one and it’s one of my largest personal holdings, but I doubt it’s Badiali and Hunt’s pick, it would be tough to make momentum “boxes” work on this one’s recent performance, and the stock is nowhere near it’s all-time or 52-week highs. They have Silver Wheaton’s former CFO, golden boy Nolan Watson, as CEO and use the same basic project-financing model as SLW (streaming as opposed to royalties).

Terra Nova Royalty (TTT) is a royalty company with interest principally in the Wabush iron ore mine in Labrador, this one was spun out of old value investing favorite KHD Humboldt Wedag (or technically, the operating business of KHD was spun off last Spring and this royalty company is what was left — so the TTT chart includes the history of KHD). They’re trying to expand, but they have just the one royalty that I know of, and like Sandstorm they’re far from their 52-week high so this one is tough to fit into the Darvas Box, too.

Golden Predator (GPD in Canada, GPRXF on the pink sheets) is another “possible” with a somewhat uninspiring chart, Darvas-wise — the shares spiked higher in early September, but fell back and are below the highs of last Winter, so it’s hard to make a longer term momentum case, but they do have a big position in the Yukon, which lots of gold folks are excited about, and they do have a bit of income coming in now from existing royalties that helps to fund their exploration. They’re also planning to spin off some silver projects — for whatever reason, I haven’t ever researched Golden Predator very closely, and it doesn’t strike me as a likely match given the price performance and the relatively small number of current projects, but it’s certainly possible.

Callinan Mines (CAA in Toronto, CCNMF on the pinks) has one big royalty coming in on the 777 mine originally discovered by their founder, and they have a lot of other exploration licenses for base metals, mostly nearby in Manitoba, but they seem focused on mine development and exploration — I haven’t heard that they’re particularly focused on building a royalty portfolio. On the other hand, you could probably fit them nicely into your momentum-breakout boxes, and the shares are now at a new high (not just for this year, but for at least 15 years).

Anglo Pacific Group (APF in London, pretty sure it’s AGPIF on the pink sheets and APY in Toronto, though it rarely trades in North America). This one is trying to build an international royalty portfolio in natural resource, with a breadth of focus similar to Franco-Nevada — though currently they’re pretty overwhelmingly a coal royalty company (almost 75% of revenues), with smaller chunks in iron and gold and a tiny sliver of uranium. The shares are near highs and have been fairly volatile over the last several months, don’t know if they’d please a momentum trader right now or not.

I’ve ignored a few royalty companies that are really, really tiny — like under $50 million market cap, since they seem too small to project as possible future royalty giants, which seems to be what the implication is for this tease. Which leaves me with one more stock that I think is a possible for Badiali: Altius Minerals (ALS in Toronto, ATUSF on the pink sheets).

Altius is a stock I also own and like very much, so I’m quite sure that I’m biased. They are what’s often called a “prospect generator” and they’re trying to turn their prospects, mostly in Labrador and Newfoundland, into joint ventures that lead to producing mines — with their joint venture share gradually disappearing over time as their partner invests all the development money to explore and mine, so that in the end Altius is left with just a royalty on the end product. Many of the current royalty companies, especially big ones like Royal Gold and streamers like Silver Wheaton, can be accurately described as being in the business of financing mining — they pay up front for a future return from a mine, and their up-front payment helps to get the mine built. That’s not true of Altius, their contribution is the early-stage discovery and delineation of ore bodies and the staking of claims and very initial exploration to add value.

I think Altius has fairly quietly built an impressive portfolio, including joint venture iron ore, uranium and gold projects that could become mines in the years to come, and they also have a teensy, tiny royalty on the Voisey’s Bay mine that was the end result of a brilliant move by CEO Brian Dalton back when he was still a student (while tiny, the mine is so big that it’s by far their biggest slice of actual revenue on an ongoing basis right now). Altius is not yet really a royalty play, it’s a prospective royalty play — other than Voisey’s Bay, not a lot of royalty income is likely to be rolling in within the next couple years. The stock also had a breakout very recently to a new two-year high (though it’s still far below where it was when their refinery project collapsed back in 2008) — I hesitate to say that the recent price spike would constitute a breakout for the “box” system of Badiali’s since he has liked this stock for a long time (though I don’t know if he actually recommended it) and there’s some unverified indication that earlier positive comments of his helped cause the price spike this month (it was at about $11 in November, and is near $14 now).

So I can’t tell you for sure which picks Hunt and Badiali are pitching in this new service, though I’d say Altius is my best guess for their pick despite the concerns noted above … and there are, at least, a few possibles for you to look into if you like. If I were betting on the next big royalty champion among small caps I’d wager on either Sandstorm for gold or Altius for (mostly) base metals … but that’s pretty obvious, because both stocks are among my largest personal holdings so I’ve clearly already found a fondness for them, and I don’t know the others nearly as well.

I consider Sandstorm to be an emerging cash flow story that will do well if gold prices remain high for several years, and I bought Altius as a clearly undervalued stock initially, with cash and marketable securities (including a bet on ROY before the takeover) that have sometimes been valued at more than the share price, giving you the future potential as a “kicker.” Development is progressing nicely, particularly with the recent Alderon and Cliffs Natural Resources joint ventures for iron ore exploration, so you can start to make a case for future growth as well as current value, which is at least part of why the shares are substantially above cash liquidation value again now. If you’re willing to expand the definition of “royalty” stocks as I have with Altius, by the way, the universe grows quite a bit, with dozens of smaller “prospect generators” who would like to become royalty companies, and though I’m certainly not an expert on most of those stocks, none that I’ve seen impresses me as much as Altius in terms of proven deal-making ability and future development potential.

If you’re interested in the royalty companies in general, the folks at Metal Augmentor also recently did a very good valuation analysis of a number of these companies, including most of the ones I’ve mentioned as well as a couple of other smaller ones — you can read their free report here if you like.

What do you think? Assuming that this is a pitch for a new mining royalty company, as I think, who do you reckon is the likely target? Or, given the relative underperformance many of the smaller royalty-type companies have shown during this year’s gold bull market, would you be better off with one of the big names like RGLD or SLW, or with just putting together a portfolio of juniors or buying the actual metal? Let us know your thoughts with a comment below.

And this newsletter is too young for there to be any reviews yet, but I’ll start pestering subscribers to share them with us if the letter survives for a while — in the meantime, you can see reviews of (or review yourself) the other Stansberry letters here (Badiali’s entry-level newsletter is their top-ranked product right now, for what it’s worth). Thanks!

Full disclosure: as indicated above, I own shares of Sandstorm Resources and Altius Minerals. I also own shares of Sandstorm’s sister, Sandstorm Metals & Energy. I will not trade in those companies, or stock of any of the others mentioned in the article above, for at least three days.