Precious Metals: Has the Tide Finally Turned? (February 23, 2016)

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Anyone who has followed this blog for awhile now knows that I don’t like to get caught up with calling absolute market tops and bottoms. I’ve argued that as investors, we should always be cognizant of where we roughly are in a cycle, but there’s absolutely no way for anyone to know definitively.

So, when assets are cheap, I go into full throttle hyper-accumulation mode. When the merchandise is overpriced, I simply leave it on the store shelf… So far in life, this strategy has served me well.

As it pertains to precious metals, well, I’ve been pounding the table with a screaming “Buy now!” thesis for quite some time now…

Now that sentiment has started to shift, the most common question everyone is asking at this time is, “Is this rally for real?

I don’t know…

But I will say this — The mining sector, perhaps more so than any other, can change on a dime and in a heartbeat. What was previously HATED can become LOVED like no other…

Right now, every last one of my friends has a burning desire to get into the mining trade…

That’s just how markets work.

Anyway, here are my latest thoughts:

Previously, we were operating at the Depths of Despair, so it was in my best interest to focus on “survival” stories… With everyone and their grandma calling for sub $1,000/oz gold, I didn’t want to be caught owning companies with far too much debt (e.g. Barrick Gold; ABX), regardless of how world-class their assets were… In a downmarket, I heavily focused on buying up shares of companies with strong balance sheets and low All-In-Sustaining-Costs (AISC).

Over the last year, I was rapidly building up positions in the following: Lake Shore Gold (LSG), Klondex Mines (KLDX), Teranga Gold (TGZ.TO), Richmont Mines (RIC), etc.

At the time, one of my favorite stories was First Mining Finance (FF.V). I often compared their investing strategy to that of a real estate developer…

Imagine this — The entire real estate market gets whacked and there is a firesale of inventory. Everything is in liquidation and even the best assets are selling for pennies on the dollar… Pretty soon, the market is overrun by distressed sellers, and there are hardly any buyers left… Out of the blue, a new company, led by a world class management team emerges from the dust and offers you, the investor, this type of proposition — We are going to come in and consolidate the industry. We’re going to put folks who are struggling out of their misery and in the process rapidly accumulate up (as much as possible) a portfolio of high quality assets.

This particular management team also has a track record of being twice successful before implementing this exact same type of strategy — “Buy low and sell high”, creating two $1 billion companies in the process.

 

As an investor, to me it was a no brainer to invest…

 

I saw flashbacks of my real estate mentors who bought up a storm in 2009-2013 and retired happily ever after because of that…

 

But like I mentioned earlier in the post, sentiment in the gold sector tends to change rapidly, and when it does, the entire landscape with it…

 

It may sound absurd to say this, but just over 1 month ago, FF.V was one of my favorite investment ideas… Especially as someone who has a background in real estate, you can bet that I totally appreciate the strategy of rapid accumulation when no one else is interested in buying!

However, what you want to do, and what you’re actually able to accomplish are two totally separate things…

No, it’s not that I doubt FF.V has the skills or ability to execute on their plan… Right now, I just don’t think the market is going to allow them that opportunity (and you can’t fight the macro)… With gold piercing through $1,200/oz and support building strong there, I just can’t see how any previously distressed sellers would now be willing to let go of premium assets on the cheap.

Not anymore..

If you were an owner of beachfront real estate and saw prices rapidly climbing back up, would you still be desperate to sell? Would you be eager to accept a low-ball offer?

I don’t believe so…

You would fight tooth and nail for every last penny you could get…

Which is why in a bull market, I’m becoming less and less of a fan of FF.V.

Granted, if the company had 2-3 more years to execute their gameplan, I would be completely on board… But to me, it’s like investing with a real estate developer in the SF Bay Area who says, “We are going to buy up all the best land during this downturn.

At the end of Year 1, let’s say they were successful in securing some plots in Tracy, and Morgan Hill (on the fringes of the “high quality” land; close but no cigar)…

In my mind I would be like, “Ok, that’s pretty good progress! Oh boy, I can’t wait to see what unfolds in Year 2… Maybe they’ll start encroaching into Silicon Valley and be able to win some deals in South San Jose next… and then maybe Santa Clara? Who knows, maybe even Palo Alto will be on the radar if this bear market really drags on! Wouldn’t that be soooooo awesome!”

But if the “bargain basement sale” goes away in Year 2, then what?

The story changes… dramatically.

Obviously, that wonderful fairytale you initially invested in doesn’t sound so appealing anymore, does it?

Don’t get me wrong, I’m not trying to pick on FF.V! They were very successful buying up good assets last year (Coastal Gold, Gold Canyon Resources, PC Gold), but if the most recent acquisition of Clifton Star Resources is a sign of things to come (these assets are nowhere near as good as the previous acquisitions) in the future, I just can’t say that I’m feeling all too good with the prospects for tomorrow…

Funny what a change in sentiment can do, right?

 

On that point, I’d like to address another company, New Gold (NGD). Previously, readers had asked on numerous occasions my thoughts on this mid-tier gold producer. In a $1,000/oz gold environment, my response was always, “I like the company but it’s not one of my favorite ideas. Their projects have high CAPEX, the IRR is not so great, and they have a lot of debt to service. It’s a riskier play in a downmarket.

Again, so much can change so fast…

As we stand now, I would have to do a complete 180 degree turn on that previous stance…

In a rising bull market, NGD would be one of my favorite ideas…

Their flagship project, Rainy River, doesn’t look so hot at $1,000/oz gold, but it’s much, much more prospective at $1,200/oz gold…

If you believe this recent rally is legit, I can’t imagine there are many mid-tiers that would be a better pick than NGD. As mentioned, they have a great management team… but even more than that, the company only invests in projects that are located in first world jurisdictions (USA, British Columbia, Ontario, Mexico, Australia, etc.). Further, the stock is very liquid, so I would imagine that big institutions and funds will be piling into this “safe” mining stock as one of the preferred vehicles to ride the next wave up.

And most importantly, but obviously, that previously concerning debt burden would be much alleviated with rising metal prices.

 

Crazy, crazy how much can change in just a single month…

 

Full Disclosure: I still hold shares of FFMGF. I’ve thought about swapping those for NGD, but have not made that move yet. However, I did get mostly out of dodge (Greece and Turkey both scare me) with Eldorado Gold (EGO), and liquidated about 2/3 of that position, using the proceeds to buy shares of NGD and Richmont Mines (RIC). 

 

So, I previously was a HUGE fan of FF.V. I still like the company, but I think they’re going to start facing an uphill battle to win good deals (if this rally in gold is for real). Meanwhile, a mid-tier like NGD, with a wonderful new project in Rainy River due to go online in 2017, increasing production by over 300,000 oz/year, should outperform on the way up.

 

With gold mining stocks, it’s important keep up with the latest headlines, developments, and most importantly market sentiment. I’ve never looked at these stocks as “Buy and Hold Forever”, but more like “Buy and Monitor Actively”.

 

It’s a lot of work, sometimes, but you know the saying, “Hard work pays off…

 

Hopefully.

 

Fight On!

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Jamespapsdorf@yahooFI FighterCardboard CrusaderBeSmartRichJimbojinx Recent comment authors
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Mike
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Mike

Thanks for keeping us updated on your views. I always find them fascinating.

I bought a few shares of Yamana a few weeks ago…I just wish I backed up the boat like you did :). Just don’t have that risk tolerance.

MiningBookGuy
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Love the contrasting examples of FF.V and NGD! While completely different companies, you’ve got to turn with the market, and I think your reasoning is right on the mark. Of course, I’m biased as a long-term holder of NGD. But I’m trying to make the same types of decisions, realizing this past month changes so much! To give a great example of this that I just ‘discovered’ today, check out this solid article on Sandspring Resources in Guyana (SSP.V): https://chat.ceo.ca/@tommy/a-ten-million-ounce-call-option-on-gold I read that, then checked out the 1 month chart…and it was a “whoa!” moment. NO WAY that really would… Read more »

Jon
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Jon

The problem with FMF is that they just issue more equity to make each new acquisition, diluting existing shareholders. It’s a good buy at 32 and sell at 40 though…

Income Surfer
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It may have buddy. I had a similar thought about Agricultural commodities last week. Now that BHP has slashed their dividend, I need to dig into that one too. It’s a shame I’m remodeling the house, I’ve got lots of research to do.

I know I owe you an email. Should get that out today. Have a great week!
-Bryan

Reepekg
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Reepekg

I find your attention span incredibly short. How will your plays have time to deliver real profits if they change month-to-month?

Nevertheless, I owe you a huge tip of the hat! I finally got into GDX for 1k shares at $16.7. Not exactly $12, but I’m off to a great start up 15% as of writing. We’ll see if this was the right choice a few years from now.

Jon
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Jon

Check out Sunridge Gold for a great arb opp similar to the FMF one you blogged about a few months back.

Also, have you thought about dry bulk shipping at all? These companies (and the BDI) are trading at all time lows, primarily due to structural oversupply that should go away in the next year or two. I’ve just bought some DSX and NMM.

Bowman
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Bowman

Very interesting article again, thank you for that. I have tried to diversify my precious metals portfolio so that upsides would be substantial if the tide really turns (investments in companies like B2Gold, Endeavour Silver, Bear Creek Mining…). And on the other hand, part of the portfolio (about 25 percent) consists of more ”defensive” plays (e.g. Silver Wheaton, Franco-Nevada) that would probably not go bankrupt even if the tide doesn’t turn for a while. In addition, 25 percent of the portfolio consists of physical bullions (mainly silver, some gold) ensuring there would be at least some value left after total… Read more »

Jimbojinx
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Jimbojinx

Today’s report of extended gold findings for Richmond Mines at Island Gold look promising. Any thoughts about possible extension of mine life from what is reported today ?

BeSmartRich
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Yup. I bought some stocks of a gold company when gold was around $1000 then it shot up by 60% now. I think it would only go up even further probably by 300-500% within a year or two when people start to realize that it was a bargain. I was tempted to capture the gain but did not. That was a fun money anyway. My target selling price for the stock is around book value which means it will have to go up by close to 1000%. We will see 🙂

Cardboard Crusader
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Jamespapsdorf@yahoo
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Jamespapsdorf@yahoo

Almaden, AAU, looking good. Anyone else looking ?

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