Despite the doom and gloom over sovereign debt problems in Europe, Hard Rock Analyst co-editor Eric Coffin remains optimistic, especially about junior resource equities in the gold and bulk materials spaces. He even provides a few investment ideas that he says are ‘cheap.’
SmallCapPower.com: Eric, in a blog titled “Tough Love” posted on the SmallCapPower.com website in late September, you wrote: “Eurodrama will cap the gold price and weak U.S. statistics will improve it. That should leave gold in a broad channel until there is closure on Europe.” Since you wrote those words, a deal was reached to keep Greece in the Eurozone but then there was further drama with an again/off again Greek referendum, which culminated with the resignation of Greek Prime Minister George Papandreou and the formation of a coalition government. What do you make of the Greek situation?
Eric Coffin: God willing, let’s hope it is just the Greek situation, andnot the Portuguese and Irish and Spanish and Italian situations. Let’s just stick with Greece for the time being. The banks are going to take a 50% write-down on Greek debt. They don’t have a choice. Greece has no chance whatsoever of not going into technical default. There’s no way anybody can make those numbers work.
But if Europe had taken the situation more seriously two years ago and not conducted stress tests that were a joke, this would probably be less of a problem. It’s hard to say that we’ve got closure. I mean, you really don’t.
SmallCapPower.com: What’s the political climate in Germany given the terms of the deal? Do you think there is the necessary political will in Germany to write a check to bail out Greece?
Eric Coffin: I think the Germans and, in fact, most of the northern Europeans are extremely unhappy about the idea of bailing out Greece – much less Italy, if it comes to that – and I don’t blame them. This is partially in the hands of German voters. I think you’re going to see Germany drag its feet as long as it can. And I don’t think it’s because Merkel isn’t willing to do it or that Germans aren’t willing to do it. It’s because they aren’t happy about doing it. I don’t think Germans have got over Greece being less than honest about their worsening deficit numbers. Not to put too fine a point on it, but I don’t think the Germans trust the Greeks, and I think they’re going to drag this out as long as they can because I think they want to see the austerity measures passed. And unless Athens actually does that, I don’t think Germans are going to write the check. The same goes for Italy, which is the latest blow up. The European Union (EU) cannot back all of Italy’s debt, but Italy is more a liquidity than a solvency crisis. The EU and European Central Bank (ECB) can buy them time. But, like Greece and the rest, I don’t see Germans or other northern Europeans letting them off the hook easily. They are not going to commit until they see a broad spectrum of the political class sign on to austerity measures. The situation is too fluid and the Germans in particular don’t want to leave any room for backpedalling by the countries they are helping.
SmallCapPower.com: You’ve argued in the past, however, that it is difficult either way, but that it’s actually more difficult if Greece defaults outside of the Eurozone. Please explain those consequences.
Eric Coffin: If Greece defaults unilaterally, there’s no way Greece could go to the bond markets and raise money. No one would buy those bonds. You’re talking about an economy that shrunk 13-14% in the last few years, which is an incredible amount. It’s really nasty. And Greece continues to run 14-15% deficits.
If you take where Greek bonds are being priced, and if you assume for a moment they could actually sell bonds, it’s about a 25-30% coupon. By the end of this year, Greece will have a 180% debt to Gross Domestic Product (GDP) ratio. That means just carrying the interest, not anything else, would consume 40-50% of Greece’s GDP. There’s no way those numbers are going to work. If Greece does default though, they cannot go back to market for years at least. That means the deficits they are currently running have to go – immediately. On top of that they go back to the Drachma, which will almost certainly fall in value by a huge percentage compared to the euro, so the whole GDP of the country gets discounted again. It’s a depression scenario for them. I don’t know if the guy on the street in Athens necessarily gets that. I hope they do for their sake.
If there is a unilateral default, in all likelihood it’s going to be a 100% default. No one really knows, but most of those bonds are probably held by Euro banks and insurance companies and they’re going to take a big hit. Those institutions are going to see a few cents on the dollar, at best. You’ve got a lot of large financial institutions in Europe, including a number of them in Germany, that would get crucified by the market because the market doesn’t believe they’ve got a big enough cushion to handle a default that size.
And the Germans aren’t just doing this out of good fellowship. The EU has been pretty good to Germany. Germany’s one of the world’s great export economies and having this huge free trade zone has been really good for the German economy. If Germany pulled out of the EU, the per capita cost would be 5,000 or 6,000 euros per person.
There are a couple reasons for that. One, they would lose access to this huge free trade zone. And two, the deutschmark, which is the currency they would have again, would go through the roof. Everyone would be buying deutschmarks. And as an export economy, the last thing you want to see your currency double or triple. It would be a financial nightmare.
Germany could probably pay off Greece and Ireland and probably Portugal and it still wouldn’t be that much per capita. There is self-interest in it; they’re not just being altruistic. I honestly believe most Germans believe in the EU as a concept. They were a major force in building it and I think they want to see it survive.
SmallCapPower.com: What about the dreaded “C” word, contagion?
Eric Coffin: I think that’s a big fear. For weeks, the market’s main concern was: Is Greece going to default or not? I think the market’s been assuming for months that Greece is going to default in some form. What people are really worried about now is another Lehman Brothers moment; some bank that’s big enough to be systematically importantgoes bankrupt because it had to write off a large amount of this debt.
The main way contagion would spread would be write-down on those bonds. That’s why the EU is going to backstop those banks so that the market stops worrying about which bank might go under.
SmallCapPower.com: Indeed. The EU has already agreed to bail out Franco-Belgium bank Dexia.
Eric Coffin: Yes, for all intents and purposes, Dexia went bankrupt in 2008 and it never was in particularly strong financial shape after that.
Most banks frequently lend and borrow large amounts from each other on a short-term basis. When the interbank lending market started freezing up in 2008, that’s when the problems really started. And that’s apparently what happened in Dexia’s case – other banksjust stopped lending them money. And that’s the concern that starts happening with other banks. And the only way to stop that is for the EU to put in guarantees and backstops and say: “We’re going to underwrite whatever we have to.”They hate the idea of that sort of blank cheque and the ECB hates it too, but it may be too late for them to have a choice.
SmallCapPower.com: When you spoke at the Cambridge House Show in Toronto in September, you said gold investors were waiting to see a floor before returning to the market. Have we established a floor?
Eric Coffin: We probably have. Short of a complete catastrophe, that pullback that we saw into the high US$1,500 range was probably about it.
Some of the selling we’re seeing is profit taking and margin call. When the market turns ugly and the margin calls go out, traders tend to sell what they’re up on. And they cross their fingers and hope what they’re not up on will come back. That’s just the way traders behave.
A couple of months back, the one trade that almost everyone was up on, was gold. It’s far and away the most successful trade of the last few years. It was an obvious target for selling. But we saw a lot of buying come into the physical market when it briefly dipped below US$1,600/oz.So I think you have a floor there.
SmallCapPower.com: So gold has some good fundamentals in its current range?
Eric Coffin: I don’t think there’s a lot to be afraid of. If you view gold as being a currency, you have to look at it in terms of which currency you’re thinking in. Most people think in U.S. dollars so that’s as good a currency as any to use.
But when things don’t go well in Europe and the EU disappoints people, you see the euro get hit. On those days, it’s difficult to see the U.S. dollar gold price go up at the same time the U.S. dollar is skyrocketing.
If you go back to September, the euro went down 10% in the space of four or five weeks. And U.S. dollars, of course, had the same move in the opposite direction. So, gold pricedin U.S. dollars had a 10% headwind against it before you even started thinking about any other trading implications. Given that, it’s not surprising that the gold price dropped 10-15%. A lot of that drop was just a currency swing.
SmallCapPower.com: Swiss Bank UBS is predicting an average gold price of US$2,075/oz in 2012. Is that in line with what HRA is seeing?
Eric Coffin: We expect the price to go higher but we don’t have a firm number on it at this point. Personally, I’d be quite happy to see it back at or US1, 800/oz or maybe a little more. I’m not hoping for more than that though I’ll be happy to see it if it happened.
SmallCapPower.com: Let’s go back to your “Tough Love” article for a moment. You essentially said you’re buying equities on dips in the gold price. Tell our readers about some companies you’ve added during gold price softness.
Eric Coffin: When the gold price moves up, normally you are going to see the first reaction in development level companies, the ones with assets in the ground that people can easily put a value on.For us, that would be a company like Kaminak Gold Corp. (TSX:KAM), which doesn’t yet have a resource but it’s obviously going to have one, and probably not a small one.
Kaminak has had a pretty fair pullback; it’s trading around $3.00. It’s been a slow season for labs and the company still probably has the results from close to 100 drill holes or more in the lab. Every time Kaminak puts out news it’s been good. I’ve got no particular reason to think it’s suddenly going to get terrible so I’d be pretty comfortable with that one.
SmallCapPower.com: When is that resource estimate due?
Eric Coffin: There’s no specific date. Kaminak was talking about getting one out this year. I think they want to have enough drill holes in enough zones to be able to build a substantial number. I don’t know if they can do it that fast with the slow lab turnaround this year however.
SmallCapPower.com: What size do you expect the resource be? Perhaps three million ounces (Moz)?
Eric Coffin: Kinross Gold Inc. (TSX: K) has 1.5 Moz at its White Gold project (formerly held by Underworld Resources) and I’m sure Kaminak is aiming for at least that. It’s a function of how many drill holes they have and the kind of drill hole spacing that the person calculating the resource needs. Kaminak has two or three zones now and probably has a couple more but it needs to get the results from some drill holes to confirm that. Kaminak probably wants a resource in the 1.5-2 Mozrange but that’s only going to be the first number – it’s not going to be the final number.
Another company that’s quite cheap right now is Riverstone Resources (TSX.V: RVS). It just did a deal with a company called Roxgold Inc. (TSX.V: ROG), which was a joint-venture partner on some of Riverstone’s secondary projects. Roxgold has a project called Yaramoko in Burkina Faso, West Africa, that’s been delivering some pretty wicked high-grade holes and the market’s been responding to them. Roxgold wanted to own 100%of Yaramoko so they bought Riverstone’s 40% interest in the five joint-venture projects they shared. In return for that, Riverstone got $16 million and 17 million Roxgold shares. At current pricing that’s worth close to $35 million. Riverstone has a market cap of about $65 million so the residual market cap there is $30 million.
Riverstone’s last resource estimate on its 100%-owned Karma gold project in Burkina Faso was 1.9 Moz and there’s been a hell of a lot of drill holes since then but Burkina Faso has a big problem with itslabs assays on time. Riverstone is still waiting for results on a lot of drill holes from the summer program and has started drilling again with 3-4 rigs.
I haven’t tried to work with the number but I would imagine Riverstone’s next resource estimate would be in the neighborhood of 2.5 Moz. So you’re basically paying $12/oz for something that’s still growing and a company that won’t have to go back to the market any time soon after its deal with Roxgold. That one looks pretty cheap to me.
SmallCapPower.com: Are you specifically seeking companies that have a lot of cash in the bank because of the possibility of financing drying up?
Eric Coffin: David (Coffin) and I are looking at a number of deals. There are companies operating in the Yukon that did a really good job of financing in the spring when the market was better and everybody was hot on the Yukon. So, if the market’s still weak through the winter and in the spring, it’s not going to be an issue for some of this juniors.They simply won’t have to go back to the market for a year or two.
This year in the Yukon was kind of stillborn and the market is partially to blame. But a lot of the issues in the Yukon have to do with the backlog at assay labs. It’s a huge issue for these companies. There are so many companies sending so many samples to a small number of labs, that the pipeline just got clogged. There are companies in the Yukon that have done a lot of work this year that have put out basically zero news because they don’t have their assays back from the lab yet.
I don’t think these companies are sitting on bad results –they just don’t have any results to sit on. Some companies have started reporting now but they’re way behind. ATAC Resources Ltd. (TSX.V: ATC), for instance, published results from about 20 drill holes or so but it probably has 60 to come. Rockhaven Resource Ltd. (TSX.V: RK), has published two sets of drill holes but they easily have another 70-80. Northern Tiger Inc. (TSX.V: NTR) put out nine from its main project but it has another 21 coming. It’s like that across the board. Ironically, it means that the quiet period for Yukon exploration news is going to be a lot shorter this winter.
SmallCapPower.com: What are you looking for from those drill results?
Eric Coffin: We’re watching those assays come in and we’re hoping to find two or three companies that look like they may actually be on to something new that the market hasn’t noticed.
SmallCapPower.com: In addition to gold, you’re bullish on some base metals. Where do you see strength in base metals heading deep into 2012?
Eric Coffin: I wouldn’t say base metals so much as bulk materials. The one base metal that we like is copper. We’re starting to look again at some new copper deals but we’re waiting to see what happens in Europe and for more numbers from China. China’s economy does appear to have slowed down some, which is what the government in Beijing wanted. Exports are important to China so you can’t ignore what’s going on in Europe and the U.S. And although the copper market looks very balanced to us, we’d be a lot more comfortable if we saw the inventories come off a little more and we want to see the impact of labour disputes taken out of the market. There are strikes at a couple of Freeport-McMoRan Copper & Gold Inc.’s (NYSE: FCX) big mines that is accelerating the inventory drawdown. That is a good thing but when the strike ends that part of the drawdown ends, too.
The bulk materials that have done well are iron ore and potash. Potash right now is actually higher in price than it was early in the summer. It’s still up $180 a ton, and we’re following companies in both those spaces.
One company we follow in the iron-ore space is called Champion Minerals Inc. (TSX: CHM). Champion’s gone from $3.00 in early 2011 all the way back to $0.75 and it’s back to about $1.40 now. And that’s in the face of the iron-ore price essentially going up only a little bit during that period. The swing on Cap-Ex Ventures Ltd. (TSX.V: CEV), another iron ore story we follow, has been even larger.Iron ore prices haven’t moved much but these are high-beta stocks so if the market’s doing well, they do well. If the market’s doing badly, they don’t do well. Champion and Cap-Ex have actually advanced things quite on their Labrador Trough iron ore projects but the market didn’t care until the major markets started to calm down a bit.
Champion has a 2-billion-tonne resource on the books now and it’s going to be quite a bit more than that by the time it has finished its current drill program. Champion published a good preliminary economic assessmenton Fire Lake, which is its most advanced iron-ore project but there are several other coming right behind it.
Champion also has lots of cash so there’s no concern about them running out of money. Even at this price we’re not afraid of it.
SmallCapPower.com: What are you telling Hard Rock Analyst readers who are skittish about putting money into the junior mining space after watching equities get smashed in August?
Eric Coffin: In early August we told people that if you can’t handle the swings that we’re going to see, you might not want to be here at alluntil the situation gets resolved one way or the other. Just close your eyes take some profits and don’t even look at these equities for awhile.
But if you are comfortable with the volatility, thenyou want to be looking atcompanies with assets in the ground or small producers. And catch those on the weakdays when you can; put in stink bids and ride it out.
I imagine there’s going to be some resolution on Greece and the European banking system before the end of the year. I don’t see this dragging out forever. The market’s not going to let it drag out forever. Hopefully it’ll be a good solution; it might be a bad one. The final solution – debt deleveraging – will take years. The market knows that. The important thing is for the Europeans to put enough backstops in place to avoid a “Lehman moment” along the way.
The other thing we mentioned more recently because of the pullback in the markets – and it’s especially true in the juniors, which have had the bigger swings – is that there’s going to be a number of companies in the junior space that are going to see significant tax-loss selling this year.
SmallCapPower.com: Please explain tax-loss selling to our readers.
Eric Coffin: Basically, investors that bought the stock for $2 but it’s now sitting at $0.50 and while investors might still like it, they sell it anyway for tax reasons. This is because you can sell the stock and as long as you don’t own it for 30 days, you can buy it back and still own it but take the loss this tax year.We’re already starting to seethat happening as most of it tends to get done in November.
SmallCapPower.com: Thank you for talking with us today, Eric.
Interview Disclosure: This interview was conducted by Brian Sylvester on behalf of SmallCapPower.com. Mr. Sylvester and/or his family may own shares of the companies mentioned in this interview.
Eric Coffin may own shares in all of the companies mentioned in this interview.
Disclosure
Except for the historical information presented herein, matters discussed in this document contain forward-looking statements that are subject to certain risks and uncertainties that could cause actual results to differ materially from any future results, performance or achievements expressed or implied by such statements.
Ubika Research and www.smallcappower.com (are both divisions of Ubika Corporation), and are not registered with any financial or securities regulatory authority, and does not provide nor claims to provide investment advice or recommendations to readers of this report. For making specific investment decisions, readers should seek their own advice. For full disclosure please visit: http://smallcappower.com/disclosure.aspx