Cymor Strategic Growth Funds CEO Larry Cyna, and Special Advisor David Toles both think gold is a 'gamble' at this time but nonetheless offer practical advice on playing the small-cap space, replete with some small-cap names to get you started.
SmallCapPower.com: Gentlemen, gold recently underwent a dramatic correction. On the Cymor Strategic Growth Funds blog you wrote: "If you’re a gambler and like to take enormous risks, then buy gold." Until recently gold was seen as a safe-haven investment and many would still argue that it is. Please explain the rationale behind your statement.
Larry Cyna: The issue here is the timing of any proposed purchase of gold. In the last 20 years or so the price of gold has been on a consistent uptrend. However, during that uptrend there have been some dramatic falls in value where people have said: "We’ve reached the top of the cycle." We are in the midst of a dramatic fall now, so a lot of people are looking at gold and asking: "Is gold still a safe haven or not?" What really happened is that the pundits – the people on television and in newspapers – are using the economic uncertainties of the world as a means of filling space in their media. As a result, a lot of fear has been created, which was exacerbated by the debt crisis, and people have rushed to buy gold. As with everything in this age of instant communication, real issues are blown out of proportion and exaggerated. Demand for gold has increased the value of gold.
A problem with buying gold is that it’s not easy to buy. Over the last 10 years or so people started buying gold derivatives. People believe they’re buying gold but they’re not buying actual metal. They’re actually buying an ETF or some sort of derivative. As people rush to buy that derivative, the underlying gold is purchased or futures are acquired for gold in order to fill that consumer demand. So there’s a continual demand for gold that is filled by the ETF.
When and if something happens, either to show stability or to show instability in the world, people will sell their purchase if they feel safe, or they will purchase more gold if they feel at risk. The derivative and ETF situation will exaggerate the effect of whichever feeling prevails, and the rise or fall could be dramatic.
If you believe that the instability will continue and that Italy will default on its debt or that Spain will, then perhaps gold is a wonderful thing to buy. Because people will see that instability as a currency crisis and buy more gold through their ETF and that increased demand will skyrocket the value of gold. The point here is that when an ETF buys or sells gold, it can have a dramatic effect on the market as supply is fairly constant, but when a mood strikes the market, large numbers of investors all move in the same direction, thereby affecting demand and accordingly the price of gold.
On the other hand, if there is an agreement to solve sovereign debt problems in Europe, or if the Democrats and the Republicans in the U.S. somehow reach an agreement on the deficit, then people will get confident, sell their gold, and retreat to more conventional investments. That means there will be a surplus of gold on the market.
In either event, the price of gold can and will move dramatically. So, if you wish to gamble on instability, you gamble on buying gold. If you wish to gamble on stability, you sell gold or you short gold. It’s 50/50 as to which will actually happen.
SmallCapPower.com: That’s an either/or approach. Couldn’t you allot a certain amount of your portfolio to gold and at the same time take a moderate view of the world economic situation in other parts of your portfolio?
Larry Cyna: That’s a very reasonable approach. Most advisors would say that 10% of your portfolio must be in gold or gold derivatives and I think that’s quite reasonable. We don’t ascribe to that approach because if you believe that gold will go up in value, and you’re putting 10% of your portfolio into gold, it’s a wise thing to do. But if you believe that gold will not move up, then what you’re really saying is: “I will lose on 10% of my portfolio. So, how much do I have to make on the remainder of my portfolio to remain even?” I don’t think that gold is a moderating influence on a portfolio. I think gold’s more of a gambler’s instinct.
I would add that gold tends to go up after events, not during events, so gold is not the safe investment during a period of volatility or instability.
David Toles: What I’m hearing from the gold bugs is that gold is not an investment for growth – it’s for protection. But by having it there you basically cap the earning growth potential of your portfolio.
SmallCapPower.com: Where do you see gold bottoming?
David: I think it could go as low as US$800.
Larry: I’ve heard a number of pundits say US$800 and it could easily happen. It depends on the timeframe you’re looking at. I think US$1,200 is also a very reasonable number. If you examine the fundamentals, I think US$1,200 is closest to the value of the metal compared to other metals and compared to its real uses in the real world. That’s not to say it’s going to go to US$1,200 because I still believe that it has an equal chance of rising in value, and in following its long-term upward trend.
SmallCapPower.com: In another blog entry on the Cymor Strategic Growth Funds website you discussed the off-balance sheet debts of Chinese banks and how those debts could ultimately cripple these institutions and perhaps even the Chinese economy. How likely is that?
Larry: Looking at off-balance sheet financing, you go back to the derivatives created by the American banks which, almost destroyed the world’s economy in 2007 and 2008. That was a similar type of financing, although used for a different purpose. You had the same effect in Japan where the amount of borrowing at earlier times had a dramatically negative effect over time, and remains a large problem. China currently faces the same issue. If you borrow money you either repay it out of current GDP or future GDP. So should China’s economy slow down, the effect of this enormous amount of debt could be quite dramatic. I personally believe that the chance of that happening is quite high. I would put it somewhere at 40-50%.
SmallCapPower.com: Wouldn’t that be a positive influence on the gold price?
David Toles: It depends on the lending. After the first stimulus injection (quantitative easing) the U.S. government was saying: "See, it’s working. There are all these "green shoots" and the Chinese are investing heavily by building infrastructure." Well, they’re still building and they’re buying all these commodities like steel and coal and copper. In reality it was really more a reflection of the Chinese banks that they would lend if there was some asset that they could lend to. They were basically hedging the commodity risk.
Larry Cyna: The green shoots refer to signs of immediate recovery. But the problem with gold is that it is affected by supply-and-demand. The reason that gold has gone to US$1,900 and then US$1,600, as it’s closer to now, is that there was a demand for gold, but as stocks fell, so did gold. Gold is not an immediate counterbalance to stock market or currency instability. Should China have an economic problem or a disruption in its growth pattern, the demand will drop from China, which reduces demand for gold. So, a disruption to China is not positive for gold.
SmallCapPower.com: Larry, you said that gold could bottom around US$1,200. Do you think investors will come back to gold at that point?
Larry Cyna: Investors historically have sought out gold because of the fear of inflation. When inflation reared its ugly head, gold was the likely source of safety as people bought gold in order to protect themselves against inflation. As the current threat of inflation receded, the object of attention became debt, and currency crises. And that created instability in currencies and then people started flocking to gold because they didn’t see another asset class that would retain its value in great periods of instability. As inflation becomes less of a perceived threat, and world instability becomes less of a perceived threat, gold can easily fall, as it did in other periods in our recent past. Gold reaching a price of $1,200 may only attract investors wishing to catch a falling knife. But lack of a permanent solution to the world’s economic problems, could continue to make gold attractive. After all, $1,200 would only be a fall of 1/3 from the high, and technically gold could still be in an uptrend. Future events will determine the price of gold, and with no surety. That’s why it’s the great gamble.
SmallCapPower.com: Gentlemen, your fund specializes in small-cap resource stocks. Why do you focus on that segment of the market?
Larry Cyna: Firstly we are in Toronto – the world’s centre for resource stocks. For us to devote efforts to the specialties of the centers of finance in New York or London would be to take us away from our base strength.
Secondly, we like investing in companies that we can easily hear and see. In this area of the world, we see the management of these companies. We hear their presentations. We often go to their sites to see what they’re doing or visit their factories to see their technology. They are small, simple, and easy to understand.
When one looks at General Electric (NYSE:GE) or Apple (NASDAQ: AAPL), for example, one is dealing with a far larger entity that has a far different structure, which is more difficult to analyze and understand, and harder to look beneath the covers to see the blemishes. Here we feel that we have an excellent grasp on the type of companies that are traded in the TSX, which is our specialty, and we’re very comfortable with those stocks.
SmallCapPower.com: But there’s a lot of risk in that sector. Do you see the potential gains as offsetting that?
Larry Cyna: We don’t agree that the risk is higher than the risk elsewhere. If you examine the stock prices of any of the major corporations over the last five years, what you’ll find is very dramatic swings in value. Large caps tend to be very consistent as long as the economy is consistent. But as the economy collapses, the large caps collapse even more. And as they collapse, or as they grow, the danger, in our opinion, is as great or greater than the small caps.
Because we’re so close to the juniors and because we understand the companies, we find that the swings in value, although they can be dramatic in individual stocks, the chance for picking stocks that will escalate dramatically, is far higher. So by taking a portfolio of small caps, we’re able to pick out enough winners that they will overall establish a far more beneficial track record than taking a portfolio of large caps over which we have no say, no control, and very little ability to analyze beyond what public information is disseminated.
David Toles: I agree with Larry. By meeting management and doing our due diligence, we have a better comfort level than reading a financial report. There are so many examples in the marketplace where company management has misled analysts.
SmallCapPower.com: Among the small caps, what are three or four commodities you’re most bullish on at this point?
Larry Cyna: First would be copper. We think there could be a dramatic copper shortage. Next is rare earth elements, but not all rare earths. Rare earths are a very misunderstood class. There are 16 so-called rare earths and many of them are in fact very common. But there are some that are in very high demand and dysprosium is one of them. The U.S. military puts dysprosium as number one on its list of strategic metals. So we like dysprosium, and we like copper.
David Toles: Dysprosium quadrupled in price from January to June and it’s doubled again since then. We see a lot of upside.
SmallCapPower.com: There are light rare earth elements (LREEs) and heavy rare earth elements (HREEs). Dysprosium is a HREE. Do you look for companies with projects that have a high concentration of HREEs?
Larry Cyna: There are two deposits in the western world that have very high concentrations of dysprosium. One of the deposits is in Alaska and it’s owned by Ucore Rare Metals Inc. (TSX.V:UCU), which happens to be one of our favourites. The reason we like the one in Alaska is that it’s on U.S. soil and it’s strategic to the U.S.
SmallCapPower.com: But that’s not a dysprosium-only deposit.
Larry Cyna: No, but the majority of the available dysprosium in the free world is there, the accessibility to transport is easy, there are no environmental fights, and the costs of bring it to production are reasonable and imminent. In addition, recent exploration in the surrounding area, which also owned by Ucore, has indicated further HREE deposits.
SmallCapPower.com: Is there another commodity you’re bullish on?
David Toles: Uranium should be included in that list as a long-term play.
Larry Cyna: We believe uranium will come to the fore. There is some debate going on around the world as to whether uranium is safe or not. We believe uranium will be found to be safe and that the price of uranium will eventually escalate. But we don’t believe it’ll be this year.
Next on the list would be silver. We put at a higher value on companies either exploring for, or producing silver, than we do gold juniors. The reason is that the use of silver is expanding dramatically. Silver is the weak sister to gold but industrial demand is growing and growing rapidly as opposed to gold where there’s limited industrial uses. The supply of silver is not keeping up with the demand for silver.
SmallCapPower.com: Let’s look at the methodology you use to select the companies you invest in. Let’s begin with management and the components you’re looking for there.
David Toles: Half of our valuation is on the asset itself. The other is on the people. Larry and I like to examine management in detail. Some people have good track records of developing an asset and making it viable.
SmallCapPower.com: Do you have a specific ranking system?
Larry: Very much so. At the top of the list is the trend in the market. One always has to look at the market because whatever the market does, every stock is affected to some extent. A rising trend or a rising tide carries all boats, so to speak.
Number two is the jurisdiction. Is it in a safe political jurisdiction? Is it some place that we want to be? There are areas that are not as stable as others or that have a history of being unstable or have a political system that has varied in recent times – those places fall on the list because they’re given a low valuation based on that particular criteria.
After that we go to management. If management is new, or untried, then of course, we look at it with skepticism because we know that if you have two equal companies with equal resources or equal technologies, the one with experienced management has a far better chance of succeeding. If we don’t meet the management, we’re very reluctant to invest in the stock. We want to meet and hear and see either the plant or the resource. So, experience and track record is next on the list.
The actual metal or the actual product is next. And then you get into all the lesser criteria, but those are the major criteria.
David Toles: Another criteria is that they should trade on the TSX or TSX Venture Exchange. We’ve traded in other jurisdictions and it’s not fun. Having such an open well-oiled machine as the TSX makes our jobs a lot easier.
SmallCapPower.com: What are some of the lesser criteria?
Larry Cyna: Another criteria is the number of shares outstanding. How many shares are there and how do they relate to the value of the underlying company? What’s the market cap of the company? What is the trend on the chart for that particular company. If a trend is down on a chart we’re very reluctant until the technicals turn positive. That lets you know something is not quite right.
SmallCapPower.com: Do you prefer producers, near-term producers or pure exploration plays?
Larry Cyna: Our number one choice is near-term producers. We’re not as comfortable with pure exploration plays versus a project where they believe that they have found a significant deposit and that deposit has been drilled but not yet totally proven.
SmallCapPower.com: What about the prospect generator model?
Larry Cyna: We’re not especially in favour of those although some of them have succeeded. Golden Valley Mines Ltd. (TSX.V:GZZ) is one that we like. They have a gold prospect near Osisko Mining Corp.’s (TSX:OSK) Canadian Malartic gold mine, as well as many other good prospective properties and joint ventures.
Numerous companies have tried that model, where a company tries to pick up many properties, drill a few holes and then tries to attract another company to spend the money to fully explore the potential. When they find what they consider their prime asset or the company builder, they’ll often try to get rid of all of the other properties that aren’t quite as high on their list. As a general rule we’ll go with the company that’s got the prime asset.
SmallCapPower.com: Let’s go by commodity, starting with copper. What are some names that offer upside in the copper space?
Larry Cyna: Mustang Minerals Corp. (TSX.V:MUM) is a good example and they’re in Canada. A smallish deposit, but in an excellent location with lots of upside potential and good management.
SmallCapPower.com: What about small-cap silver names?
Larry Cyna: The first choice there is Argentum Silver Corp. (TSX.V:ASL), but I’m a director and shareholder of that company so I’m biased. Another choice would be Soltoro Ltd. (TSX.V:SOL), which is also a very good company. Both companies are in Mexico in good jurisdictions with on-site permanent employees and infrastructure.
Some of your earlier questions centered on gold and while gold may not be our favourite commodity right now, we think that the shares of junior gold companies are much undervalued. When you can produce an ounce of gold for $600 and sell it for $1,600, it is a no-brainer. Capital costs and ease of location remain important, but there is no difficult technology needed, and the techniques used by the industry are tried and true.
One of the favourites is Lexam VG Gold Inc. (TSX:LEX). Lexam’s CEO, Thomas Meredith, is a dedicated manager whose first priority is running the company, rather than running the stock. Recently Rob McEwen took the position of chairman. He has an excellent reputation in gold. This is a fine company that has good upside.
SmallCapPower.com: If a retail investor was looking to play the small-cap space, what advice would you offer them?
Larry Cyna: We created the CymorFund blog to help the average investor understand buying stocks and investing. We would often see people buying stocks on a tip from a neighbour or a broker. We think that you should never buy stocks on tips. We wanted to give the average investor a way of understanding the language that the market professionals use. Most of the information in the blog is common sense: this is how you analyze what a stock is; this is how you pick a stock; this is what an ETF is; this is what a mutual fund is; this is what a junior stock is, and so on. Our blog is to educate people in how to look at these types of stocks.
David Toles: Not only that but to make sense of all of the media ‘speak’ that you hear from the talking heads on TV, and to help investors avoid panic situations by teaching them to be patient and unemotional in their decisions.
Each investor should have their own set of rules, their personal criteria for purchasing something and selling it, too. They need to stay focused on building their own set of rules and criteria and then following them.
Larry Cyna: When the so-called professionals make a suggestion ask common sense questions about that company because companies operate on common sense. A company will not zoom up in value if you hear some gossip somewhere. By the time you’re buying it, somebody in the inside is selling it, and that’s a very dangerous situation. So when somebody suggests a stock to you, look at the stock and do your own investigation. Read their website. Read their presentations that are normally posted on their website. Do they make sense to you? Never buy something unless you have done your own research, and a lot of that information is now available to every investor.
Larry Cyna and/or David Toles and/or their firm own shares in all of the companies mentioned in this interview.
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.