Mickey Fulp: Hard Rock Geologist
Interview

The Energy Report: The media is abuzz about energy, but it seems none of the individual energy sectors is really breaking out. What's your take on the energy sector as a whole?

Mickey Fulp: Well, here's what I know—oil is currently undervalued with respect to gold. Historically, you could buy 12 barrels of oil for 1 ounce of gold. Right now, that ratio is above 16.

I think gold is being driven solely by speculation, and I expect a pullback. Gas is severely depressed with respect to oil. Historically speaking, the oil:gas price ratio should be around 6:1. Right now, it's about 23:1. You can argue that not only should oil's price be higher, but gas is also way out of whack due to the oversupply in the U.S. The so-called "green" energies that include wind, solar, geothermal and hydro have somewhat limited applications. And wind and solar will require government subsidies and tax incentives to make them economic and drive growth.

TER: Oil relative to gold is low and gas relative to oil is low. Gas I can understand due to the current U.S. oversupply. What's going to kick oil up to historic ratios? Or are you expecting gold to pull back to create the historic ratios?

MF: However, oil is not in short supply right now. The price for West Texas crude is $82 a barrel, which is as high as it's been in awhile. At an investment conference in June, we were asked to predict oil prices through the end of the year. I said $70–$90. So far, I'm good on that prediction.

TER: Clearly, you are a fan of uranium. Since last year, you've been saying that uranium is the only sector wherein you feel the entire sector is undervalued—not just a few companies within the sector. Why does it remain undervalued?

MF: The sector remains undervalued because it is driven by the spot price of uranium. Although the spot price amounts to only 15%–20% of demand in any given year, the market pays attention—rightly or wrongly—to the spot price. Until the spot price increases, the sector will continue to be undervalued.

Not every company is undervalued within that sector. I can give you a couple of names that are wildly overvalued. But I see upside in the sector as a whole, which I've been saying since January 2009. We've started to see some movement in the spot price over the last two or three months. Plus, there's increased awareness, especially by the 800-pound gorilla on the block—the American retail investor. As awareness increases, we would expect market valuations to increase. Again, that's very dependent on the spot price.

TER: What's going to drive the spot price up?

MF: Buying at higher prices. Spot prices are negotiated with buyers and sellers sitting across the table (e.g., "I've got some uranium to sell; how much are you going to pay me for it?"). I think there's a growing consensus among uranium analysts that the supply fundamentals are skewed. We do not produce enough uranium to supply all of the nuclear reactors currently under construction. We expect that the supply/demand fundamentals will lead toward a higher price.

TER: That argument has been around for a few years. At some point in time, it's going to come true. Do you have any additional insights as to when supply will become an issue and, thus, drive stock prices up?

MF: I thought it was going to come true in 2009, but it didn't happen. In 2013, the Russians are going to cut off the supply of high-enriched uranium to be converted to low-enriched uranium. Currently, that supplies a big portion of the market. And there are still government stockpiles; the U.S. Department of Energy (DOE) is still sitting on slightly less than one year of total global demand of low-enriched uranium suitable for reactors. That overhangs the market. Kazakhstan set record production figures last year, and we expect continuing high production from Kazakhstan, but that's certainly not a place where most people would choose to invest.

It's a very complicated equation. You have geopolitics heavily involved in the uranium sector. Chinese national nuclear corporations are attempting to build a reactor in Pakistan right now, and the U.S. is not very happy about that because Pakistan has never signed the nuclear non-proliferation treaty.

Predicting when it's going to turn around is very difficult; predicting that it will turn around isn't so difficult because we see increased demand on a yearly basis. Where is that supply going to come from? Currently, mine supply satisfies about two-thirds of demand every year. That's going to become more skewed when the Russians quit selling high-enriched uranium in 2013.

TER: In your Mercenary Musings newsletter, you wrote up Strathmore Minerals Corp. (TSX.V:STM; OTC.PK SHEETS:STHJF) recently. Can you give our readers a summary of your observations on the company?

MF: Strathmore has been my favorite uranium company ever since I got involved with the sector. It is without a doubt the most undervalued uranium company in the junior development sector. Strathmore is proceeding nicely with its feasibility study at Roca Honda in the Grants Mineral Belt. That's a joint venture (JV) with Sumitomo Metal Mining Co. Ltd. (STMNF:US), the giant Japanese resource conglomerate. I expect some positive news to come out soon on its second core asset in the Gas Hills of Wyoming. The company is aggressively pursuing spinouts of seven other non-core uranium development assets. It has sold two projects this year, one of which generated about $30 million in cash and royalties for Strathmore. I would expect some additional spinouts in the mid to near term.

TER: Is that $30 million being distributed to shareholders or put back into feasibility studies and further exploration?

MF: It will help the company fund its share of the feasibility study at Roca Honda and progress with development of the Gas Hills assets. Those two projects are arguably the most robust, undeveloped uranium projects in the U.S.

TER: Given that you love this whole sector, you must be following other uranium companies. What other names are you following in the space?

MF: Uranium Energy Corp. (NYSE.A:UEC). It recently cleared another environmental hurdle in south Texas and is still on schedule for initial uranium production in the fourth quarter. Uranium Resources Inc. (NAS: URRE) had a key win in a court case that clears the way for development of the Church Rock deposit near Gallup, New Mexico. Hathor Exploration Ltd. (TSX.V:HAT) continues to drill on its Roughrider deposit in the Athabasca Basin in Canada. Hathor is by far the most overvalued uranium company in the explorer space. That said, I am a long-term shareholder of Hathor. I'm not selling Hathor because the Roughrider deposit continues to grow more pounds in the ground.

On trend but 10 km. away from Hathor is a little penny stock called Forum Uranium Corp. (TSX.V:FDC). It will be drilling this winter on the ice. At some point, I think Forum has a good chance of making a discovery on its ground. The property is on the right structure intersections and has drilled the right style of alteration. At $0.08–$0.10 a share, it won't take much to get your dough out of that one on a double.

TER: Would you consider Forum one of your undervalued uranium juniors?

MF: That's pure speculation right now. It's an $0.08 stock, but the company has more than 100 million shares outstanding. It's a low market-cap stock that will double easily if the company hits a nice uranium intersection next winter. That's what I'm playing it for. I see little downside risk in the stock.

TER: You are also heavily involved in the rare earth element (REE) sector. What's your take on the sector at this point in time?

MF: It is the hottest commodity space around just like the Yukon is the hottest area play. Valuations have gone through the roof over the last couple of months. With a speculative play like this, it's necessary to separate the few contenders from the many pretenders early on. I think I've done that. The stocks have been on quite a run since early July, and the companies that I'm invested in average returns of about 300%. This entire sector is an overvalued speculation right now.

TER: Some might point to China's export restrictions, but that was last year. What's causing the sudden move in the sector this summer?

MF: China further restricted export quotas this summer. The country announced that it was going to crack down on the black market in south China, which is estimated to supply from 20%–33% of the market. This morning I heard an estimate that two-thirds of the supply of heavy rare earths (HREEs) is coming from the black market. China is trying to nationalize its heavy rare earth element sector and force the small and illegal miners to become parts of larger companies.

There is also increased awareness about the sector in the U.S. I think the U.S. retail investor is driving this market. A final catalyst—and perhaps the biggest—was Molycorp Inc.'s (NYSE:MCP) initial public offering (IPO) on the New York Stock Exchange at a little less than $14/share. It was not well received and went down to $12. During the past six weeks, however, the stock has reached a high of $30.

TER: For investors who aren't already in rare earths, is it too late to get into the game?

MF: I don't think they're too late, but they have to be very selective. Let me give you some examples. In early July, you could've bought Rare Element Resources Ltd. (TSX.V:RES; NYSE.A:REE), Quest Rare Minerals Ltd. (TSX.V:QRM) and Avalon Rare Metals Inc. (TSX:AVL; OTCQX:AVARF) on weakness for less than $2. Quest went to something like $5.50 before it pulled back to about $4.50, and Avalon went above $4. Rare Element has been the real star—that stock touched $9.90. Buying stocks on weakness in a bull market is a strategy that will work.

There is a lot of risk involved in buying these stocks; however, Avalon just raised $30 million for its feasibility study. Quest is in the middle of raising $50 million, which will take it through feasibility and provide working capital.

Rare Element Resources also is looking at a major equity financing in the near term, something in the range of Quest and Avalon. These companies have gone to the next level. Probably my favorite in the sector right now is Scandinavian explorer Tasman Metals Ltd. (TSX.V:TSM; Fkft:T61; OTCPK:TASXF). It was a $0.51 stock and has gone as high as $2. It's pulled back now to around $1.90; I think there's upside with Tasman Metals.

TER: You mentioned risk in buying these stocks. Yet all of them seem to be going up and with some type of financing. The sector is really hot so companies probably get the capital easily. Where does the risk come in?

MF: There's extreme risk in this sector because it is highly dependent on the economic health of the world. We saw that with the "flash crash" and the Greek crisis in late May–late June. These better rare earth element explorers took major hits to their market capitalization. If we don't have a robust world economy, these stocks will suffer.

TER: One of the arguments I've heard is that rare earth metals are becoming a strategic metal for governments and military uses, so there's some impetus for the U.S. to ensure it can produce its own rare earths. Are you discounting that argument?

MF: That's part of the equation in the U.S. for sure, but less so outside of our country because U.S. defense operations are so much larger than any other country in the world. What portion of HREE demand goes to the military? I have no idea.

Here's what I see—in the U.S., the United Steelworkers Union is asking the government to file a complaint with the World Trade Organization (WTO) about China's export restrictions and there are ongoing congressional hearings, as well as the House passage of a bill that sets up studies and committees to institute national policies. I don't really consider those legal beagle efforts to be material changes to what we do in the U.S with respect to securing REE supply.

Meanwhile, the Japanese are buying—or trying to buy—offtake contracts from future producers and tying up exploration plays in Canada through JVs and in Vietnam. Japan has been very proactive, whereas, in the U.S., it looks like we'll just sic the lawyers and politicians on it.

TER: In your newsletter, you wrote that REE mines "will not be built and operate under the usual economic models of profitability or rate of return. The financial reward in this market is the downstream supply chain." To me, it sounds like this sector will be relying on offtake agreements. Once you get those, there'll be some type of long-term fixed prices.

MF: I think that has yet to play out. The market will likely operate on long-term offtake contracts, but these contracts are likely to be graduated for worldwide increases in prices—and for higher operating costs. I don't think it's necessary for them to be long-term fixed prices; they could be floating prices. Security of supply is the key ingredient here. I see offtake contracts as one way to do it—also strategic alliances with consumers of the products and/or consolidation of players within the industry. One company has a deposit. Another needs supply of the separated, or even the concentrated, oxides. Then you have another one down the line that makes magnets. Finally you have end-users, such as hybrid carmakers, wind turbine generators, and the fluorescent light industry. There are endless possibilities in terms of how this could work out.

Only a few deposits in the world are likely to be developed, and that depends somewhat on who is the first to develop strategic alliances or sell future products. All of the juniors I mentioned have robust deposits—but these explorers will not become miners without help. They are generally run by geologists and are adding engineering staff, but these projects are much larger than any junior could possibly fund. That's going to mean demand for partners on both the financial end and downstream supply chain.

TER: The companies you mentioned earlier, Rare Element, Avalon and Quest, all seem to be raising money. Do you expect that money to come from a JV partner or the ultimate REE user like a carmaker from Japan?

MF: In the case of Avalon and Quest, the funds have been raised largely through North American-based financial institutions. I don't know where Rare Element's money is going to come from. All I've heard is that it will be raising major money in the near term. At this point, the various entities comprising demand for REE have not been in the public eye. Financial institutions are funding the feasibility studies and prefeasibility studies.

TER: I'm intrigued that the ultimate users are not coming up with the financing. When would you see the offtake contracts coming into play?

MF: I expect them to come into play soon. Companies need to get to the prefeasibility stage where financial analysis can be done and capital expenditures and costs of production lead to net present values and internal rates of return that actually have solid studies behind them. We should see this happen within the next year for Quest and Rare Element. Avalon has published a prefeasibility study, but it is marginally economic.

TER: In rare earths, there's an advantage to being the first to produce. There are more than enough REEs around the world to meet demand, and the first to produce will get most of the market share. Do you agree?

MF: There are probably more metals in deposits right now than there is demand. This entire sector is based on future demand outside of China. I very much think that China is tightening exports because it sees internal demand increasing, especially for select HREEs, and won't be able to supply the world as it has for the last 20 or so years. We need a secure supply in the West. That's what's driving the sector right now.

TER: I understand you recently met Gino Roger, CEO of Midland Exploration Inc. (TSX.V:MD) and are now getting up to speed on the Midland story.

MF: It's a very well-run company, a prospect generator in Quebec, with one rare element project of significance that's joint-ventured with Japan Oil, Gas and Metals National Corp. (JOGMEC). Their projects are very early, however.

TER: What else is the company doing?

MF: It also has gold and base metal plays. Its share price has touched about $2.

TER: Anything else you'd like to share with our readers in terms of either uranium or the rare earths?

MF: I'll give you another idea in the rare earth element space, Medallion Resources Ltd. (TSX.V:MDL). It has two projects in Northern Canada—a light rare earth element (LREE) project in Manitoba and an HREE project in Eastern Labrador. Its share price has tripled since the last financing. There is some risk but it's still a penny stock, so it might be something speculators want to take a look at.

TER: How far along are Medallion's projects?

MF: Very early stage. The project in Manitoba has a few drill holes. It is a JV with Rare Element Resources. Medallion CEO Bill Bird was the chief executive of Rare Element when that drilling was done around 2006. Its play in Eastern Labrador in the Red Wine complex is at the drill-targeting stage with geophysics, prospecting and sampling being done. And it has a low market capitalization right now, which the more advanced companies in this space do not have.

TER: Thanks so much for your time today, Mickey.

MF: The pleasure is always mine, Karen. As a final note, I would like to say that readers should realize that I am talking my own book here and it is incumbent on all investors to do their own research and due diligence before speculating in the junior resource sector.

Michael S. "Mickey" Fulp is author of The Mercenary Geologist newsletter. He is a Certified Professional Geologist with a B.Sc. Earth Sciences with honor from the University of Tulsa, and M.Sc. Geology from the University of New Mexico. Mickey has more than 30 years' experience as an exploration geologist searching for economic deposits of base and precious metals, industrial minerals, coal, uranium, oil and gas and water in North and South America, Europe and Asia. Mickey has worked for junior explorers, major mining companies, private companies and investors as a consulting economic geologist for the past 22 years, specializing in geological mapping, property evaluation and business development.

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DISCLOSURE:
1) Karen Roche of The Energy Report conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The GoldReport: Strathmore, Rare Element, Avalon, Midland and Medallion.
3) Mickey Fulp: I personally and/or my family own shares of the following companies mentioned in this interview: Strathmore, Hathor, Forum Uranium, Avalon, Quest, Tasman Metals and Medallion Resources. I personally and/or my family am paid by the following companies mentioned in this interview: Strathmore, Quest and Tasman are current sponsors of my website.