The Mining Report: You're the editor of Junior Gold Report, but you also follow similar-sized companies in the energy sector. Please give our readers an overview of the energy space.
Kal Kotecha: I've been involved in the space since 2002 and I've never witnessed anything like what is currently happening. In the energy sector, I see the price of uranium increasing, but to see price appreciation across energy stocks, the price of oil must remain near $100 per barrel ($100/bbl). That $100/bbl benchmark could prove challenging, given the growing supply of shale oil in the U.S. Texas produces as much oil as Iraq or about 3 million barrels of oil per day (3 MMbbl/d). Most of it comes from two sources: the Eagle Ford Shale in southwest Texas and the Permian Basin in west Texas. Chris Guith, senior vice-president of policy for the U.S. Chamber of Commerce's Institute for 21st Century Energy, estimates that recoverable resources amount to 120 years of natural gas, 205 years of oil and 464 years of coal at current demand levels.
Fracking has lowered the price of natural gas by about 70% over the previous seven years or so. The price of oil, especially in the U.S, should decrease to $60–70/bbl on average because of shale oil. U.S. dependency on imported oil should lessen, too.
TMR: You said that the ready availability of shale oil could eventually push crude prices to $60–70/bbl. Is that a near- or medium-term forecast?
KK: That's a medium- to longer-term forecast. I don't believe in peak oil theory. The U.S.' savior in the oil industry is going to be shale oil, and there is a lot of it. Ultimately, that's going enhance the U.S. economy. Basically everything runs on oil. The U.S. won't have to import as much oil from Saudi Arabia or even Canada.
TMR: What are some companies that you're following in the shale oil space?
KK: A primary region of U.S. shale oil production is the Bakken Shale in South Dakota. Quantum Energy Inc. boasts good upside potential for investors. Quantum Energy proposes to develop five "21st Century Energy Centers" throughout the Bakken field with each to include a 20 Mbbl/d diesel refinery and a separate adjacent processing plant to strip the crude of natural gas liquids (NGL) for barrel value enhancement and regional production of NGL byproducts. Quantum Energy is green-friendly, too. The centers will use the latest CO2-capture technology to reduce emissions, while providing an injection-ready supply of CO2 for enhanced oil recovery.
The centerpiece of each energy center is a 20 Mbbl/d diesel refinery modeled on a refinery currently under construction in Dickinson, North Dakota, that will produce 7 Mbbl/d of low-sulfur diesel. The western North Dakota and eastern Montana region consumes 75 Mbbl/d diesel, providing more than enough demand for Quantum's five proposed energy centers. Quantum will also make money by refining other companies' oil.
TMR: Quantum will be essentially toll-refining oil. How does $60–70/bbl oil affect that business model?
KK: I don't think the price is going to affect the company. Investors will be rewarded once it is up and running.
TMR: What's your price forecast for natural gas?
KK: Natural should stay between $4–6/thousand cubic feet ($4–6/Mcf). It's more expensive in Europe, but in North America the floor should remain around $4/Mcf. I don't think it's going to go back up to $12 or down to $3.
TMR: Much of your recent writing on Junior Gold Report has either focused or touched on China. Chinese e-commerce firm, Alibaba Group Holding Ltd. (BABA:NYSE), recently conducted a record-setting initial public offering (IPO) and has a $220 billion ($220B) market cap. What should that tell investors about the Chinese economy and its growing influence on the Western market?
KK: That's a great question. I believe the Chinese economy is not as weak as reported, though it is probably not as strong as it had been in recent years. China will likely undergo a modest recession due to the growing debt of Chinese consumers. Japan went through something similar in the 1980s and 1990s. I don't think we will see double-digit growth for China any time soon. To support that, the Chinese government said recently that it will not provide any stimulus to the economy. That is a good thing in the long term.
China and India are going to be the next dominant global economies. Corruption is an issue in India and socialism is a challenge in China, but I believe both countries can live up to their billing as the next economic super powers.
TMR: You believe that the Chinese government has essentially duped global investors into believing that lower GDP growth ultimately means lower demand for resources. And that tactic has ultimately lowered prices for commodities and beaten up the resource market in the West. Do you have examples?
KK: One recent example is Chinese company Guangdong Rising Assets Management bidding AU$1B for copper and gold miner PanAust Ltd. Another is the Chinese government building infrastructure in Africa to support the African economy and lower the cost of transferring resources to China.
China is getting sleepy with its lower growth prospects and is seizing opportunities in a market full of people who doubt China's ability. State-owned enterprises are buying as many foreign mining companies as they can when commodity prices are depressed. In fact, they're buying anything tangible—gold, silver, real estate.
TMR: You also write about boron and how it's a leverage play on Asian economic growth. Please explain.
KK: Boron is a huge leverage on Asian growth. Boron minerals are used extensively in the manufacture of over 500 products, including fiberglass, insulation, LCD screens, detergents, agricultural products and insecticides.
Economic borate deposits are very rare and two are currently supplying 70% of the world's production: Rio Tinto Plc's (RIO:NYSE; RIO:LSE; RTPPF:OTCPK) U.S. Borax in California and Eti in Turkey—and both are operating near capacity. The world needs more boron, but it's hard to find.
One company that could change the market is Erin Ventures Inc. (EV:TSX.V). It's one of my favorite companies by far in any space. The company recently completed a preliminary economic assessment (PEA), and some of the highlights are mindboggling. The net present value (at a 10% discount rate) is $428M with an internal rate of return of 64%. A mine would pay for itself in 15 months and last at least 21 years with annual revenue of close to $100M. The net operating margin is estimated at 68.7%, with a net project cash flow of $1.16B and preproduction capital costs of $84.6M. These numbers are based on conservative boron price of $400 per tonne ($400/t). The current market price is $500–700/t.
TMR: That said, it's trading at around $0.05/share and the market cap is $13M. How is it going to raise the kind of capital it needs to develop these assets?
KK: When the PEA came out in September, the price went up to almost $0.10/share. We're in difficult times. A lot of the money will come from debt financing, with some possibly coming from some form of partnership. But it has to be the right type of partnership. There will be a lot of suitors for Erin Ventures. A full economic assessment will be conducted in the next year or so. That will clear the picture up going forward.
TMR: You mentioned earlier that you expect uranium prices to rise.
KK: Uranium is an interesting space. As oil prices slowly decrease, the demand for uranium seems to increase. Geopolitical tensions, especially in Russia and Ukraine, could lead to much higher prices. Russia is a large uranium producer and Western nations might stop importing uranium from Russia if political fires burn much hotter.
As of last month, China had 21 nuclear power reactors operating on 8 sites and another 20 under construction. China's National Development and Reform Commission intends to raise the percentage of electricity produced by nuclear power to 6% by 2020 from the current 2% as part of an effort to reduce air pollution from coal-fired plants. Ultimately, uranium demand will triple inside six years.
In India, the government is expected to spend nearly $150B to develop nuclear power over the next 10-15 years. India now has nuclear energy agreements with about a dozen countries and imports primarily from France, Russia and Kazakhstan.
TMR: Are there any junior uranium developers that could help meet the growing demand for uranium?
KK: I believe Fission Uranium Corp. (FCU:TSX.V) is probably the best junior uranium company available to resource investors. Patterson Lake South (PLS) is one of the most exciting uranium discoveries ever made in Canada's prolific Athabasca Basin, which hosts the richest producing uranium mines in the world. After a series of transactions, Fission consolidated 100% ownership of its PLS property, which comprises 17 claims totaling over 31,000 hectares.
The property is accessible by all-weather Highway 955, which continues north through the area of the UEX Corp. (UEX:TSX)/AREVA SA (EPA:AREVA) Shea Creek discovery to the past-producing Cluff Lake uranium mine. The PLS discovery is a basement-hosted unconformity uranium deposit, characterized by shallow, high-grade mineralization in five separate zones trending for about 2.24km. Fission is doing a summer 2014 drill program after completing a winter drill program where every drill hole hit uranium mineralization.
TMR: In a recent note on Junior Gold Report you wrote, "I smell smoke, but where's the fire?" in relation to the current sentiment in the junior precious metals market. What's your conclusion?
KK: The current pessimism surrounding the junior precious metal space has largely contributed to the fall in price of the commodities, but the beautiful thing about pessimism and hate towards a market sector is that there is plenty of room for error. Fantastic opportunities arise when great companies have been undervalued due to negative news that does not have a long-term impact on the company. So how do you determine which stocks, in a beaten up resource market, are great buys?
TMR: Do you have an answer?
KK: One must understand the essential principles of intrinsic value and the margin of safety. The principle of intrinsic value determines the worth of a stock through a combination of the price and the condition of the company. So no matter how great a company is, it may not always be a good investment. As Howard Marks wrote in The Most Important Thing: Uncommon Sense for the Thoughtful Investor, investment success doesn't come from buying good things, but rather from buying things well.
The principle of the margin of safety involves minimizing risk and then, therefore, minimizing the potential loss of one's money. Dealing with risk is a necessary part of investing, as stock price fluctuations occur and are often unpredictable. If the risk perceived by the herd—general investors who follow the majority—is less than the actual risk, then the returns will outweigh the risks. So when consensus thinks something is risky, the general unwillingness to buy it pushes the price down to where it is no longer risky at all, given it still has intrinsic value, because all optimism has been driven out of the price.
You mentioned that Erin Ventures is trading at about $0.05/share, but the upward potential is quite large due to the enormous potential that it holds on its properties. The same goes for Quantum Energy. Those are examples of buying things well.
TMR: What are some metrics to help investors?
KK: A junior mining company's ability to produce resources at a cost below its market price is essential for its sustainability. Junior mining companies should be judged by their ownership of mines, the quality of these mines and how management has executed similar projects in the past. Determining whether this data has been incorporated into the stock price is essential when seeking undervalued companies. I think this is where a lot of resource investors get duped.
Do you smell the smoke? I suggest investigating the source. I'd say that the herd is done shouting fire, and smart investors are filling up their baskets with goodies. But don't forget to do your research, check the facts and invest in a contrarian fashion. To obtain superior results, you cannot do what everyone else is doing.
TMR: Many investors have heard the adage "buy when there's blood in the streets." When should investors reasonably expect to start making money again, given the current market conditions?
KK: That's a billion-dollar question. A lot of colleagues have predicted prices that have not come true yet. The big upswing in gold in the late 1970s was followed by a collapse and we had to wait 20 years for another upswing. It's already been three years. I don't think we have to wait another 5 or 10 years, but there is going to be a time very soon where investors will be rewarded. I think when the upswing happens it's going to be very parabolic. I think it's going to take wings on its own. Patience will be rewarded.
TMR: What gold price are you using in your analysis?
KK: $1,200 an ounce ($1,200/oz).Many factors go into determining the price of commodities, especially gold and silver. Some of these factors include price manipulation, which cannot be foreseen; geopolitical strife; and import quotas, which are happening in India. However, I remain very bullish on precious metals in the long-term.
The best buy right now is silver. Silver is a screaming steal at $18/oz. I first started buying silver at around $7/oz in 2003 and I sold quite a bit in the $48 range a few years ago. I'm starting to accumulate silver quite heavily again. The ratio of gold to silver prices is currently around 68:1. I see that going to 50:1. If there's another precious metals mania, perhaps 25:1. Silver demand is also very high. A record 6,000 tons silver was imported into India last year—roughly 20% of global production.
TMR: Are there some gold and silver equities that you're following?
KK: Two companies that are undervalued in my opinion are Barisan Gold Corp. (BG:TSX.V) and Newstrike Capital Inc. (NES:TSX.V). I believe Barisan may be the next Indonesian elephant, on trend with Grasberg and Batu Hijau. Barisan should be publishing some exciting technical data in the next few months that could make it a high-leverage play. The drill results released a month ago were some of the best results from a copper-gold porphyry that any junior exploration company has had in 2014. Barisan has drilled about 10,000m to date and will be spending about $3–4M next year to delineate the Upper Tengkereng copper-gold porphyry. That includes 10 additional holes in the next 12 months with the objective of producing a maiden mineral resource estimate. The Upper Tengkereng discovery is just one of eight outcropping porphyries Barisan owns and is on trend with two of the biggest and most profitable copper-gold mines in the world.
TMR: What is the infrastructure like there?
KK: Upper Tengkereng has a paved road on site. As far as access to water, it rains 365 days a year and a deep-sea port is very close. Shipping concentrate to a smelter would be easy. There is power on-site, but it will be need to be upgraded. One of the challenges of Indonesia has been the government. However, some of the largest U.S. mining companies have been making fistfuls of money there for the past 50 years.
TMR: What about Newstrike?
KK: I really like Newstrike. The company has a strong management team. It just published a PEA that indicates that Ana Paula, its flagship property in Mexico, is a robust, high-margin, rapid payback, 8.2-year open-pit mining project that benefits from high gold rates with a low strip ratio. The Ana Paula project has excellent assets and infrastructure and is located in an established mining jurisdiction. The PEA highlights include a pretax net present value (discount rate of 5%) of $405M and internal rate of return of 47.5% with a two-year payback.
The initial capital costs would be $163.9M for an open-pit mine with a 6,000 ton per day gravity/flotation/carbon-in-leach processing plant. Cash costs come in at $527/oz gold. All-in sustaining costs are $567/oz gold. Ana Paula would boast annual production of 115 Koz gold and 239 Koz silver over 8.2 years. That's respectable value.
TMR: What's your advice for investors in the current junior resource market?
KK: I think a combination of five or six stocks in a portfolio with a mix of junior energy and mining equities is probably a good start. That's what I do. It's difficult for the average investor to follow more than five companies. My favorites are Erin Ventures, Quantum Energy, New Strike Capital, Barisan Gold and Fission Uranium and I believe they offer amazing value relative to their current share price.
TMR: Thank you for your insights, Kal.
Kal Kotecha is the editor and founder of the Junior Gold Report, a publication about small-cap mining stocks. He was the editor and creator of The Moly/Gold Report, which focuses on critical analyses and open journalism of companies profiting from the precious and base metals sector. The scope of his current activities include worldwide onsite analyses and reporting of developing companies. Kotecha has previously held leadership positions with many junior mining companies. Kotecha completed his Master of Business Administration in finance in 2007 and is working on his Ph.D. in business marketing. He also teaches economics at the University of Waterloo.
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DISCLOSURE:
1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: Rio Alto Mining Ltd.2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Fission Uranium Corp.Streetwise Reports does not accept stock in exchange for its services.
3) Kal Kotecha: I own, or my family owns, shares of the following companies mentioned in this interview: Erin Ventures Inc. and Quantum Energy Inc. I personally am, or my family is, paid by the following companies mentioned in this interview: Erin Ventures Inc. and Quantum Energy Inc. My company has a financial relationship with the following companies mentioned in this interview: Erin Ventures Inc. and Quantum Energy Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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