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Sorting Through the Rubble
by Lawrence Roulston

There are bargains amid the wreckage of the mining industry

The past few months have been the worst time for investors in decades. Stock markets around the world are down around 50%. Resource stocks are down even more, with many of the juniors trading at less than 10% of their values earlier this year.

At this time, all we can do is look forward and find ways to make the best of the situation. For anybody with some cash, this could the best investment opportunity in years.

It could be some time yet before there is a full economic recovery. However, long before the recovery is well recognized, commodity prices will have rebounded and the prices of many of the better companies in the sector will be at levels substantially higher than the grossly oversold levels at present.

I would like to highlight gold, because I believe that gold will be the first commodity to rebound.

I'm sure all of you recognize that the markets are cyclical, and at some time there will be a recovery. For now, everybody wants to know how much lower will prices go and how long will it take before the upturn begins.

Nobody can give you a definitive answer, especially at a time like this when there is so much uncertainty. It looks like all that government bailout money, in the U.S. and other countries, is beginning to have an impact and things are beginning to stabilize. Letís hope for the best.

Just remember, nobody rings a bell to tell you when the markets have hit bottom. For most investors, by the time they get enough certainty that the markets are on the way up, itís too late. Once the uptrend is firmly in place, a big piece of the upside has already passed you by.

There is another danger in waiting until you are certain that the markets are on an uptrend. Not all companies turn around at the same time. In fact, the best quality companies will move well ahead of the pack. By the time the overall market has established an uptrend, they already will have been rising for some time.

If you come into the markets too late looking for bargains, you will have to settle for second or third-tier companies. Or, you will have to pay higher prices to get the top quality companies.

Make no mistake, some of the companies that appear to be selling at bargain prices today will be selling at even better prices over the coming months. Some of those apparent bargains will not even be here in half a year.

But, the high-quality companies Ė those with cash in the bank, with strong management and good assets, will begin to rebound from the current levels as soon as there is some sense of certainty in the markets.

In looking at commodities companies at this time, there are two major objectives. One is to take advantage of the extremely oversold situation in many of the small companies. Many are down 90% or more from their prices earlier this year.

Those severely depressed valuations are the result of forced liquidations which led to panic selling. In this market there are few or no buyers for some of those companies. As a result, prices have plummeted. The values at which some of these companies are trading are far below any sort of tangible or objective valuations.

Many good companies are trading at or below the value of the cash in the bank.

There are many opportunities in this market to take advantage of the extremely oversold valuations. But, the overriding objective at all times should be to invest in companies that have good assets and strong management teams.

Furthermore, management should be creating shareholder value. What I mean is that they should be working to increase the values of their companies and not just waiting for moves in the markets or the commodity prices.

In other words, look beyond the near-term bargains. Be careful to look for companies that are sound investments in their own right.

It is very important to emphasize that not all resource companies are the same. There is a spectrum of risk and potential reward. At one end of the spectrum are the early-stage explorers; companies where the next drill hole might turn up a discovery and give you a several-fold return in a matter of days or weeks. Those situations are extremely exciting, but not every drill hole results in a discovery.

At the other end of the spectrum are the major producers. Those companies are far less risky. However, their values tend to move as a direct function of the commodity prices and investor sentiment. There is little that any of the major mining companies can do to influence value in the short term. In essence, the majors are a commodity play.

In the middle of that spectrum are group of companies that offer a balance of risk and potential returns. The companies that I like most are those that have outlined a big metal deposit and are in the process of expanding and upgrading that deposit. This process can generate ten-fold returns to shareholders, even at times of weak markets.

For example, you can now find companies with gold deposits that are priced at a couple of dollars an ounce for gold in the ground. Those same ounces, once they have been advanced to the status of proven and probable reserves in the hands of a major gold company can be worth a couple of hundred dollars an ounce.

Why do we care about the junior companies and their exploration and development projects?

Simply put, they are an essential part of the mining industry. They have been for decades and they will continue to be.

Whether or not we have a recession, the mining companies are continuing to produce metal. The gold industry, for example, is mining about 80 million ounces of gold every year. Companies like Barrick and Newmont need to find or acquire millions of ounces of new reserves every year, just to stay even.

Pierre Lassonde, former president of Newmont, in a recent speech, pointed out that over 80 percent of current mined gold production is over 15 years old with some big mines nearing the ends of their days. Ore grades are falling, underground mines are getting deeper, costs are rising and junior gold exploration has come to an abrupt halt. Production is likely to fall around 7 percent over the next few years, possibly more.

The big companies are always aware of the need to replace reserves. Many of the metal deposits that will become the mines of tomorrow are now in the hands of the junior explorers.

The fact that the markets are down does not mean that the larger companies are sitting back. In fact, exactly the opposite is true. The majors see tremendous value in the beaten up share prices of the companies which hold metal deposits that they would like to get their hands on.

Letís look at an example. A little company called Forsys has a uranium deposit in Namibia. Last summer, the company was trading as high as $6 a share. When the markets collapsed, Forsys fell to as low as $2. Just last week, a larger mining company made a cash offer for all the shares of the junior. That offer was at $7 per share Ė in cash. In total, the deal is worth $500 million.

This example is important from a couple of perspectives. First, it demonstrates that even in the midst of the worst volatility and uncertainty in the financial markets in decades, a large mining company is prepared to make a cash offer valued at a half billion dollars to acquire a metal deposit.

Equally importantly, it demonstrates that the junior companies can expect to get fair values for their deposits, in spite of temporary setbacks in their share prices.

Just because the last trade price was low does not mean that the majority of shareholders would sell at that price. The majors know that. Thatís why, for Forsys, they offered a premium even to the high price before the recent collapse. Of course, if the markets were strong, the price would certainly have been higher yet.

Mag Silver also received a takeover offer, but that offer was more opportunistic. Joint venture partner Fresnillo based its offer on the depressed market value of Mag, down by 50% from its level earlier this year. However, it is not clear that the Fresnillo offer will succeed unless it is sweetened.

There are numerous examples to demonstrate why right now is a particularly good time to be seizing opportunities in the resource sector. There are various lists around that show companies trading for less than the value of the cash. One list has more than 100 companies.

Think about it. When you invest in a company that is trading at less than cash value, you are effectively buying cash at a discount. Now, if all they had was the cash, I wouldnít get too excited. But many of these companies also have a committed management team, exploration potential and metal deposits, all as a bonus to buying cash at a discount.

Maybe they will get cheaper. I doubt it. Not the companies that are already trading for less than cash value. The overall market may fall further, but the good companies that are trading for less than cash value are unlikely to get any cheaper.

Those companies are so cheap because a few sellers were forced to liquidate, with no regard to value, and they are selling into a market with few or no buyers.

If getting cash at discount and getting a free gold deposit isnít enough motivation, how about buying a silver company producing silver essentially for free, and trading at a 4.5% dividend yield. Or how about buying gold in the ground at $0.75 an ounce. These are all real examples of the kinds of values that are available to those who act now.

The recovery in the near-term will be a great deal more than a rebound from an oversold market for many of these companies. You see, some of the companies are doing the same thing as some of the forward-looking investors. They are seeing exceptional values and taking advantage of the opportunities.
There are a few companies that have cash and aggressive management teams that are looking around for opportunities to acquire additional assets at distressed prices.

If you think back to 2000 and 2001: metals were out of favor. A few smart people in the resource industry were picking up assets almost for free. Those people recognized the cyclicality of the commodities industry and set out to aggressively acquire assets at a time when few others had an interest. Those companies generated huge returns for shareholders.

That same process is getting underway now. In fact, this time around there will be even more opportunities and even better values than there were at the start of this decade. The reason is that over the past 4 or 5 years lots of money was spent on exploration. Some of that money resulted in discoveries. Many of those discoveries are getting no value in this market.

Investing in junior explorers at this time gives you potential gains in 4 ways:

∑ Taking advantage of oversold situations
∑ Project progress can move the share price, even in poor markets
∑ Markets will eventually rebound
∑ Ownership of gold juniors provides optionality to the gold price Itís tough to act contrary to popular wisdom. Just remember that the biggest returns go to those who buy when others are selling, and then sell when others are buying.

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