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
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
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
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
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
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,
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
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
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
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.