Eric Coffin: Stick with Commodities & Resources Exploration Stories that Work
Commodities / Resources Investing Aug 05, 2009 - 12:20 AMBy: The_Gold_Report
Investors have been beaten down and battered over the last year. With correlations between markets continuing to shift unpredictably, many are uncertain about where to put their money. "It's been a strange year," says Eric Coffin, co-editor, along with his brother David, of the HRA (Hard Rock Analyst) publications. The good news, he says, is that it's probably not going to get worse than March; the bad—a bear market this deep almost always revisits the major bottom. Read what Eric foresees going forward and why he's sticking with the exploration stories that work in this exclusive interview with The Gold Report.
The Gold Report: So, Eric, what do you make of this market? Is the rally going to continue or are do you see us moving sideways for a while?
Eric Coffin: We've been expecting a summer rally on companies we deal with. We've been a little more skeptical, to be honest, on the summer rally for the large companies. There is not a lot in terms of macroeconomic numbers to drive markets very much higher in the short term. It's going to come down to more earnings surprises. At the start of July, Dave and I were looking at the market and thinking, we're almost in earning season, and there really haven't been a lot of pre-announcements, which is a good sign. The pre-announcements are usually the bad news, not the good news.
So far, at least, it looks like we're going to have a few companies beating their numbers and some of them have beaten them quite resoundingly, so that may get us over 1000 on the S&P. What happens then? I went back and looked at a lot of market cycles and, given how horrendous the market crash was, we think March was probably it. It's probably not going to get worse than that, but that's the good news.
The bad news is every time there's been a bear market this deep (there have only been three) you've almost always had the major bottom revisited. Given that, it's a little hard to imagine us being so lucky that we don't see this market come back a bit some time going into the fall. That sort of consolidation after a major move off the bottom is normal. We've had some pretty good gains and we're happy with those and we're staying with the exploration stories that are working.
But we're going to continually tell people, look, the market's giving you a triple or quadruple, whatever; don't be too brave. Take some money off the table. Make sure you keep yourself liquid because there's still real potential for something to go bad. I don't think anybody has any illusions that the U.S. is going to come out of this downturn strong. It's going to come out of it and it may be bottoming now, but it's not like we're going to turn around and have 4% or 5% growth next year. That's just not going to happen.
TGR: So if you're looking at a stronger S&P, how do you see that affecting gold and gold stocks?
EC: Gold has tested and didn't get through $1,000 three or four times now. I think it's probably going to have to do that to really bring in the masses. That said, in the last little while, the strongest correlation I've seen with the dollar has actually been an inverse correlation with the major indices.
There are people jumping in and out of Treasuries and some of that's obviously foreign money because there's recently been a fairly strong negative correlation between the New York indices and the dollar. If the S&P goes through 1000, I think gold's probably got a shot of going through it as well, because the dollar will be coming off as people bail out of the Treasury market, at least for the short term. That'll happen because people are bailing out of bonds and going into equities. And that same trade seems to be driving the dollar down. If the S&P goes through 1000, gold may well go with it. It's a weird market these days. The correlations between markets seem to just keep shifting all the time and it's been a strange year.
TGR: In terms of your newsletter, what approaches are you taking? How do you divide your universe? Are you looking at soon-to-be producing companies, explorers, producers?
EC: We cover all of them, though we tend not to initiate coverage of large producers for the simple reason that there are just too many guys doing that. Our feeling has always been that our strength, because of our background, is dealing with the exploration and development level companies because we've got the experience. Dave and I used to run our own exploration consultancy before we started the newsletter, so we're used to looking at these companies, and Dave lives on airplanes and flies around the world all the time looking at these properties.
As far as our newsletter, when we came into the new year, Dave and I felt that base metals had bottomed; copper, in particular, so we recommended a couple of copper miners on the list that were producers, Capstone Mining Corp. (TSX:CS) and First Quantum Minerals Ltd. (TSX:FM), specifically (HRA subsequently closed out the position in First Quantum, originally recommended in 2001 at $2, at $67, having taken profits in 2007 at $100). They've both had pretty large moves since then. Other producers like Goldcorp (TSX:G) (NYSE:GG), Teck Cominco Ltd. (TSX:TCK.A) (TSX:TCK.B) (NYSE:TCK), and Silver Wheaton Corp. (NYSE:SLW) are on our list because they've taken over companies that we followed. About 15 other companies we follow have been taken over in the last three or four years by large producers, so you might say we "back into" those.
In April-May, gold was coming back. There were exploration stories that we'd looked at and liked but we were waiting to make sure the market had actually bottomed. We saw money coming into the sector and moving down the food chain, particularly on the gold side. Funding is still very tough for grassroots exploration but companies that have a bona fide discovery that they're working on were starting to get attention. We added four companies in the last few months that we thought had particularly strong gold exploration stories. Companies that could grow their assets and could go from zero ounces, officially, to a relatively large resource in the space of a couple of drill campaigns, and that had either enough following or strong enough management that they could get the money to do it.
Of course, the market still isn't that great, so even with a good exploration story, you've got to have some comfort that management can get the money it's going to take to get from A to B without diluting the heck out of everybody.
TGR: Copper's had one heck of a move. Where do you see the copper going the next 6 to 12 months?
EC: Yes, it has had a heck of a move. It's gone from $1.25 to $2.50. Our expectation is it will probably go sideways here for a couple of months. It might actually dip a bit. It is an industrial metal, after all, and when you get into July-August, a lot of the big users tend to cut the shipments down as factories are on vacation schedules and the buying starts again in the fall. I think that the buying we've been seeing is real. A lot of people are wondering if the buying out of China is real. I'm sort of in the "buying is buying" school. Even if they are buying it for inventory, so what?
I think the Chinese, who tend to take a longer view of these things, are honestly worried about what's coming three to five years down the road, which I realize most traders don't care about. But the Chinese are looking at the basic physical supply-demand equation and are worried about miners' ability to keep supply coming when the world economy heats again. From the start of this cycle in 2001, Dave and I have talked about this being a secular commodity cycle—and we haven't changed; we still think it is a secular commodity cycle—all of what's happened in the last year hasn't altered the basic picture in our view.
Everybody focuses on demand and, obviously that's important, but part of our focus has always been the supply side because there really haven't been supply responses. It's amazing, when you look at how much price movement there was in copper, for instance. It's actually surprising you haven't seen more production come online. For example, Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) a couple of months ago said, look, at $2 a pound, we're building what's already in development, but all you guys that are expecting us to add another billion pounds of copper production, it ain't happening. We are not starting anything else new until we know we have long-term metal prices that will deliver the returns we need.
If you look at the industry, production costs have gone crazy right along with prices. I think the days are over where the mining industry was everybody's chump. They would increase production until they were all losing money, and then keep losing money until the economy turned around. I'm not saying every metal price will go to the moon, but think of oil as an example. You're seeing the start of a similar trend in most metals. The days of $1 copper and $2 nickel and 50 cent zinc are probably gone forever. We're not saying there is no copper left; we're saying there is no (or very little) $1.00 copper left.
TGR: Let's talk silver. We've been hearing more and more about silver being undervalued relative to gold or oil. What do you see on a macro basis there?
EC: It is certainly true that the gold-silver ratio has widened quite significantly recently. Silver hasn't really followed gold in the last couple of moves. For all its investment appeal, silver to a much larger extent than gold is really an industrial metal. About half of its demand is industrial, after all, and I think that does hold things back.
Another way silver is unlike gold is that there are a lot more gold mines that are just, well, gold mines. There are very few silver mines that are just silver mines. Most silver mines are actually silver-based metal mines. If somebody looks at a three-year chart for copper or zinc or lead, they think this stuff really crashed. If you look at a 10-year chart, they got cut in half or went down by two-thirds, but the moves down last year weren't nearly as large as it has been in the past. And I think one of the effects of that is a lot of the marginal poly metallic producers are still hanging in there by their fingernails. So that silver production is still coming into the market; whereas, in a "normal" cycle, there's probably 50 small- to medium-sized mines in Mexico that would have shut down by now that haven't this time. I think that's part of it. I think the main thing, however, is just that it's a more industrial metal. More of its usage is going into the manufacturing sector and we all know what that looks like right now.
TGR: Can you share with us some of the stocks that you think our readers should be looking at and buying today?
EC: I think for the summer season the gold specs are probably your best shot and all the companies I'll mention are active right now. That's very important. In a market that's still weak, if you're going to be trading, you need to know there's going to be news flow and, hopefully, a significant amount of news flow going forward because you need that to keep the market's attention when the market's still weak.
The first one I'll mention is a company called East Asia Minerals (TSX.V:EAS) (Download Hard Rock Analyst's "Special Delivery" news alert that covers East Asia Minerals.) It's an interesting company. They've got a couple of gold-copper porphyries. They'll probably have 43-101s sometime this year that between them probably have a million or two million ounces.
The real story for us though is a project of theirs called Miwah, in Aceh Province, Northern Sumatra. It's a large epithermal system, basically a big ridge. They noted that the gold all seemed to be coming up structures, which is normal for this sort of thing, and their take on it was the closer you get to these structures, the better the grades will get.
Dave and I sat down and ran the numbers based on the size of the ridge and the sampled areas. If the drilling replicates the averages that they're getting in the trenches, this thing honestly has room for 5 or 10 million ounces. We think it's going to be a very big story this year. We started talking about it about four months ago at about 42 cents. It's about $1.73 now. It's been trading a lot of volume lately. They raised money at 51 cents a little while ago. That'll carry them for a few months. I think if they get good results in the kind of price gain we expect, they'll probably put more money in the bank, but we think this one's going to be a pretty big story. (Note – EAS released its first drill results from Miwah after this interview took place. HRA is maintaining its strong spec buy rating on the stock)
Another company that we're following, Evolving Gold (TSX.V:EVG) (Download Hard Rock Analyst's "Special Delivery" news alert that covers Bravo and Evolving Gold), has put their initial results out and gotten a pretty big bump out of it. Evolving has a series of properties in Nevada and, more importantly, Wyoming, which is where they're working right now. It had a big run up about a year and a half ago based on hopes for hot results out of the Nevada projects. They did manage to put a bunch of money in the bank during that run up, but the Nevada results weren't really up to snuff. They put out some pretty strong drill results from their Rattlesnake Hills project in Wyoming last winter, but, of course, that was last winter, so it didn't really have much impact. Nobody cared then, but it got our attention and prompted us to initiate coverage at $0.35 before the current Rattlesnake Hills program began this summer.
They put out their first drill hole in mid-July from their current drill campaign. That was 67 meters of 10.8 grams gold. It was important for two reasons. One, obviously, it was 67 meters of 10 grams. That was enough for most people. But what it showed was that this project does, in fact, have the high-grade structures. Their model for this is the Cripple Creek mine in Colorado. That mine has produced about 20 million ounces and it's almost two systems overprinted on each other. There is the high-grade structurally hosted material, which is what got mined first at Cripple Creek. That is surrounded by a large halo of lower-grade bulk tonnage material, which is what is now being mined by open pit. Another project of this type is Porgera in Papua New Guinea. They discovered the large low-grade halo there first and it was several years before they hit on and started to chase the higher-grade structural material that made it economic.
The one caution I would give people is that it's had a big move—we started talking about it at 35 cents and it's about $1.73 right now and has traded tons of volume, so it's building a nice base. But because they are drilling different target styles, you shouldn't expect every hole to look like this last one. Some of the holes are not targeted on stuff that's going to be high grade. They are, in fact, targeted on a bulk tonnage target, so they might get 200 meters of .8 grams or something like that. And we've cautioned our readers, don't freak if you see a drill hole like that. It's probably a different target. Again, very well managed—very strong technical group, lots of cash; that's not an issue. They upped their drill budget to 25,000 meters for this year and just added a fourth drill so there's going to be tons of news.
TGR: Great. Any others?
EC: Another we're following that just started drilling and I wouldn't expect to see results for probably a month at least, is a company called Bravo Venture Group (TSX.V:BVG) (Download Hard Rock Analyst's "Special Delivery" news alert that covers Bravo and Evolving Gold). It's a very strong management group, very strong technical group. They're drilling a project called Homestake Ridge up in the Eskay Creek area in B.C. It's actually one where we got a good gain in the middle of the horror last year because they pulled some really amazing high-grade numbers out of it.
We think the odds of them getting to 1.5 or 2 million ounces are good. It has 900,000 ounces gold equivalent already and that does not include drill intercepts from last year's work and there is quite a bit of trend still to be tested. If they manage to grow it that much or more, it's likely they will also be putting out some more pretty spectacular drill holes. We think it's a good trading stock. I think at these prices it's fine because it's fairly valued for the ounces they've got. Given the current pricing, it's got about a $50 million market cap, so it's basically priced to the ounces it has now, but we think there's room for the resource to get to be 50% or 100% larger. But, if that happens, it will happen because they're putting out holes that include some spectacular gold/silver intercepts. So far this summer, spectacular holes have led to some spectacular trading. We see no reason that shouldn't apply in Bravo's case as well.
TGR: You mentioned Nevsun Resources Ltd. (TSX:NSU) (NYSE.A:NSU). Can you talk more about that one?
EC: Nevsun's another one that we used to follow years and years ago and then we picked up again when Robert Bishop passed his subscribers and company list to us when he retired from publishing the Gold Mining Stock Report. They had their trials and tribulations in Eritrea, but that's behind them now, though I think the politics are still a negative for many people. They discovered a deposit, Bisha, which is a really, really nice deposit. It's very high grade all the way top to bottom. They have a joint venture with the government of Eritrea and we've talked to management numerous times. They've always said, look, once we got this JV done, we've never had any issues with these guys. They've been great with permitting, helpful with local relations and never late with their JV contributions.
Bisha's got quite high oxide gold grades at surface; then you move into quite high copper grades in the supergene zone, followed by high zinc grades at depth. It shifts from basically two years of high-level gold production, then about three years of high-level copper production, and then high-grade zinc production. And they do have several other targets and several other projects in the area, where they're likely to add more resources. Eritrea is Eritrea. It's got some political discount there. There are no illusions, but I think as they get closer to completing this thing and finishing the construction, it looks like a pretty obvious takeover to us, frankly.
TGR: You think they'll be in production third quarter of '10?
EC: Yes. They've actually built a lot of the groundwork and camp already. They've already probably spent 30% of the cap ex.
TGR: This has been great. Any last words you'd like to give our readers as we continue into summer?
EC: Right now it looks like we've again got a market where success is being rewarded on the exploration side. We're not quite there yet with base metals, but we're hoping that as we go towards the fall we will be and some of the base metal explorers that we've kind of had on the back burner will, hopefully, go to the front burner. But, that said, we are in a market where if companies deliver the kind of results we hope for, the gains have been there. We're certainly riding some of these, but given the overall state of the union, if you will, use some common sense. If the market gives you a triple, take enough off the table, then you're playing with house money.
DISCLOSURE: Eric Coffin David and/or I, personally hold positions in all of the companies mentioned in this interview. HRA (Hard Rock Analyst) publications are all subscriber-supported; we neither request, require nor accept compensation from companies that are covered in HRA publications.
For Gold Report readers, HRA is offering a discount on HRA Special Delivery, their premium "as-needed" alert service. Take advantage of this limited-time offer.
Eric Coffin and his brother David are the co-editors of the HRA (Hard Rock Analyst) family of publications. David is the "rocks side" of HRA, and has been active in mining exploration for over 30 years in roles spanning prospecting through feasibility studies, and now markets commentary. Responsible for the "financial analysis" side of HRA, Eric has a degree in Corporate and Investment Finance. He has extensive experience in merger and acquisitions and small company financing and promotion. For many years he tracked the financial performance and funding of all exchange listed Canadian mining companies and has helped with the formation of several successful exploration ventures.
Eric was one of the first analysts (along with David) to point out the disastrous effects of gold hedging and gold loan capital financing (1997) and to predict the start of the current secular bull market in commodities based on the movement of the US Dollar (2001) and the acceleration of growth in Asia and India.
David logs, literally, hundreds of thousands of miles every year, visiting exploration sites on six continents in order to bring back the real goods for HRA subscribers. Eric and David can be reached at hra@publishers-mgmt.com or through their website at www.hraadvisory.com .
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