Three Companies to Watch in a Recovering Commodities Market
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
Source: Streetwise Reports 02/06/2018
Investors are more bullish on commodities than they have been for a long time. Gwen Preston, founder and editor of The Resource Maven newsletter, discusses trends with commodities and three companies that are on her radar.
The Gold Report: There recently were three mining conferences in Vancouver. Can you tell us some of the top takeaways?
Gwen Preston: The biggest takeaway was investors, analysts and those participating in the sector are more bullish on commodities than anybody has been in a long time. A lot of fundamental forces are lining up. Since the market turned at the beginning of 2016, there have been reasons to believe that gold could or should strengthen. There certainly have been reasons to support why copper was moving and why zinc was moving, but there was never a solid, broad argument for commodities that made a lot of sense. But now, that has come to be. And that's giving people a lot of confidence.
TGR: What are a couple of the factors behind this argument?
GP: I would say 2017 was the year that we all got over a lot of questions like what does Trump's presidency mean for investors, is this plow horse economy actually growing, and what's Brexit going to mean. This year, we're finally at the point where growth is happening, and not just in America. Growth is happening in Europe and in Japan, if you can believe it. That's really significant because when global growth happens, that means we've moved into a stage of the economic expansion that is historically bullish for commodities. Growth means more demand for metals, for commodities.
Of the other factors that are important to note, one is currency competition. For years since the financial crisis, the U.S. dollar was by far the cleanest shirt in a very dirty laundry pile, so it was the obvious long currency play. That is no longer the case. Big picture-wise, the U.S. dollar is now competing with the euro and the yen and other currencies as the long currency play. So U.S. dollar strength is no longer obvious, and that clearly helps commodities that are generally priced in U.S. dollars.
Add to that the possibility of inflation. I'm not convinced we're going to see a huge amount of inflation this year, but I think this is the year inflation is going to show up. If it does show up, inflation by definition means higher prices for all metals. One factor that argues for inflation right now is oil. Calculations have shown that a 10% increase in the oil price boosts domestic inflation by almost 0.5%, and we're seeing a much stronger oil price. There are a lot of factors at play, from quantitative easing to the price of oil to all the arguments that say we're already seeing rampant inflation—but it's not in the official numbers. That means higher prices for metal. It also means more stock market volatility.
The stock market is the other force that is at play here. A bull market is a bull market until it isn't a bull market. I think we are going to stay in a U.S. stock bull market for some time. A global stock bull market is actually what we're in. But we're definitely later in that game. We're already having rate hikes, and the U.S. Federal Reserve is unwinding the balance sheet and the yield curve is flattening and volatility is really low, and confidence and greed are really high. These are all factors that suggest we're late in a bull market game.
Within all of that, in general, stocks are really expensive, but commodity stocks are one of very few groups that are inexpensive. That relative opportunity is why you're seeing some famous, influential fund managers, like Jeffrey Gundlach of DoubleLine Capital, coming out and saying investors should overweight commodities this year because that's where there's actually some opportunity.
It is incredibly significant when you start to see generalist investors like that rotating some of their money into commodities. The reason is because the metal sector is tiny compared to the rest of the market. We only need a small fraction, not even one percent, of generalist funds to rotate into commodities for diversification in case the market crashes and for the opportunity for profit, because it's one of the only sectors where companies actually offer fundamental value. If you get just that small rotation into metals, the impact is outsized. I think that's the real thing that we're going to see this year, a little bit of generalist money starting to—and we're seeing it already—rotate into commodities and into metals.
When we get that rotation, not only is that when metal prices move but, also, leverage will return. Leverage is what we've been missing. We haven't seen mining stocks produce multiples of the gains in the metals. They've just been tracking the gains in the metals. But if we get generalist money coming in, we'll start to see leverage return.
That was a very long answer, but those are the reasons why people are broadly more bullish. There are definitely—and it's important to include this—risks to those arguments. But broadly speaking, that's the perspective that people are holding right now. People are pretty excited about the opportunities the metals space provides this year.
TGR: Do you see certain commodities doing better than others in the metals space? Or is it a rising tide raising all boats?
GP: Always there are going to be those that are better and those that are not so good. The metals that I have the most confidence in, in terms of performing well—not necessarily the biggest price gains but just solid performance—are probably copper and zinc. They fit best with these fundamental economic expansion and inflation arguments. I also like gold for sure. Gold being such a political beast, you're never quite sure. But gold, copper and zinc are my favorites.
The energy metals space is obviously very attractive right now. In recent years, we've seen lithium go. We've seen cobalt go. There's reason to believe another more niche metal like those could absolutely go this year, but those spaces are harder to play. They're more volatile and less predictable.
So, I put most of my money into bigger bets.
TGR: Are there a couple of companies, Gwen, that are on your radar that you'd like to tell our readers about?
GP: If we want to start big and work our way down, one that is quite interesting right now is Entrée Resources Ltd. (ETG:TSX; EGI:NYSE.American). This is a slightly complicated story. Entrée owns a 20% interest in two parts of the massive set of deposits that make up the Oyu Tolgoi mine in Mongolia. One of the two parts that it owns is in the mine plan and will start being developed and will see initial production in a few years, in 2021. Then over time, the amount of its ground that's being mined will increase. It may sound small to own 20% of parts of a mine, but Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK), who's really the operator here, is busy spending $5 billion developing an underground block cave that will be the third largest copper mine in the world. So, 20% of parts of that is really significant.
The other partner in the mine is the government of Mongolia, which owns about a third of the asset. Because of how the agreements are structured and signed, the government of Mongolia right now hasn't signed on to the part of the deal that covers the ground that Entrée is involved in. The government of Mongolia, not surprisingly, wants more money from this project. The way that all will fall out is that Rio Tinto, I think, is going to need to buy out Entrée. It—Entrée—gets a better deal than the government of Mongolia. That's the way the deals are structured right now. I think Rio is going to need to take Entrée out to keep its relationship with the government on solid ground.
I think Entrée is a really undervalued stock with a long-lived essentially royalty project—it basically is like a royalty with some advantages beyond that—that is going to get taken out, I would guess sometime in perhaps 18 months. Despite it being Mongolia, I would call that a low-risk royalty play on copper, which fits a lot of the bills that I'm looking for these days. So that's one.
TGR: What about companies closer to home?
GP: On the exploration front, I'll name two explorers that I think are positioned to have a really interesting year. One of them is Great Bear Resources Ltd. (GBR:TSX.V). It is exploring the Dixie Lake project, which is in Red Lake, Ontario. It is a really tight company. There are less than 20 million shares out in this company, so that means that success could create really significant share price moves. The price has already moved some because people are starting to realize that this story exists.
But it has been working on the Dixie Lake project for a year and a half now. Between the work that it has done and some historical work, what stands out is the consistency of high-grade gold. So, over a 500-meter strike length, 73 holes have been drilled. In general in Red Lake, when you drill these high-grade vein systems, you hit gold and then you miss, miss, hit, hit, miss, miss, miss in your drilling. That's just the way Red Lake usually is. By contrast, Great Bear has hit better than 3 grams gold in 70 of its 73 holes.
The consistency of gold in this zone is standout. Now, it's going to begin to drill again. It's going to try going deeper, which is where gold in Red Lake often gets better. It is going to try going into the Hinge zone. This is a structure that, to the southwest, appears to double back on itself, which is the kind of structure in Red Lake that can host fantastic gold. If that Hinge zone works then that suggests that where it doubles back, there's another limb. There's been some work that says there's gold over there, so it's going to test what could be a replica of the zone that it has on the other limb. And it's going to go the other direction, 2 kilometers to the northeast, where one odd historical hole hit gold that geologically looks exactly the same, and it's going to see if the gold continues up there.
Success on any one of those four expansion targets would increase the potential scale of this gold resource significantly. Success on more than one of them, it gets big quickly. That's a pretty exciting exploration story. It's in Red Lake, it's road accessible, its costs are low, the team is very careful with money, they have very few shares out. There are a lot of reasons to like Great Bear Resources.
TGR: What was the second explorer?
GP: It is TerraX Minerals Inc. (TXR:TSX.V). TerraX is exploring the Yellowknife City gold project, a large land package over 400 square kilometers that's around Yellowknife City in the Northwest Territories. TerraX has been establishing this land position and doing work on it for five or six years now. The obvious advantage here is that there's gold everywhere. Its project surrounds two very high-grade historical mines, the Giant and Con mines, where the average head grade was 16 grams per ton. These were incredibly high-grade gold mines.
Closure problems at those mines meant that the region got ignored for a long time. TerraX saw opportunity in that, moved in and locked up a really big land position. There's a lot of gold on surface. There's a lot of gold all over its project. That's certainly an opportunity. It's also a challenge in trying to figure out what are the controls on this gold, how do we find where there's one place that has a significant deposit. It's a challenge as well as being an opportunity.
Last summer, TerraX in a sense slowed down. It decided not to do any drilling because it had added to its land position a lot and it needed some time to do regional and structural work to really figure out what to do next. But the market always wants you to drill. The market is impatient like that. So TerraX did not have the most successful year last year in terms of its share price.
But now that inexpensive but essential groundwork is done. A lot of that regional work didn't lessen the interest that TerraX had in the zones that it already drilled. In fact, it increased its interest in those zones. And now it has big picture ideas about how those zones work. So it's going to go back to some of those zones and do a bit more drilling. Then it's going to publish an initial resource. It has never published any resource counts for this project.
I think that the market is going to be quite surprised by the resource that comes out of there. It's been a little bit of a difficult story to follow because there have been a lot of results from a lot of different zones over the years. So it's a bit of a challenge to understand exactly what's coming together up there. But I think this winter drill program is going to pull some zones together and generate a resource that's considerably bigger than the market thinks it's going to be. I think TerraX, after this slow but steady summer of groundwork and now heading into this new drill program, is in a really interesting position to do well in 2018.
TGR: TerraX recently announced that it acquired the Ptarmigan mine property adjacent to its project. Is this significant? Is it trying to consolidate more land?
GP: Consolidating land up has been part of its process for the six years that it's been up there. There are a lot of small landowners. There are a lot of small mines, historical mines. So, yes, getting those deals done has been a slow, steady process. CEO Joe Campbell has been working up there for years. He knows everyone. He's getting these deals done. And now, the company really has locked up pretty much everything that it can lock up in the area. That helps clear the slate for it to be able just to get out this year. So that's just one more piece of the puzzle.
TGR: Thanks for your time, Gwen.
With almost a decade of junior resource-focused journalism under her belt, Gwen Preston launched Resource Maven. Preston watches the wires, talks to her network and analyzes economics to identify resource news that matters and figure out how to profit. She focuses on early-stage exploration and development stories. Preston has been interviewed on CBC and in Financial Post.