Shift from Millennium Minerals to Gryphon Minerals (GRY.ASX) - nice upside

We have just seen a rally in the gold price and a corresponding recovery in gold stocks. I took this opportunity to take some profits on a small producer, feeling that it had got ahead of itself, and had room for a correction. There was no strong reason for the pull-back in gold. It was technical to a point; and thereafter it was manipulation by a fund to lock in a low price. The strong factors for gold:
1. Very low interest rates - negative real rates
2. High asset prices based on yields
3. End of US stimulus; addition of Japanese stimulus
4. Iran and North Korea as potential issues

So my trading action today inolved, based on the following charts selling MOY.ASX because its a gold producer which has rallied from 1.5c to 2c. Now, in fairness, it still has upside, but in the medium term its earnings are going to be curtailed by the terms of its JV agreement with North West Resources (NWR.ASX), where it will be splitting the revenues. This will diminish earnings. The chart suggests a pull-back to 1.7-1.8c, so I'll expect that.

In the meantime, another one of my favourite stocks, Gryphon Minerals (GRY.ASX) has pulled back considerably in recent times. This stock has significant appeal because it will be a low-cost gold producer. It has 3Moz and a lot of upside. It will of course benefit from low interest rates, and a subdued market to commission a plant, and it is destined to report a revised resource in the next quarter, along with a decision-to-proceed with a mine. The more Iran and North Korea beat their chest, the more one is inclined to expect some imminent action. These countries will not be allowed to develop nuclear weapons. The implications are clear for global monetary policy. The company has $62.8 million in cash, so given the need for 1/3rd equity, it has essentially enough funding to finance the $200mil capex for the plant. It is envisaged to produce 150,000 oz per annum for 5 years, at an average grade of 2.38g/t.
The financial analysis of the company suggests a net present value of $321 million for a rather conservative $1500/oz gold price. Even if you accept the $121million NPV based on a gold price of $1300/oz, you'd have to concede that this is a good investment given:
1. The conservative case gives you upside in terms of economies of scale, i.e. plant expansion and more gold discoveries in the 1200km2 license area.
2. The positive exposure to gold at a time when there is an imminent risk of military action and Quantitative Easings (QE).
3. The company has $62million in cash, a resource base of 4Moz (worth $2.8 million in undiscounted cashflow). The company is capitalised at just $84million, giving the project only a nominal value of $20mil.

The added upside is the prospect of a merger with a similar sized Canadian or Australian producer with the intent of raising the profile and liquidity of the stock to fund managers, as well as diversifying sovereign risk, only adds to the appeal. The prospect of only minimal capital dilution in future as well as the resource upside and exploration appeal is truly good value. The company also has other projects it could divest in future to raise further cash. More likely is the prospect of using mine cashflow to expand these projects. I like this company a lot, so I just bought more of them at 20.5c.

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Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

The dynamics of global commodity supply and cost

This company specialises in the production of iron ore supply cost curves. I don't know this company, however I spent a lot of time when I came out of university working for a company, Barlow Jonker, generating lots of these curves for the coal industry. The problem with such curves is:
1. Context - like with financial ratios you need to be aware of the context of each mine contributing capacity to the curve. How do these mines differ? Now, you can do things to overcome these obstacles, i.e. Not simply saying that a mine can supply at cost, but you can identify other constraints on these miners and include them in your formula, i.e. They can only supply power stations with certain coal quality specifications. These are really complicated algorithms. It gets even tougher when you have mines producing different blends, and if the fix depends on variability in the ore or product prices. The reality however is that the 'blends' are fixed by contractual undertakings. Another issue is 'destination'. It is one thing to say you have produced a cost curve, but one needs to know to what destination. If to Asia, one needs to consider the characteristics of the port (panamax, capesize), as well as the freight rates that will impact on competitiveness of different routes. The freight market is pretty volatile, so you might wonder how useful these curves are. Of course shippers will fix rate for some sense of certainty. Power stations and steel plants also have an important control over supply because they like 'stable' or certain quality coal or iron ore to ensure predictable furnace geochemistry. But what about those other buyers, like cement plants who are far more flexible in their fuel use? They drive the market in every which way, and they don't care about quality; its the price for 'useful heat content'.
2. Prices - Prices are set at the margin. This is another indicator of how difficult it can one to use cost curves. Consider however that many investors are interested in only the long-run supply cost curve to establish the long run outlook for mines. Of course if they are interested in the long-run, they are interested in the trends.
3. Future proofing - Is it possible to build future assumptions into a cost curve, so that they can become useful indicators. i.e. The curve might become dated if a company announces a new mine, or the closure of one. The problem is less the prospect of a new mine, but the prospect of price changes at the margin causing the deferment, not just of one mine, but 5-10% of the market capacity. What if brownfields capacity is identified in that time. There is a certain utility to such curves, but you mind wonder at just how complex their models would have to be. If you are a senior mining executives, I wonder if you look at the detail.

You might be forgiven for thinking that supply-cost curves are just economic rationalism. The problem is many people just look at the curve....and not the data, and what the data means. Anyway, if you want to explore these types of issues, I suggest looking at the following website - as supply-cost curves are their 'speciality'. Iron ore markets are a little simpler in terms of their dynamics.

We discuss supply-cost curves in our book Global Mining Investing eBook. The book is pitched at investors who want to be active custodians of their savings. We book is focused on mining, so it should appeal to:

1. Active investors who want to specialise in a sector - mining is a good sector because of its cyclical price volatility and range of commodities. This approach is for people who are keen to learn; who take pride in their mental efficacy. 

2. Geoscientists who want to leverage their knowledge of science, finance, mining to achieve non-salary income. I would argue that you can use your savings more effectively than a non-industry person. The popular misconception is that diversification is risk management. Not necessarily; but I can assure you is that 'diversification is opportunity cost'. 

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Profit from mining with Global Mining Investing eBook   Global Mining Investing Community.

Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Union Resources - takeover comes as expected - locked in 180% gain

On a number of occasions - the last time being November 2012 - we have strongly recommended Union Resources as a takeover target, and therefore a great stock to just buy and to through away the keys until a takeover bid arose. That day has come by 6 months later. This has in the last day caused the stock to rise 180%. We bought this stock for 14c, and on the day of the takeover it was 11c in a weak market. Today its 31c, and truth be told, if markets were logical, it should probably be worth 50-odd cents. The problem as I see it is that shareholders are not going to get a good deal simply because in this market 'cash is king'. People will accept cash, even if its not a good price. Its not a good price because:
1. Mermaid offshore phosphate deposit in Namibia was bought from Minemakers (same share) for $US25mil; valuing the stock at around 41c a share. Correction: The takeover price values the company at $A32million, which is $6mil over and above the valuation of the Minemakers purchase price. 
2. The bid places no value on the company's shareholding in the Iran project; one of the largest undeveloped lead-zinc deposits in the world.

Now, you can wait for a higher offer, but there is the risk that it won't come. This is an unconditional cash offer; so my understanding is that it can be withdrawn after the expiry of the offer. The question for you is not so much the risk of missing out, but the opportunity cost of holding when a higher offer might not come. This is a statistical question because the market has been hit, so it might be more prudent to take this opportunity to take the cash to prepare yourself for the next buy.

The problem as I see it is that the takeover suitor does not necessarily need control of the project. They can creep along and get it slowly at a lower price. Having said that, they might raise it to tidy up lose ends. The question is - is it worth the risk as a shareholder? The last thing you want is to be one of the 10% equity holders holding stock when they move to compulsory acquisition. Now, much depends on how the directors respond to the offer. My problem is that:
1. The directors seem to be saying its a huge premium. That does not give me confidence. Indeed, its kind of misleading if they now come out and say its poor value.
2. I'm wondering if the company executives have a blocking stake of 10% to force a higher shareholding.

I have reluctantly taken the offer because:
1. Its cash and its a good time to re-invest
2. Its a bad market - and the company needs to raise working capital
3. The capital requirements for the company are onerous

But prospective sellers should consider that the upside is another 200% profit, i,e. for a total 400% gain if the directors are able to get a higher price. I frankly think the company is worth $1.50, but until Iran is the subject of a revolution, and shareholders discover that value, I don't see anyone offering that type of money. The lack of cash is a big factor for selling for me. I don't want to be diluted after the expiry of the offer. By al means wait for the offer. I might be a little cynical selling early because I've just become accustomed to the 'big boys' getting all the profits because they can rely on the lack of access to capital for small companies. You have to save your criticism for the governments who make this type of 'boom-bust' economy possible, which is ultimately the source of the tragic market conditions which allows big companies to win the day.

Interested in how you can make 200% profits like this more often. Well, this is actually a disappointing gain given the upside in this stock, and the spectre of a takeover in bad market conditions, however we do try to please. We first suggest learning how to become an active investor. You can become one of an elite group of investors who make exceptional profits by developing 'active minds' to manage risk, or really to dissipate risk, rather than to accept it, and 'diversifying' away from great returns. This only serves the fund managers who make commissions and the large multi-nationals who win on the 'divide and rule' strategy. If you like our active investment strategy - join us on Facebook or our Google Plus Community. Feel free to ask questions.

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Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Orica an appealing exposure to mine services - look for that entry

Orica Ltd (ORI.ASX) is a particularly interesting company because its one of those mine service companies which differs from others in several respects:
1. There are not too many explosive manufacturers that provide a down-the-hole delivery services. i.e. Yes, they actually charge the holes with 'prill' or ammonium nitrate and detonate the charge.
2. They benefit from the economies of scale and rapid expansion in 'volumes' which I describe in an article on mine service contractors. See this article.
3. They are benefiting from the development of larger scale BIF iron ore, copper-gold, copper-Molybdenum, coal mining operations globally.
4. They are involved in a highly concentrated service industry

If we examine the Orica chart over the long term its apparent that this company has been trending sideways ever since the global financial crisis started in late 2008. Now, the dividend yield is currently a very appealing 4% and the stock is actually off its lows.

Now, back in 2001 I made a lot of money using a secured leveraged equity product on Orica. This product was obtained through a company called Leverage Equities Ltd, however there are other companies like Macquarie Bank, which do this as well. Now, it entails them attaching a put option to your equity acquisition, and your downside is effectively underwritten. It is actually a very nice way to invest at certain 'great stock' plays or at certain points in the equity market cycle.

Now from the chart above, it is apparent that the commodities boom was great for Orica. Well, understand that Orica, as a producer of explosives and down-the-hole deliverer of those explosives, did not benefit so much from the 'price premium' for metals and coal, but mostly the volume increases. For the reasons highlighted in the previous blog post, this next cycle, will see Orica benefit more than it did in 2001, when I first bought into Orica. This is a clear indicator for investors to take two strategies:

1. You can trade the stock in the consolidation channel shown from 2010-2013. Currently its a good time to buy, and you can do that through CFDs like www.cmcmarkets.com, and sell when they reach the top of the channel. The stock pays a 4% dividend, so you could also opt for a put option at that point. 

2. You can set an alert at the top of that 'consolidation channel', and when you get that signal, look for a break-out, as that will in all likelihood signal the start of a new minerals boom. It might not start for another 2-3 years, but you have a nice 'signal'. You can set an alert and forget about it. maybe you might want to set a hyperlink to this article.

The cost of that leveraged equity was about $25,000. The profit to be gained was truly phenomenon. My entry price was around $3.70 if I remember correctly. The reason I bought this was because of two coincidental events:

1. A representative from Leveraged Equities came to our company. I was working for a boutique mining finance company at the time. So they gave us a presentation to promote their product.

2. Then later in the day, a representative of Orica came to our sister company, a retail stock broker, and gave us a presentation on the company. It was readily apparent at the time that Orica was a turnaround story. I jumped on. 

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Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Mining service companies offer good profit outlook - choose wisely

One of our roles as investors is to critique others research; but an additional role is to add-value to others research without plagiarising it, since we respect their intellectual property, as we would expect them to respect ours. Now, I came across this article by TheBull.com.au describing the financial fundamentals of a number of mining service companies. I have not examined their calculations because its not a sector that I follow; however it is actually good exposure to this next phase of the mining boom. If you recall me saying, this next phase will be about 'volume' or 'capacity' increases; as opposed to strong real price rises. 

China and India will need more ore, but the supply-cost curve will be flatter, as they pay less for those more tonnes, but demand higher volumes. The reason why the supply curve will be flatter is because:

1. There will be many more mines

2. New capacity will be incremental to existing capacity, whether expansion of existing mine capacity or satellite capacity using existing railways, ports, etc. 

3. The spectre of pass-through of cost advantages to buyers resulting from these economies of scale at the tail-end of the supply cost curve, as they attempt to be competitive

4. There will be fewer factors to differentiate between projects

5. Cost savings through consolidation of miners. i.e. In the price spike in the 2000s, there was a rapid rise in the number of miners, particularly in the iron ore sector, which was already highly consolidated. This prompted miners to sponsor new market entrants, to give them more bargaining power looking forward. Now the majors are going to embark on another phase of consolidation. It will anger China of course, and that will probably demand some kickback for a party official. Yes, I know, its against Communist Party policy. Rest assured; it will be all worked out. 

Now, why is this good for mine services companies? Well, the reason why its good is because:

1. Mine service contractors struggled to provide cost-competitive services in the price boom because the spike to exploration caused a shortage of parts & equipment, rigs, as well as labour.

2. Mine services are actually more profitable than exploration services, since mining is continuous, so more easily supported. 

3. A flat supply-cost curve means its easier for mine service companies costs to be absorbed by miners as simply a 'pass through' to the consumer. 

4. The prospect of 'tough times' now means that consolidation in the sector will result in better profit margins moving forward.

5. The cost of capital for debt-financing has never been cheaper

6. We have already mentioned the very favourable growth in 'volumes'. Mine service companies are paid to mine 'volumes' as opposed to the contained metal content.

That is a lot of benefits. Of course some projects are better than others. i.e. You would expect a mine services company to prefer large mining operations, say coal, iron ore, because they have a 20+ year mine life, so easier to leverage their services and debt finance. Remember interest rates are going to be low for a long time yet. Of course these companies still have to be good managers, and you will want to watch their profit margins to ensure they are good analysts of their costs. Leverage is a two-edged sword. 

So this brings us to the research performed by The Bull - see this article. I never liked the accounting; I prefer the strategy and conceptual side rather than the number-crushing. Thanks to The Bull! 

Now, you might wonder which of these companies offers the best exposure; and whether you should invest now. The market is going through a 'correction' at the moment, so you might want to wait for a technical entry into these stocks - or others. These are mostly drilling contractors, however you might want to look at providers of other services to mines like:

1. Recruiting companies that specialise in mining - since recruiters are paid really well - though they have suffered a shake-out of profit margins as well. 

2. Security companies 

3. Catering companies

4. Transport companies, i.e. regional airlines servicing the mines, or bulk ore handling groups (you will need to look internationally). 

5. Regional media groups. i.e. A Western Australian newspaper group.
6. Explosives providers - A company like Orica does not just manufacture explosives, it provides a down the hole delivery service. i.e. This is a value-add service. I have made a special topic of this company

It is hard in most of these areas to get 'specific' exposure to mining. This tends to leave you looking at mining contractors, or regional service providers benefiting from the 'trickle down, like newspapers. Just ask yourself where the greatest upside and growth lies. I would think its with the mining contractors. Recruiting has low barriers to entry, so margins can be undermined. Once you get a good contractor, you won't change for a price reason; you will change by default, unless its a substantial point of disadvantage, and no contract is the same, so its hard to undermine the competitive position of a contractor. Its harder than signing up for a new cell phone contract, but you can see how they bog you down in details. Where do you think they learned how to 'complicate' the process....from dealing with companies. 

So back to what makes a good entry? Well, you will want a company who displays high margins, but you will not want a company who has high debts because they are fully leveraged, so there is no upside in terms of expanding earnings as the market volumes recover. You will want a low PE; but you would not want to compromise on the leverage upside. Cash on hand is not necessarily a good thing because it could be construed as under-utilised resources, or funds for acquisition. They may use these funds for acquisition, and that would be good news at this time. A takeover in uncertain times is always good if its a contrarian investment. 

Lastly, one will want to know what 'work in progress' might change the nature of these financial ratios. Such ratios can be dangerous because they can conceal an important context, which might not be alluded to with ratios, or it might be a conceptual consideration not readily quantified. This is the problem with ratios. Financially, use your technicals to pick entries. 

So when would you expect to sell such investments? Well, that would be:

1. When they are a technical sell

2. When interest rates start rising substantially - a long way off

3. When and if your stock is a takeover target - wait for alternative bids, and seek out the smaller companies which might in fact be the target rather than the predator

4. When global economic activity or equity markets again look peakish

The implication is that these mine service companies will be good long term investments when they bottom. You can happily put them in your super fund. I would not leverage a leveraged enterprise though using contracts for difference unless you have the diversification to do so. The last thing you want is a contractor dispute. It is preferable for this reason to have a stock with a diversity of projects, with no single over-investment in one project. Its actually good to have a regional focus since that is an economy of scale; and miners are price-takers anyway. This would not be the case however if your region of interest is all high-cost mining capacity (i.e, at the tail-end of the mine cost curve), as they will all be priced out of the market at the same time. i.e. Let's say that most iron ore miners are close to the cost, and you buy a mining contractor exposed to a suite of miners 2000kms inland. This is a 'transport cost penalty', so unless they have an offsetting advantage like premium ore grade and economies of scale from thick ore horizons and bulk mining and train freighting advantages, and say a backhaul, then you will find that this is a critically vulnerable stock to failure at times of metal price vulnerability. A likely ghost town scenario. 

When you see a bottom in this vulnerable market, you might consider mine service contractors. Just be weary about the timing as this financial uncertainty is undermining confidence, and therefore spending. But don't wait too late, use technical indicators. Its a long term strategy, so use a 1month 20-day period for an entry, then a relatively long term moving average as an exit signal. Mining contractors only go broke if mining ceases; otherwise their earnings are more sheltered than actual miners.

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Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com

Calculation of mine profitability using disclosed C1, C2, C3 mine cost data

In our book 'Global Mining Investing' we offer some explanation of how to create mine cost calculations so that you can calculate the earnings of a company. Well, in this blog I want to provide some additional resources so that you can in fact practice with your appraisal of mining company earnings.

Consider Millenium Minerals (MOY.ASX). The company has just released its earnings for the March 2013 quarter. They were $10million, or $40 million annualised. This compares favourably with a market capitalisation of $60mil (according to Google Finance); however you might want to confirm that. It addition they have $11mil of cash and bullion on hand, so effectively worth $50 million. Now, you have to consider the impact of:
1. Mine expansion - generally justified by successful resource drilling - or extended mine life
2. Future capital raisings - to cover large capital expenditure like a mine expansion
3. Gold price outlook - price recently fell, but appears to be consolidating
4. Hedge book - a new mine will have some hedging to consider
5. Mining costs - High costs make the company sensitive to gold price fall, but greater upside to a recovery in gold prices.

But I identify this company to provide a case study in how to appraise mine costs and revenues, because it offers you all the information. When you buy most equities, you will have no idea what their commercial viability is because you don't see their 'unconsolidated' operational accounts. This is not the case if you buy miners because:
1. Prices are evident
2. Mine operating costs are disclosed - This is because they are 'price takers' (there are many producers in the market) - so you are more readily able to appraise them
3. Price outlooks can be forecast up to 1-3 years out - whether hedged or open to forecast

These are of course compelling reasons to invest in mining stocks. So what are our sources of information:
1. Quarterly report - see here offers the quarterly cost, production levels, etc.
2. Mine cost model - see here for base metals, here for copper, and here for gold (Oz Mineral's Prominent Hill project)
3. Google Finance - for the latest number of shares and market capitalisation - you should confirm this number with the Quarterly Cashflow reporting because unlisted shares are often not included, and this will also tell you their cash holdings.

Here is another gold project which you could model to test your skills establishing the value of companies. This is an emerging gold miner in New Zealand, listed on the NZX and ASX, called New Talisman Mining. I did not look at their broader corporate interests.

Of course if is desirable if you can model these spreadsheets on Google Documents or Excel. I will eventually do this for a stock so that people can access it, or share it. 

Asian property markets outperforming Japan Foreclosed Guide Philippines Property Guide
Profit from mining with Global Mining Investing eBook   Global Mining Investing Community.

Author Andrew Sheldon| Applied Critical Thinking | www.SheldonThinks.com