Jim Letourneau: Opportunity in Uncharted Waters
Source: The Energy Report (1/29/09)
As a geologist and investor, Jim Letourneau, editor of Big Picture Speculator, has a unique perspective on the energy sector. An admitted optimist, he claims to be "short term bullish, medium term terrified and long term bullish." In this exclusive interview with The Energy Report, Jim discusses the irregular flow of today's markets, where to drop anchor for some good short-term returns, and why he foresees a more sustainable balance in oil going forward.
The Energy Report: Jim, let's start with an overview of where you think we are right now. I like the line in your January 5th newsletter that says: "Today I'm short-term bullish, medium-term terrified and long-term bullish." Are you saying that you're medium-term terrified because you think there will be some sort of "Obama effect," and once that wears off, we're going to have some more bad news by the end of second quarter or so?
Jim Letourneau: Yes that, and just the flow of the markets. January, February and March are typically good months; and this year, because we had such a massive sell-off—you know, a lot of stocks are down 90%, many of them in the junior sector fell below 10 cents a share—it's pretty easy to have doubles and triples off of these lows. People are going to get a little bit excited here in the short term; but medium term, I don't see us getting back to where we were. That old adage, "sell in May and go away;" if there was ever a year to use that phrase, I think this is the year. It might even be "sell in April and go away."
There's a great trading opportunity in the short term because things were so oversold. And in the longer term I'm bullish because we haven't come up with new supplies and commodities, and, ultimately, we're going to need those supplies. The investments weren't made long enough to actually get the new mines up and running and the same on the oil and gas side. So I'm longer term bullish, but there's this gap in the middle where things could get worse.
TER: So the long term—you were talking about the lack of supplies, what's your long term? Is it 9 months, 12 months, 18 months or 2 years?
JL: Well, as an optimist I'd like to think it's a year, but some people think we could be in a recession for much longer than that. I think we have to distinguish between the United States being in a recession and the global economy being in a recession. The developing economies, India and China—though they're slowing down and pulling back—there's still a lot of growth there. So I'm kind of leaning towards the shorter side. I was looking at some statistics. 2008 is the third worst year since 1858. Not many people have been through this, and we're in uncharted waters; so I can make a pronouncement and say what I think, but it's not really worth very much. We kind of have to watch what happens as opposed to predict.
TER: As you just said, it's not that easy to predict, but if you were going to put on that hat, what do you think the big sectors for 2009 might be?
JL: I think it depends on timeframe. In first quarter, some of the base metals. Energy and uranium stocks are doing really well, and that's partly in the really slow time in the market—around the Christmas holidays and New Year's. A lot of them doubled quite quickly on not a lot of volume just because they've been so beaten up. And IF there is a bit of volume in that market. So we can see them run for a while.
We still may see lower prices, but things have gotten pretty cheap on a fundamental level. That doesn't mean that can't get cheaper, but I think we see a bounce first and that's why I continue to be short-term bullish.
TER: Was it the uranium companies being so decimated, and then showing this recent activity that prompted you to do the report you just came out with?
JL: It comes down to methodology and, you're right, I look for areas of the market where money flows. Uranium stocks were seeing some higher-than-average volume, and those small sector moves can be very powerful. In the past we've had little bull markets in tungsten and molybdenum, and very narrow niche markets—and uranium is one of them—where it doesn't take a lot of money to move the market quite a bit.
Looking at how much cash some of the companies had and the value of their deposits, they remain a long-term call option on the price of uranium. If you buy a quality company that's got a nice deposit (even though it may not get advanced for a few years), you may not be able to buy that kind of asset for less down the road because things really did get beaten up.
TER: Part of what you're saying is that it doesn't take a lot of money to move these markets, but the converse is also true. If those with money to invest decide that there's another shining bauble somewhere else, that market can turn just as quickly on the downward side.
JL: Exactly. That's what we've seen. I can make long-term pronouncements that are fundamentally sound about supply and demand; but in the short term, the market goes all over the place. That's the challenge, I think, for anyone investing in the junior companies; you need to watch the eggs in your basket very carefully because you get runups and then you get pullbacks. It's only the really high-quality companies that are going to be around in 5 or 10 years. So, when you get involved with a company, you have to decide if it is a short-term thing or a long-term thing.
TER: As you were using your methodology and looking at some of these juniors, are there some that realistically should be at a higher value?
JL: One of the first things I looked at was how much cash they have, because it's going to be hard to go to the market in the short term. And it may be hard to go to the market in 2010. It's nice to see that they've got a cash buffer, and then they have a lot more flexibility. If they're down to $5 million or less and they've got an average burn rate, they're desperate. They need to do something to raise money and they're not making any money, so those companies are more in danger, I would say.
TER: So you're looking at the balance sheet at that point.
TER: I know that you have a geology background. What recommendations would you give to investors, in terms of the importance of understanding the geology and the projects in place?
JL: As a specific example, in the uranium sector, it's how strong is the management team? What kind of deposit is it because, in uranium, there's everything from very high-grade deposits in the Athabasca Basin (which are very small) to in situ leach (ISL) mining or in situ recovery miners in Texas and Wyoming that have a much higher cost structure. And both can function quite well in a relatively high-priced environment. But the ISL miners are a lot more sensitive to price change.
There's at least one company that's having trouble making money at current uranium prices. There are a couple of new projects and new companies coming on stream. So if you want leverage to rising prices, you might want to have ISL miners in your portfolio. But if you think prices are going to remain constant or drop, those deposits might not make economic sense; whereas, a really high-grade deposit of uranium is a lot more robust when you run the economics on them.
The other issue is where the deposit is. If it's in an area where there's infrastructure and a stable political jurisdiction, you've got the wind at your back vs. trying to build everything from scratch in a country where maybe they don't have very good mining laws or they might even want to expropriate your deposit.
So all of those factors are kind of swirling around and you have to look at all of them. A uranium deposit can be valued at anything from 10 or 20 cents per pound in the ground to over $10 a pound in the ground if the valuation is really based on the price of uranium, the deposit's stage of development, the grade of the deposit, the political risk, and all of these other factors. So there are a lot of different factors that come in to play.
And then the other question is: did the company raise money when they could; do they have enough money to survive for a couple of years? There are a lot of moving parts to determining the worth of a company. We were seeing some companies that were trading at their cash value that had enough money to explore for two years. I think those types of situations are fairly interesting, especially in the short term. You're getting the upside for free, basically.
TER: Well, the cash in the bank, though, really depends on your monthly burn rate.
JL: Exactly. So some companies are a little bit low on cash, but they're not drilling right now. That's a good point. But, ultimately, if they're not spending money, they're not generating news; and if they're not generating news, they're sort of dead in the water, so that's the other part. If they just have the cash to not do anything, they're kind of out of the running—they're less interesting because there's nothing that they can point to, no upside.
TER: Jim, you had a chart in your most recent newsletter that shows the world's major non-producing uranium deposits. Why you were focusing on the non-producing uranium deposits?
JL: These are assets in the ground. They're well-defined deposits, so you're not taking high exploration risk. And if the price of uranium does go up, the value of these could increase significantly, whereas, once you actually get into mining a deposit, you're at the whim of "are you meeting your targets?" Cameco Corp. (TSX:CCO) is a good example, where they're always having problems with flooding in their Saskatchewan mines. That raises a whole bunch of other issues. So these are nice assets and, if you find a good deposit and a good jurisdiction that's been delineated, those are nice assets to look at. The other reason is that I just found the chart handy—it showed where the deposits were and how much uranium they had. Then I just went and looked up the market caps of the companies that own the deposits, how many shares are out, how much cash they have—and that just added a little bit in terms of determining where there might be a good bargain to pick up.
TER: So, in essence, this chart was really proven, but not yet producing, deposits listed with the companies that own them, plus a little bit of background. As you went through these, which ones are standouts? Can you give us a couple of examples?
JL: Obviously, everyone looks at Cameco—we don't have a uranium index; but if Cameco isn't doing well, it's going to be hard for the junior companies to do very well. And then it came down to: where's the deposit located and what is the grade? A low-grade deposit isn't as interesting as a high-grade deposit. One company that keeps coming to the forefront is Hathor Exploration Ltd. (TSX.V:HAT) because they've got a very high-grade deposit that's still being expanded and it's in a good jurisdiction because there's infrastructure there. Cameco Corp. and AREVA (ARVCF:OTO) are right next door to them and are likely acquirers. It's the type of deposit that, if any company in the world is interested in uranium, that's the kind of company they're going to look at because it is one of the highest grades and one of the most exciting.
Out of all the exploration that's been done in Saskatchewan over the last two or three years during the uranium boom, the Rough Rider deposit looks like the one that's actually going to go somewhere. There are varying estimates of what they'll find, but they're already at a significant level. The jurisdiction's safe and it's around existing mines, so there should be fewer issues in getting that deposit up and running.
TER: Should an investor look at Hathor as a takeover candidate, or could Hathor just become a Cameco?
JL: No, they want to be taken over. They want Cameco to buy them at a nice high price. It's a different skill set for management to look for deposits and develop them vs. running a mine. It's a completely different skill set. And, actually, one of the companies that I like is UEX Corp. (TSX:UEX), which Cameco has a significant ownership position in. The UEX people like to explore and the Cameco people like to produce. They're great exploration geologists that are happy looking for uranium deposits, and Cameco likes to work with them as opposed to doing a lot of exploration themselves.
TER: So what deposits does UEX have that make it particularly interesting to you as an investor and Cameco as a partner?
JL: They were in the Athabasca Basin when nobody else was in the Athabasca Basin, and so they've got a series of fairly high-grade deposits—though nothing seems to be as exciting as what Hathor has found. But they're very solid deposits that are well defined and, again, just from a valuation standpoint, UEX had been a real high-flying company Its share price was over $9, and then it was 50 cents. So what's the fair valuation of that? Probably somewhere between the $9 level and the 50 cent level. The fact that it had a nice little bounce and touched $1.20 briefly and is now pulling back should give investors a sense of hope that these companies can at least get part way back up to where they were. I wouldn't expect them to get all the way back.
TER: Even halfway back is quite a significant increase.
JL: Halfway would be huge. The bottom line is these companies were oversold. I just saw money moving into the market over the Christmas holidays and I found that interesting because, when I first started writing my newsletter, I noticed something similar. A lot of money was moving into these little uranium stocks. Most of the time the actual commodity story is pretty consistent. We talk about supply and demand, and demand was coming from India and China, and nobody had built a new uranium mine in a very long time—you could do that for every commodity. The story's very similar. And it was a pretty good story.
That story everyone loved, and then everyone got scared and hated it, and there was tons of selling and it didn't really matter what you did. If you were a publicly traded company, you were taken out and shot. And now people are going, well, maybe there's something there. It's one thing to have a company with really marginal projects that spent a bunch of money and didn't really find anything. Some companies deserve to die, but others do deserve to be around in five years because they found something or they have something of value.
TER: One of the interesting things with uranium is clearly its use in nuclear facilities, power generation. And with the capital markets seized up (and not looking like they're going to open up any time soon), wouldn't the development of new nuclear facilities be delayed? And, if so, wouldn't that impact the demand?
JL: Definitely. Now you're talking about the medium-term terrified part. So in the short term—and when I say short term, I'm saying two to three months, four months at the most, the "sell in May" kind of model—uranium companies really oversold like the UEX example. It's $9, and over the course of the year it's 50 cents. Meanwhile, they've actually added reserves and they've got more uranium than they had a year ago. But then longer term, you're right. The global financial crisis is going to impact a lot of commodities, and the demand for them (including uranium) is no exception. So people looking for it have to try to take that into consideration.
Is China still going to go ahead and build all the reactors that they were going to build? We weren't expecting a lot of growth in North America for nuclear fuel simply because of the permitting processes. That was a 5- or 10-year process if you even wanted to build a nuclear facility; but China was going pretty gung ho on them. If they don't completely collapse, then maybe the uranium story is going to hold up quite well. Your point is extremely right on the money.
Does the economy slow down for one year, two years, five years? And, when we talk about the economy, are we talking about the U.S. only, or are we talking about the global economy? If we're talking about the global economy, I'm a little more optimistic, but the U.S. economy is definitely in trouble. We've never seen a crash like this. People make comparisons to the Depression, but this is different and it's somewhat indeterminable; so I like to take my clues from the market, use a bit of technical analysis. I wouldn't jump up and down and buy uranium companies if they went even lower because they might stay low for a long time. We're seeing a nice little bounce right now, and I think people can take advantage of it.
TER: So it sounds like you're saying, "Hey, this is good; all you investors invest in the short term. And, even though there are some underlying fundamental supply-demand issues, jump in—there's some good short-term returns. Then jump back out and wait and see what's going to happen."
JL: Nobody wants to be a long-term investor anymore, and I think we've seen some evidence that maybe that isn't the best way to go. It is not a safe time in the market places by any means. You can't buy anything and just walk away and expect it to be around in five years. We can paint longer-terms pictures, but I don't think anyone really knows what's going to happen over the next few years. There's a lot of uncertainty. So why not take advantage of what's in front of us, right? Take what the market gives us. I like to say there's always a bull market in something—and there always is a bull market in something—but that's all we can do. We can't expect the market to just miraculously recover in six months, and I think we have to be realistic about our expectations of what we can get out of the market.
TER: If the investment strategy is really more short term, we'll take advantage of some of this optimism that's being created by the Obama bump; but then we'll get ready to jump back out of the market. Is uranium really the only sector, or could we look at a broader number of sectors wherein we could use that same strategy?
JL: There are a broad number of sectors. There are base metals; a lot of the base metal companies have been crushed. Infrastructure has some potential, obviously, because Obama's said that that's where he wants to spend a lot of money. Potentially alternative energy, wind, solar—all of those things could see a short-term bump. But, again, I don't know if it's going to be sustainable over the longer term. If they keep going up, well, then we don't have to sell; but I'd just be mentally prepared. It would be a shame to lose the opportunity of the short term by becoming a buy- and-hold-investor and losing those gains into the summer.
TER: You're based in Calgary, where there are many oil and gas companies. You haven't mentioned them. What's your thinking there?
JL: The oil and gas business is a pretty stable business, but a lot of companies took risks on plays that were maybe economic at higher oil prices. Now, especially if they're public, they're running into challenges. The private companies are waiting for the public companies to collapse, so they can pick up their assets cheaply. It's always the game of attrition, so a lot of smart money is actually in private companies right now; and some of the public companies aren't going to survive. And those assets can be taken over by a better-capitalized company, and they could probably make a go of it. So it's a very dynamic market right now, but it's still optimistic. It sounds somewhat counter-intuitive, where people are hoping some companies go under, but the reason they're hoping that is because they know they can take those assets and turn them into something that's going to make them money.
TER: According to the "peak oil" concept, oil really should be back up to $80 a barrel. Why wouldn't oil and gas be a wonderful sector to invest in?
JL: You know, for the longer term, there is going to be a more sustainable recovery in oil just because we haven't come up with a replacement yet and we may have cut back consumption slightly. But there is depletion. There's a lot of technology out there that could extend production and create kind of a plateau, but, at the end of the day, we are going to see a lot of these fields decline. So, even though we're not spending as much money on exploration—Schlumberger just announced a 5% layoff globally and it's rumored to have increased to 10%—the combination of fields declining, less investment in drilling, and demand not falling off a cliff sort of points to a bullish case, again, for oil.
TER: But not short term.
JL: Again, the whole commodity sector was oversold. We'd expect some kind of rebound, but whether it's sustained and gets us back to where we were or goes sideways for a couple of years remains to be seen.
TER: So it sounds like even as some of the oversold stocks recover somewhat, we're going to be back to slim pickings again this summer.
JL: Potentially. For that kind of drop to magically fix itself and become a bull market again, that would be fast. It usually doesn't work like that. I think our optimism is likely to be crushed later in the year, and then maybe things get even cheaper. So that's the scary part, and that's why I'm short term bullish. There's a lot of opportunity out there right now. Medium term—no idea, terrified. It could get worse. And longer term, we will get through this somehow and there will be investment opportunities down the road. But there's a lot of uncertainty out there.
I graduated as a petroleum geologist in 1985 in Alberta. At that time, there wasn't a lot of work for a petroleum geologist and it was a very long, slow period. Then, just in the last four or five years, it really picked up. Normally, those cycles continue. This commodity cycle was prematurely interrupted by a lot of the financial problems around the globe.
And that's why I think that when we get the financial problems fixed, the strong companies in the commodity sector are going to do really well; but I don't have the expertise—and I think very few people do—to determine how long it is going to take for us to come out of this. It might not be six months; it might not be a year. It might be a lot longer than people think, and time will tell. But I would not want to throw an opinion out there because that's all it would be.
TER: Jim, this has been very insightful. Thank you very much.
Jim Letourneau, P.Geol. is a geologist, speaker, investment newsletter editor (Big Picture Speculator) and communications specialist living Calgary, Alberta. Jim frequently conducts property visits as part of his due diligence and he has toured mining and exploration projects in many parts of the world. He regularly meets with oil and gas executives in Calgary, Canada.
With the unique perspective of geologist and investor, his expertise is sought all over the world. Jim has served as an expert witness in front of the Canada's National Energy Board, and he's frequently quoted and interviewed in national media including CBC, CNBC, Resource World Magazine, Business in Calgary Magazine, The Korelin Economics Report, Market Matters Radio and HoweStreet.com.
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