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Gissen and Berol: Uranium Demand Outstrips Supply
Source: Tim McLaughlin and Karen Roche of The Energy Report (4/29/10)
Malcolm Gissen and Marshall Berol see uranium demand, and a corresponding price increase, continuing in the coming years as more nuclear power plants come online. In this exclusive interview with The Energy Report, Malcolm and Marshall talk about a wide range of opportunities in the energy sector.
Marshall Berol: In their database of over 16,000 funds, Encompass Fund was number five for 2009 and we were number one in the World Stock Fund category.
Malcolm Gissen: For the three-year period, the Encompass Fund ranked in the top 1% in the World Stock Fund category. The fund is about three-and-a-half years old.
TER: What did you see in the investment landscape last year that others apparently missed?
MG: I think it's a combination of things. We continued to emphasize resource companies and some healthcare companies, the sectors that we felt would perform well. The companies that we liked in those sectors did even better than the sector as a whole. For example, last year gold was up 24%. The gold companies that we liked, and also the silver companies for that matter, mostly doubled and tripled in value in 2009.
Early in 2009, Marshall and I discussed the fact that a number of these resource companies had been battered in 2008. We felt that they were performing well. They should not have declined in 2008 and they offered an even better opportunity. We had the courage of our convictions to add to our positions and to initiate new positions in some companies in these sectors. Our investors were well rewarded for our doing that.
TER: What do you think the difference was between 2008 and 2009?
MG: In 2008, a lot of hedge funds and other institutional investors had made money, as we had in prior years, by investing in resource companies, especially in the junior mining companies. We were pretty heavily invested in those areas in 2008. When the hedge funds and other institutional investors experienced significant redemptions and had to come up with cash to pay their outgoing investors, the first thing they sold tended to be the companies in which they had large gains. In many cases it was the resource companies that were sold.
In the case of the junior mining companies, those companies' stocks are thinly traded. So when these institutional vendors started simply dumping billions of shares of a thinly traded stock in the market, a lot of the junior mining companies fell 50% to 95% in value during the second half of 2008. Marshall and I started calling these companies saying, "We don't understand. You just discovered 5 million more ounces of gold and your stock is down 15% or 20% in two days. This makes no sense."
The companies told us they didn't know what was going on, but somebody was clearly selling a lot of shares. It wasn't until about October that these companies were in the East visiting with a number of the East Coast hedge funds, and learned that many institutions had simply dumped their stock in the marketplace. That had a very negative impact on these junior mining companies. It certainly hurt the Encompass Fund.
MB: At that time, it was not only the redemptions that the hedge funds were getting. The hedge funds were getting margin calls. Individual investors were getting margin calls. Individual investors and the professional investors were very nervous. They were shell shocked as the second half of 2008 and the beginning of 2009 wore on. There was tremendous amount of liquidation.
One of the larger gold companies such as a Newmont Mining Corp. (NYSE:NEM) or a Barrick (NYSE:ABX;TSX:ABX) could absorb these liquidations and not decline that much. However, the junior companies could not and they declined precipitously, as Malcolm has said. They went down 50% to 90%. That really hurt the Encompass Fund's performance in 2008, the only year in which the Fund suffered negative performance.
We went back and looked through the portfolio. We went through the companies we owned and assessed what the attributes were, pro and con, of those companies. We looked at their finances, their management, and their projects. Then we decided to eliminate a few of the companies that we felt weren't as strong, weren't as solid. We added to existing positions in companies that we felt were solid and the prices were mismatched to what the company represented. Then when the markets started to recover in March of 2009, a number of these companies went on to perform spectacularly for the balance of 2009 and into 2010. That's certainly contributes to the excellent performance of the fund, and what we think will continue to contribute to a positive performance going forward. Of course as we all know, and as the SEC requires us to say, past performance is no guarantee of future results.
Having said that, it is important to look at where a company has been and is and to try and determine where you think it's going to go as a company and as a stock investment in the future.
TER: Malcolm, you had an interview with TheStreet.com last year and you were quoted as saying, "Uranium is supposed to be the hottest commodity." It's about six months from when you made that comment. Uranium has gone down. Where do you expect it to return to, do you expect it to return to being a hot commodity?
MG: I don't like the concept of the "hot commodity" because that's not how we invest. The demand for uranium currently outstrips supply, in terms of the amount of uranium that is mined and the demand for it. I think the imbalance will continue. In fact, our analysis projects that this supply/demand imbalance will become more severe because there are several dozen nuclear power plants either being constructed or in the planning stage right now. Over the next five years, a number of them will come online, and they will start to demand uranium. The sources of uranium around the world are not ample. So there's going to be a need for more uranium within the next five years. Where you have an imbalance between supply and demand and the supply is not meeting demand, we know that prices will rise. So I believe that within the next few years we're going to see considerably higher uranium prices.
TER: In your interview with TheStreet.com, you commented that Uranium Energy Corp. (NYSE.A:UEC) in particular had a good chance to become America's top producer of uranium. Is that still a top pick for you?
MG: Yes. In November and December, 2008 we made very significant additions to our previous investment in UEC at under $.33 per share. The stock is now trading above $3. UEC is likely to become the next American producer of uranium. Their facilities in Texas have gotten the permits necessary for them to get into production before the end of the year. It's anticipated that will happen. Last year they bought a facility where they can process the uranium. So we believe that it's likely before the end of the year that they will become a producer. We like the company's management and the experience they have in getting into production at reasonable costs. The stock more than tripled last year. It was the largest position in our mutual fund until recently and is one of the largest positions in our separate accounts. We continue to think it will do very well over the next two years.
MB: It has been the largest individual position in the fund for some time. It's an example of where the equities don't necessarily track the commodity price on the upside or the downside.
As Malcolm mentioned, over the past year to 15 months, Uranium Energy Corporation stock has more than tripled, while the price of the uranium commodity has declined somewhat in the spot market. It's certainly the type of situation that your readers are familiar with. Gold, or silver, or stocks, for example, can move higher and quicker than the commodities or vice versa.
We feel that over the longer term, the stocks of the junior companies in particular will give you more advantageous exposure to those industries and those commodities than investing in the commodity itself.
TER: With UEC, their price has been increasing significantly while prices in uranium have declined. To what do you attribute their success?
MG: Investors are looking ahead and realizing that this company has a very bright future. They're expanding their resource. They're getting into production. They have terrific management. They have a good number of very experienced people who have gotten other uranium mines into production and they're well positioned. They have other resources besides the Texas resources. People are looking for what's likely to happen to UEC over the next few years.
MB: They also made a very advantageous acquisition in the second half of 2009. It provided them a fully permitted plant that's ready to operate, as well as additional projects. The market has recognized that and the stock price has gone up.
TER: From an investment standpoint, how do you compare major uranium companies such as Cameco Corp. (NYSE:CCJ;TSX:CCO) and BHP Billiton Ltd. (NYSE.A:BHP;ASX:BHP;LSE:BLT) to the junior producers or explorers?
MG: Well, with the juniors, and particularly with the exploration companies, there's a lot more risk. You don't know whether the exploration will be successful. You don't know when they're going to get into production. You don't know if they're capable of raising the funds they need to continue exploring or to get into production. With a Cameco, it is producing and is in fact the world's largest producer of uranium with the world's largest uranium mine. They have very nice facilities. They've run into problems, of course. You get a sense of comfort in knowing that the company is already in production and realizing significant cash flow, they have very experienced management, and they are the dominant company in this industry.
TER: Is there more upside potential to the junior companies?
MB: From a price appreciation standpoint, yes. It's that way regardless of whether you're looking at uranium, gold, silver, copper, moly or whatever. There is more potential reward in a junior company. There is more risk in a junior company. If you look back at a Cameco and what it has done pricewise over the last year, or two or three years, versus a Uranium Energy Corp., or another midsize or smaller company, I'm reasonably confident that most of these smaller companies have outperformed. It would be the same in gold with Exeter Resource Corp. (NYSE.A:XRA;TSX:XRC; Fkft:EXB), which is not in production and won't be for some period of time; versus a Barrick or a Newmont or a Kinross Gold Corp. (TSX:K;NYSE:KGC). It's the same thing with a Freeport McMoRan Copper & Gold Inc. (NYSE:FCX), which is in copper and gold versus a junior gold company or a junior copper company.
Like with the pharmaceutical industry, a major drug company such as a Merck (NYSE:MRK) or a Lilly (NYSE:LLY) or a Pfizer (NYSE:PFE) is not going to have the stock price movement that a smaller research and development biotech company has on the upside, nor would they go down as much. That's where the reward is with a junior company and is the reason why we generally prefer investing in junior companies, rather than larger mining companies.
TER: In addition to UEC, are there some other uranium companies that you think are good investment opportunities?
MB: There are. We're invested in a company that is involved in both uranium and gold. That's Fronteer Development Group Inc. (NYSE.A:FRG;TSX:FRG) which has some significant gold projects. They're exploring and drilling in Nevada. Also, it has a very significant uranium deposit in Labrador. There is activity going on in the uranium component of the company but it's been somewhat slowed down because the local government declared a moratorium on mining going into production. They have not declared a moratorium on drilling and exploration. So Fronteer has continued with that, but for a while, it certainly had a negative effect on the company's stock.
A company that we have been in before, but we're not currently in, is Paladin Energy Ltd. (ASX:PDN;TSX:PDN), which is in production of uranium in Namibia and soon in Malawi in Africa. We continue to review the company and its progress. It's had some operational difficulties and we haven't gotten comfortable enough to reinvest in it, but it's a uranium producer that we certainly are keeping an eye on.
BHP is an excellent company. We do not own it in the fund. We do own it in individual client accounts. BHP is a very broad-based commodities company. They produce a wide variety of commodities that they mine worldwide, not the least of which is uranium.
TER: Marshall, I know that you've looked at alternative energy opportunities, but as of last year you felt that the sector was still some distance away. What's your perspective now on that?
MB: Our general perspective is that it hasn't changed in that context. From an investment standpoint, there are certainly companies that are making progress in expanding their operations in alternative energy, primarily solar and wind.
In the fund, we have a small position in a Chinese company, JA Solar Holdings Co., Ltd. (NASDAQ:JASO), which manufactures components for solar systems. But it's a difficult space because of the amount of competition. As production manufacturing has increased, prices have come down due to competition, and it's been difficult for the companies to make a good amount of profits. We continue to look at the solar industry and various aspects of the solar industry, but it's just not a compelling investment situation for us.
It's the same with wind energy. There are some companies that are involved in the manufacture of wind turbines or the operation of them. For the most part they're smaller companies. If they're not smaller companies it's just a small part of a large company such as General Electric (NYSE:GE). You have a whole set of other factors involved as to whether you want to be invested there or not. We continue to look at it.
We look at geothermal, which is an interesting industry and interesting business. There are a number of companies involved in it. However, it has been difficult technologically, and from a capital structure standpoint to develop some of these companies, and to have the confidence in them that we like to have before investing in them. But we certainly continue to look at them.
Hydroelectric is not so much thought of as alternative energy, but it certainly is. The Encompass Fund is invested in Calpine Corp. (NYSE:CPN), which is primarily known for producing electricity with natural gas. It is also the largest hydroelectric producer in the United States with the Geysers Project in Sonoma County, California and some other projects. Again there is not a lot of opportunity on a standalone basis to invest in hydroelectric operations.
TER: How about in the conventional energy space?
MB: We continue to be positive on coal exploration and production. We own several companies in the Encompass Fund that are involved in coal. Peabody Energy Corp. (NYSE:BTU), a very large, well-known company, is in the fund.
The fund also has investments in three smaller companies, each of which have some unique characteristics. One is L&L Energy (NASDAQ:LLEN). It's a U.S. company that has acquired coal mining and processing and washing operations in China. L&L has been doing acquisitions and consolidations, and has grown extremely successfully, from a company standpoint and from a stock results standpoint. The stock has had a substantial increase in price over the past year and has produced a five-times return for the Encompass Fund in 10 months. We're not necessarily convinced that now is the time to be investing in it, but on the other hand we haven't sold any shares. It has a very good business plan of acquiring newer coal companies in China and consolidating them. They're bringing western safety and western environmental practices and procedures to the coal industry in China and it's working very well.
Another substantial position in the Encompass Fund is SouthGobi Energy Resources Ltd. (TSX:SGQ). SouthGobi is a Canadian company that is operating in Mongolia. It is currently mining coal in Mongolia, 20 miles from the Chinese border. It is operating 24/7. It loads trucks around the clock at the mine, trucking the coal 20 miles to a railhead on the Chinese border. The coal is then utilized by Chinese companies. SouthGobi has done very well. It continues to do well. It received a major investment earlier this year by one of the Chinese sovereign wealth funds. It's a company that has done very well and we believe will continue to do very well.
A fourth company that the fund owns in the coal industry is Western Coal Corp. (TSX:WTN), which is a company that's operating coal mines in Canada. So we think there continues to be a major future for coal. It certainly has environmental issues. It has safety issues, as unfortunately we've seen both in China and the United States recently. Chinese electricity production is 70% coal-generated. U.S. electricity production is 50% coal-generated. We don't see any significant change in that for a good long period of time to come. Coal is going to be used and needed.
TER: Marshall, in our last interview, you pointed out that natural gas was way off its high of $15, and out of line with the historic relationship between natural gas and oil pricing. You felt it was undervalued at that point, and noted that "very few people have much good to say about natural gas and that causes us to look closer at that kind of situation." Have you found any natural gas investment opportunities after further scrutiny?
MB: I would say that those comments that you quoted are still the case, probably each of those in spades. The spread between oil, let's say at $85 a barrel, and gas say at $4 per MCF is over 20-to-1. Energy content of a barrel or oil and an mcf of natural gas is a six-to-one ratio. Historically it's been maybe a 10-to-1 ratio from a stock market standpoint and it's currently 20-to-1. Currently there are probably even fewer people that have anything positive to say about natural gas than was the case when we last spoke. This creates opportunities, but we have been very cautious about taking advantage of any of them because we just haven't seen any indication that gas prices have hit a bottom.
As value investors, which we are at heart, we're also contrarians. But it's often said that value investors can be too early and that is the case. We continue to have discussions among ourselves here in the firm as to whether it's timely or not. The bottom line conclusion we come to is it's still too early. We don't know when that will change. We're confident that it will change. We just don't know what the timing is. Natural gas is in oversupply. The technology that has led to horizontal drilling has led to the development of shale properties and an increased production of natural gas. Natural gas production has far exceeded what the analysts or the companies expected. It's far exceeded the demand and therefore natural gas prices are extremely low. It's still early, in our view, to be investing in natural gas situations.
Having said that, ExxonMobil (NYSE:XOM) and others are investing in natural gas situations by virtue of buying companies or buying into some of the large natural gas producers in this country. They feel it's timely. Whether it's timely or not we'll be seeing over the coming months and years.
TER: Marshall and Malcolm, you have been very generous with your time today and we really appreciate it.
Malcolm Gissen founded Malcolm H. Gissen & Associates Inc., an investment advisory services firm, in 1985. He has been an investment advisor since 1985 and has managed separate accounts since 1999. Mr. Gissen's management experience has focused primarily on investments in publicly traded companies, including real estate investment trusts. Mr. Gissen received a B.S. degree from Case Western Reserve University and a J.D. degree from the University of Wisconsin. Marshall Berol has been engaged since 1982 as an investment manager in San Francisco, CA. Since 2000, he has been the Chief Investment Officer of Malcolm H. Gissen & Associates, Inc. In addition, for more than 15 years, Mr. Berol has owned his own investment firm, BL/SH Financial. Mr. Berol's investment management experience has focused primarily on investments in publicly traded companies. Mr. Berol did his undergraduate work at the University of California (Berkeley) and received a J.D. degree from the University of San Francisco School of Law. He was in the private practice of law in San Francisco before entering investment management.
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1) Tim McLaughlin of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report or The Gold Report: Exeter Resources Inc.
3) Marshal Berol: I personally and/or my family own shares of the following companies mentioned in this interview: Encompass Fund, Exeter Resource Corp., Freeport McMoran, Uranium Energy Corp., Fronteer Development, Calpine and L&L Energy. I personally and/or my family are paid by the following companies: None.
Malcolm Gissen: I personally and/or my family own shares of the following companies mentioned in this interview: Encompass Fund, Exeter Resource Corp., Freeport McMoran, Uranium Energy Corp. Fronteer Development, Calpine, South Gobi and L&L Energy. I personally and/or my family are paid by the following companies: None.