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Siddharth Rajeev's Commodities Rundown—Au to V
Source: Brian Sylvester of The Gold Report (3/7/11)
There is more to the periodic table—and to investing opportunities—than gold, silver and copper. Siddharth Rajeev, vice president and head of research at Fundamental Research Corp., sums up the market prospects for rare earth elements and a host of metals. He unearths some new names and some historical finds in this exclusive interview with The Gold Report.
The Gold Report: Sid, today we're going to talk about a number of different metals: gold, silver, vanadium, copper and rare earths. Could you handicap each of those metals for us, starting with gold, copper and silver?
Siddharth Rajeev: Let's look first at the factors that have been driving up commodity prices. We think two key factors are responsible. Number one is increasing global demand; the second is the continued weakness in the U.S. dollar.
Let's look at increasing global demand. We believe in the Brazil, Russia, India and China (BRIC) story and we expect continued growth from those countries. We believe that the U.S. economy will continue to see a gradual recovery. So, we expect increasing demand from the U.S. and continued demand growth from the BRIC countries to keep the demand side strong. Thus, the first factor looks good for the commodities market.
However, we expect the second factor, which is the U.S. dollar, to gradually improve with respect to other currencies as the U.S. economy improves. That should have a negative impact on the commodities market.
So, we expect to see some sort of correction this year. For example, copper is at $4.45/lb. We do not think these prices are sustainable in the long term and therefore we expect to see some kind of correction.
In terms of gold, we believe that as the U.S. economy recovers and the U.S. dollar strengthens, investors would move away from safe-haven assets such as gold and put their money where it could achieve higher returns. So, over the long term we expect the gold price to soften. But, in the near term, uncertainty regarding the U.S. and European economies and inflationary scares should give us high gold prices.
As to copper, we don't think it's sustainable at such prices over the long term. Even though demand looks very strong, we expect prices to drop with the gradual recovery in the U.S dollar.
Silver is unique as it behaves like a capital preservation asset, such as gold, as well as like a commodity due to its industrial applications. The uncertainty in the U.S. and Europe and inflationary pressures, combined with continued demand growth from Asia and the BRIC countries, are some of the reasons we think silver has been one of the best movers recently.
Although we think silver should soften in the long term, we think that silver should stay strong in the near term due to the same reasons as gold. In our valuation models, we use a long-term (2014+) price of US$18.35/oz.
TGR: What price are you using for gold price?
SR: We use a long-term gold price of US$1,000/oz.
TGR: What can you tell us about vanadium and rare earths?
SR: Unlike other commodities, vanadium prices have not been as volatile in the last 18 months. They've stayed around $7/lb. for over a year. Over the long term we have a good outlook on the commodity. We believe strong growth in steel consumption, especially from China and India, will be the key demand drivers. Steel accounts for 90% of vanadium demand; so vanadium demand is highly correlated to the steel segment.
The use of vanadium in battery and renewable energy storage devices is expected to drive the demand up. Vanadium supply is expected to remain quite stable from the three major producing countries—China, Russia and South Africa. We think the demand side should keep prices high.
The main factor driving up rare earth prices is the supply side. China accounts for 97% of all production, and has been cutting down significantly on its rare earth exports. China also has been increasing the demand for rare earths. The U.S. currently imports nearly 100% of its rare earths consumption. We are bullish on REE prices primarily because of the concentrated supply conditions.
TGR: So, the more obscure you get, the better the outlook. There seems to be a bit of a contradiction in that you see softening prices for copper, but strengthening prices for vanadium. Both of those metals have the same sort of investment thesis. Why are you bullish on one and not so bullish on the other?
SR: That's because copper has moved up by 40%–50% in the last 12 months, while vanadium has stayed pretty constant. For the last 12 months vanadium has been around $7/lb. It has not really moved up, while copper has moved up significantly. So we think copper will have a higher price correction.
TGR: What would have to happen in the Middle East before you would be willing to be bullish on the gold price?
SR: Obviously the turmoil in the Middle East is positive to commodities such as gold and oil. But, we think those factors are short-term catalysts. Over the long term, we do not think these incidents should play a role. Historically, all of these geopolitical tensions around the world cause sudden and short-term spikes in prices. They've not really had an impact over the long term.
TGR: In the 1970s there was an oil crisis that lasted about five years that paralleled a run in the gold price. Five years is pretty long term.
SR: High oil prices typically result in high inflation and high gold price. So if the problems in the Middle East somehow impact long-term oil supply, we will see high gold prices for a prolonged duration. We have not seen anything so far in the Middle East that brings up concerns over the long-term supply of oil.
TGR: The other thing to consider is that if a company looks good at $1,000/oz., it will look very good at any price above that.
TGR: Quite a few of the small cap companies in your coverage universe are exploring for gold. Many of them have never appeared in The Gold Report. Could you give us a few under-the-radar names that our readers should know about?
SR: I will name three companies today that we really like. I'll start with Rio Alto Mining Limited (TSX.V:RIO; BVL:RIO; OTCQX:RIOAF). It has an advanced-stage project. We picked them up for coverage in January 2010, when they were at $0.46. Today, its price is over $2.40. The main deposit is the La Arena Deposit, which has over a million ounces of gold in oxide. The company also has a copper gold sulphide resource (adjacent to the oxides), which has close to 2.9 billion pounds of copper and over 3 million ounces (3 Moz.) of gold. The company plans to put the oxide into production in Q211. Construction commenced in August 2010. The sulphide should go into production in the next three to four years. The company has an extremely strong management team. They recently raised close to $58 million in equity financing.
TGR: One noteworthy thing about La Arena is that it's not too far from Barrick Gold Corporation's (TSX:ABX; NYSE:ABX) Lagunas Norte project. Do you see Rio Alto as a possible takeover target?
SR: Yes, especially these days when investors and majors are more interested in higher quality assets because of the volatility in commodity prices. Investors and majors are looking for more advanced, quality projects. We believe Rio Alto fits into that category. We cover about 150 small- to mid-cap companies, and we think Rio has one of the best deposits in our coverage.
TGR: And your second gold name?
SR: Evolving Gold Corp. (TSX.V:EVG; Fkft:EV7) has made a huge discovery at its Rattlesnake Hills Gold Project in Wyoming. The company also has the Carlin project in Nevada. They have done aggressive drilling in the last couple of years and the results have been extremely impressive. Evolving Gold doesn't have an NI 43-101 resource estimate, but we came up with an internal resource estimate. We think the project should have at least 1.5 Moz. gold. This company also has a strong management team and a strong cash position. In July 2010, Goldcorp Inc. (TSX:G; NYSE:GG) invested $15 million in Evolving Gold, which is a huge vote of confidence for investors.
TGR: What's the next stage for Evolving? Could we see a preliminary economic assessment (PEA) in the near term?
SR: I think the next step is a NI 43-101- compliant resource estimate.
TGR: When can we expect that?
SR: We would like to see it sometime this year.
TGR: And your guesstimate was 1.5 Moz. But, you tend to be on the conservative side.
SR: Right. For valuation purposes we're slightly on the conservative side. Our fair value on Evolving is $1.40 per share. We have a BUY (Risk 5: Speculative) rating.
TGR: And your third gold name?
SR: This is a slightly different company from the previous two I mentioned. The company is called 49 North Resources Inc. (TSX.V:FNR). It's a resource investment company based out of Saskatchewan. It is Saskatchewan's first publicly traded resource investment company, with close to $65 million in assets under management. It invests in early stage resource projects, including minerals, oil and gas. Right now, the majority of the investments are in oil and gas and precious metals.
We think this company offers investors a very good opportunity to hold a diverse portfolio of assets in different sectors, different regions. Investors also get the opportunity to participate in the upside potential of private company investments. FNR shares are currently trading at a 30% discount to the NAV (net asset value). We will be initiating coverage on this company shortly.
TGR: It's quite a diverse group of assets that 49 holds: coal, diamonds, uranium, base metals, a little bit of gold. What are your thoughts on that business model? It is a bit unusual.
SR: Yes. For example, the company owns 150 to 200 stocks in its portfolio, but the top 15 of its holdings account for over 60% of its NAV. We think it's a very good business model, especially because the CEO and President Tom MacNeill has a lot of experience and is well known in the industry.
One of its best success stories so far include its investment in Athabasca Potash, which was later acquired by BHP Billiton Ltd. (NYSE:BHP; OTCPK:BHPLF). FNR made a 611% gain in that investment.
Basically, this model offers investors an opportunity to get exposure to the upside of the junior resource market with lower risk due to the fact that the company holds a diverse portfolio. We think the return/risk ratio is higher for this kind of model.
TGR: Let's move on to silver. Silver outperformed gold in 2010 on a percentage basis and is off to a very good start in 2011. Although you see some softness in silver, what are some silver names that our readers might be interested in?
SR: We cover two very good silver stories right now. One is an advanced stage company called SilverCrest Mines Inc. (TSX.V:SVL). In September, the company announced the first gold and silver pour at the Santa Elena Project in Mexico. We expect commercial production to be announced this quarter. SVL expects annual production of 35,000 oz of gold and 0.6 Moz. of silver. This is an open-pit, heap-leach operation. The company plans to expand operations to over 100,000 ozs. in the next couple of years. Again, this company has a strong management team; something which is important for any junior. Our fair value for SilverCrest is $2.84 per share.
TGR: What's the second silver name?
SR: It is a relatively under-followed, under-explored company called Thunder Mountain Gold Inc. (TSX.V:THM, OTCBB:THMG). Its key property is the South Mountain Project in Idaho. It's a past-producing mine. It currently has a resource of 3.4 million tons (Mts.) of indicated and inferred resource. It's a polymetallic deposit, in which the primary metal is silver. The deposit is open at depth and along strike. The company is also developing a new gold target close to the historic mine which we think should add more resources. It's working on a PEA and an updated resource estimate.
Our fair value on the stock is $0.70 and it's trading at $0.25 per share. To value the stock we looked at the average enterprise value to resource ratio of its peers. Thunder Mountain is trading at $0.47/silver oz., while the peer average ratio is $1.34. We think that it's undervalued at this price.
TGR: That's precisely the kind of name we're looking for. Now let's move on to rare earths. Their price appreciation was dramatic in 2010. What are some companies with REE projects that could show some promise in 2011?
SR: We cover a lot of companies in the rare earth segment. I will talk about three of our top companies, starting with Commerce Resources Corp. (TSX.V:CCE; Fkft:D7H; OTCQX:CMRZF). It's focusing on its Blue River Project in British Columbia, which is an advanced stage project. Then it has an early-stage exploration project in Eldor, Quebec, where it's done some aggressive drilling and is getting very impressive results. Based on the results at Eldor we believe that the continuity, depth and thickness of the mineralization are positive signs for a near-surface REE deposit. The company announced an updated resource estimate at Blue River in February, with significant increases in tonnage and tantalum oxide and niobium oxide content.
REE prices have gone up significantly. Let's look at tantalum. Its price moved up by 42% in the last four months, from $120/lb. to $171/lb. We continue to believe that demand for tantalum, which is used in electronic products, will increase. The supply side is very concentrated. For example, Australia and Brazil alone account for 50% of the production. The concentrated supply and increasing demand, and lack of production in the U.S. shows the importance of advanced stage tantalum explorers like Commerce.
Our fair value on Commerce Resources' stock is $1.51 per share. Right now, I think it's trading at around $1.00. To get that valuation, we used long-term tantalum price of $120/lb.; the current price is $171/lb. For niobium, which is used in making steel, we used $15/lb.; the current price is $23/lb. Even based on our conservative price forecast, we think it has an economic deposit at Blue River.
TGR: Any other REE names?
SR: Another name is Quantum Rare Earth Developments Corp. (TSX.V:QRE; FSE:BR3; OTCQX:QREDF). It's developing the Elk Creek carbonatite complex in the U.S. It has had historic exploration. The historical resource is 39 Mts. of 0.82% niobium oxide. According to the U.S. Geological Survey, this property may hold one of the world's largest resources of niobium and REE. A few months ago, the company raised close to $6.5 million. Our valuation on the stock is $0.85 per share, and it is trading at $0.53.
TGR: What do you think of Quantum's CEO Peter Dickie?
SR: We've been following Peter Dickie and his associates for several years. They've been involved in some good projects in the past. We believe Quantum has a good management team.
TGR: Can you give us one more name?
SR: In the rare earth segment is a lithium company called Rock Tech Lithium (TSX.V:RCK; Fkft:RJIA). It's exploring for lithium and rare metals in Ontario and Quebec. The main project is its 100%-owned Georgia Lake Project, which has historic resources of 9.8 Mts. with grades of 1.18% lithium oxide (Li2O). The company is conducting a 4,000-meter drilling program that should be completed in the first week of March. The company expects a NI 43-101 resource by mid-2011.
TGR: It's hit high-grade spodumene there. And you can get lithium out of spodumene, correct?
SR: Yes, that's right.
TGR: In terms of other similar deposits around the world, is the Georgia Lake project similar grade, higher grade, lower grade?
SR: I would say the grades are good..
TGR: What's your fair value on Rock Tech?
SR: We are currently updating our valuation on the company.
TGR: Do you cover any vanadium plays?
SR: There's a company called Apella Resources Inc. (TSX.V:APA; Fkft:NWN), based out of Vancouver. It's exploring for vanadium and titanium in central Quebec. Its Iron-T property has a resource of 11.6 Mts. inferred and 0.73% vanadium oxide equivalent.
But this resource estimate covers only a small portion of the known mineral-bearing complex. We feel that the company can significantly increase the resource outside of the current resource area. We valued the stock by looking at similar stage vanadium projects. The average ratio of enterprise value to vanadium resource is around $0.06/lb. We used that multiple to value Apella's projects. Our fair value on APA is $0.65. The shares are currently trading at $0.21.
TGR: To close, what do you see happening, on a macro level, over the next year or so?
SR: Overall, we expect to see some sort of correction in the commodities market with the gradual recovery in the U.S. dollar. Precious metals should stay relatively strong in the near term due to the continued uncertainties in the U.S. and Europe and inflationary pressures.
For investors at this point, because of the uncertainty in the markets and the volatility in commodity prices, the main strategy should be to look for companies with quality advanced stage assets.
TGR: Sid, thanks for your time.
Siddharth Rajeev joined Fundamental Research Corp. in April 2006. At FRC, he oversees the research department, and also covers a broad array of companies, primarily in the energy, mining, and technology sectors. Prior to FRC, he has had a mix of engineering and finance experience including corporate finance experience at a leading Investment Bank in Kuwait. Sid has ranked as a four-star analyst in the energy and mining sectors by Deutsche Asset Management, a division of Deutsche Bank.
Sid holds a bachelor of technology degree in electronics engineering from Cochin University of Science & Technology, and an MBA in finance from The University of British Columbia. He is a CFA Charterholder, and has completed studies in exploration and prospecting at the British Columbia Institute of Technology. Sid is sought by the media for commentary on the valuation of small cap stocks and industries he covers, and is a speaker at various investment conferences.
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1) Brian Sylvester of The Gold 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 Gold Report: 49 North, Commerce, Evolving, Goldcorp, Rio Alto and Silvercrest.
3) Siddharth Rajeev: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. FRC provides fee-based coverage on some of the companies mentioned in this article.