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Dr. Paul Zweng: Nano Caps Offer Outsize Returns, Risk
Source: Brian Sylvester of The Gold Report (9/14/11)
Dr. Paul Zweng, a portfolio manager with Resource Venture Advisors in Beverly Hills, Calif., has managed to make some big things happen with small companies. By investing in the tiniest of resource companies, he has grown the fund exponentially. In this exclusive interview with The Gold Report, Zweng tells why his biggest asset is his cast-iron stomach.
Paul Zweng: We invest in companies with market caps from less than $10M up to $75M for two principal reasons: These companies have the greatest potential for outsize performance. You can literally generate 10x returns with these tiny companies. Second, it is a niche where we can be competitive.
I am not bold enough to say that I can see things in Newmont Mining Corp. (NEM:NYSE) or Barrick Gold Corp. (ABX:TSX; ABX:NYSE) that the other 35 sell-side analysts out there haven't already evaluated. We can be competitive with these underfollowed companies that have little to no research because we understand geology and exploration. That's what my background is in.
I've been in exploration for a long time. And I've actually run/co-founded Canadian juniors with successful outcomes (e.g., QGX and Antares). We wanted to follow the companies that the multiple-discriminant analysts, the certified financial analysts and the sell-side analysts are largely ignoring because if we can find a good one, two or three here—we typically have about 10 companies in our portfolio at any one time—and if they execute on the so-called promise, then there's the chance for outsize performance.
TGR: Are the companies in this space more risky than small caps?
PZ: Yes. Most people would consider a small cap to have above $1 billion (B) in market cap. In the Canadian juniors sector, by the time a company is at $1B, it has an NI 43-101 and proven ounces or pounds in the ground. It is producing metal, generating revenues, profits, etc.
Even once a company gets above a $100M market cap, it generally has an NI 43-101. That takes a whole lot of risk out of the investment. But does that mean that you are home free? There is a lot to be said regarding the so-called quality of those ounces of gold or silver, or those pounds of copper, lead and zinc, or those tons of coal or iron ore. Those are different considerations than when you are investing in a little $10M or $20M market-cap company that literally has nothing but a good management team and some good prospects.
There is a considerable amount of risk and that is why you really need to understand the geology, the prospectivity and the management team. Are these people who can husband their money and their resources carefully? If they can't, you're probably going to be in for a bad investment.
TGR: Your master's thesis focused on porphyry-copper deposits in Peru. Do you have a greater comfort level investing in micro caps with porphyry copper and porphyry copper-gold deposits?
PZ: By studying the Toquepala deposit as well as working in the industry at both a mine and in exploration of porphyry copper, I feel very comfortable there. That is the theme of our fund. We try to invest in those types of deposits and those commodities in which we have actual, direct experience. We have direct industry experience working with gold, silver, porphyry-copper and sediment-hosted copper.
For example, Hana Mining Ltd. (HMG:TSX.V) was one of our early investments. When I was at BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK), I used to run new business development for the copper belt, which contains these sediment-hosted copper deposits like what Hana Mining has.
TGR: You were also the chief operating officer of QGX Ltd. (QGX:TSX) and eventually became the president and chief executive officer. You were also involved with Antares Minerals Inc. (ANM:TSX.V). QGX's biggest project was a coal deposit in Mongolia and that was taken over. Antares—you sold at the absolute right time there—was bought by First Quantum Minerals Ltd. (FM:TSX).
You certainly have had experience on both sides—exploring for these deposits and then turning around and selling them. What are you looking for when you research a project based on that experience?
PZ: We are looking for juniors that can take a piece of ground, drill it and develop it—and then continue to derisk the project by doing metallurgical studies and preliminary economic assessments. We want to focus on those companies that can develop large deposits and be taken over.
We are less interested in vein deposits. If you look at most gold majors, I do not think they are mining vein deposits. We are looking for large-scale, open-pit, low-grade deposits. That is also what large-cap copper producers like Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) and Antofagasta PLC (ANTO:LSE) want.
In coal, we are also looking for large, open-pit and, preferably, metallurgical coal deposits. That is where you have the potential to make that 10x return.
TGR: There has been a lot of volatility in the markets recently and the U.S. economy looks like it could be headed back into another recession. How are you managing your fund differently compared to the beginning of the year?
PZ: Probably 90% of your audience will disagree with what I am about to say, but this is really a tenet of our fund: We just ignore the macro picture. What is special about our fund is that we focus on the nano caps. These are companies that I jokingly say have two mules, a rock hammer and a pair of worn-out boots for assets. If a company drills a hole that delivers 200 meters of one-gram gold, I don't care if the price of gold drops $25/ounce (oz.) the day it comes out with that press release, this company's stock is likely to go up 10%, if not 20%. Where we invest, we are able to literally ignore the macro picture and that is a great comfort. If the price of gold goes down, but a company continues to build ounces, we are going to do just fine.
TGR: You're on the board of two of your fund's holdings: Goldgroup Mining Inc. (GGA:TSX) and Bellhaven Copper and Gold Inc. (BHV:TSX.V:). In fact, you are the interim CEO of Bellhaven.
PZ: I'm going to give you the real crux: Goldgroup has 121M shares issued and outstanding and is currently trading for $1.64. That is a market cap of about $190M, but we bought in when it had about a $75M market cap. At that time, it was the largest company we bought for our portfolio. It has a wonderful management team that is driven by Keith Piggott and Gregg Sedun—experienced people, highly motivated, and smart. It has three principal projects, but I zeroed in on one in my research even though the other two are wonderful deposits. I focused on Caballo Blanco, which I think could be producing 100,000 ounces of gold annually in a little over a year at $200/oz. It will be able to do that because it is an outcropping ore body. It is all oxide. It will be a low-cost, heap-leach, run-of-mine operation.
But let's say I am wrong and it produces at $500/oz. That creates a margin of $1,300/oz. if gold is getting $1,800/oz. Multiply that by 100,000 ounces then that creates $130M of EBITDA. Just that one project would support a $1.3B market cap. Also, what is great about this story is that the company actually has $40M in the bank. The capital expenditure number is probably going to be somewhere in the range of at least $40M, but less than $65M. It has two-thirds of the money it needs to build the mines. Maybe there will be a small financing to get the other part, but then it is going to be in position to support a market cap of $1.3B based on just that one project. I love this story.
TGR: Are there any byproduct credits in the ore?
PZ: No, it is really only gold. It is the right kind of deposit. The company will be coming out with a new NI 43-101 in November. It has an NI 43-101 now, but it will be growing to a level that will support 100,000 oz. or more. There is little to no geologic risk here. There is no exploration risk. This is just a known miner and mine builder in a good place to be doing mining. The deposit is in a part of Mexico, Vera Cruz, that doesn't have drug violence. It is a good place to be operating with infrastructure and trained labor. I see this as very low risk and high reward.
TGR: And what about Bellhaven, where you are serving as interim CEO?
PZ: Bellhaven is a completely different story. It is a much earlier-stage company that we got into when it had about a $10M market cap. The short and skinny is that it has 84.4M shares issued and outstanding, is trading at about $0.58 per share, has about a $41M market cap and about $3.2M in cash.
The prospect is called La Mina, located in Colombia. It is porphyry gold. Bellhaven's principal prospect at La Mina is called La Cantera, and Bellhaven will soon be announcing an NI 43-101 resource there. We are hoping it is going to be about 1 million ounces (Moz.) of gold. The enterprise value—Bellhaven has no debt—is essentially its market cap. So, if it has 1 Moz., its $40M market cap is undervalued. According to Canaccord's "Junior Mining Weekly" report, a company with 1 Moz of gold equivalent would be worth $117M on average. And that is zeroing out all the other prospects at La Mina, and all the other prospects it has in Colombia and Panama. I think Bellhaven should go from $40M up to $117M. That is a multiple of three, with everything else in the company thrown in for free. We love that story.
I am the interim CEO at Bellhaven, and it is one of the largest positions in the fund. Everybody should be aware that I'm "speaking my book," as I am with Goldgroup.
TGR: In 2006, AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE) and Bema Gold Corp. (acquired by Kinross Gold Corp. (K:TSX; KGC:NYSE) in 2007) drilled Bellhaven and found some gold on the property that they just left alone. Why would they just walk away from a project like that?
PZ: They drilled six holes at La Cantera, but one in three were complete misses. I have had a number of discussions with AngloGold geologists and this is what I've learned: Anglo had phenomenal success in Colombia. It came in when everybody was still afraid of narco-terrorism and ended up with an enormous land position. It found the La Colosa project, which is in the same belt as the La Mina. La Colosa has been a fabulous deposit. It publicly announced something like 10 Moz. Word on the street is it's going to be up to maybe 20 Moz. or more.
But for whatever reason—this was back when gold was at a much lower level than where it is today—the board said, "Look, we have to cut back. We're not going to give you more and more money." The exploration staff was stuck in this quandary where it could not stop at La Colosa, but it didn't know how to fund all these other prospects. The solution was to bring in Bema Gold on a joint venture.
What you will find is that most of the projects that the small Canadian juniors have, and this would include Bellhaven, Batero Gold Corp. (BAT:TSX.V) and Seafield Resources Ltd. (SFF:TSX.V:), used to be held by Anglo. Anglo dropped the property so it could focus on the few assets it had. That gave the opportunity for others to come in.
I would argue that this is the exact same thing that happened with Antares. It had a project that was then held by Phelps Dodge, which is now Freeport. It drilled 80 holes and said, "You know, guys, the times are tough and we can't do everything that we want to do. The board is giving us less and less money. This is one we are going to have to stop working on, so that we can focus on other projects."
And look at what happened: Antares ended up finding 11.9 billion pounds of copper at that Phelps Dodge project. The fact that a major has been there and has left is a very common story in our industry. It is funny, but we did studies when I was at BHP and learned that it is typically the fourth or fifth company that arrives at a project that actually turns it into a mine. The fact that AngloGold has been at La Mina and walked does not deter us at all.
TGR: Does it have a back-end right on La Cantera?
PZ: It has no percentage at all. Instead, we have a Colombian national who owns the ground. We are doing an earn-in whereby we can earn up to 100% control of the project with no back-end right.
TGR: What are some other interesting micro-cap stories that your fund has positions in?
PZ: Gold Canyon Resources Inc. (GCU:TSX.V) is a wonderful story. It is in between a very early-stage company like a Bellhaven and a more advanced explorer like a Goldgroup. Gold Canyon has 90M shares issued and outstanding and is trading at about $3.00. We got in earlier, but even at today's level, I think this is a very interesting company.
Gold Canyon has the Springpole deposit in Red Lake, Ontario, a wonderful jurisdiction in Canada in an area with a long history of mining.
But Springpole is a little different. It is the closest analogy to what Osisko Mining Corp. (OSK:TSX) has just developed and put into commercial production in the Canadian Malartic deposit to the east. Osisko found that what used to be an underground, narrow-vein mine also contained significantly wide widths of about one gram gold that allowed for a large number of ounces to be mined by an open pit. That is exactly the same situation that is happening now at the Springpole deposit.
I think Springpole is going to have 6–8 Moz. of gold. There are a lot of holes and very little exploration risk. I think it could easily be a double or triple just based on an ounces-in-the-ground analysis.
The management is more of a geologic team. I don't think they are actually going to try to put it in production. I think Gold Canyon Resources is going to be taken out within two years. I think it will put out its NI 43-101 and that will give the majors the comfort that the project has been sufficiently derisked. Given its large size and its Canadian location, particularly in Red Lake, this thing is going to be gone.
TGR: You use your industry knowledge to make your investment decisions. What are some off-the-radar resources that everyday investors could use to help them better understand resource companies coming into the market?
PZ: I use a lot of the same resources as everyone else. I start my day by going to kitco.com. But one resource that a lot of your readers don't know about is a blog by this guy who goes by the alias "Otto" at www.incakolanews.blogspot.com. I find it is a very useful blog. Inca Kola is on a jihad of exposing the bad hats in our sector. It is wonderful insight. He's not a geologist, but he's very good at vetting management teams. He has a good eye for these really early-stage companies. That's something that I look at on a daily basis. And a lot of it is a free service.
TGR: What investment advice do you have for our readers before we go?
PZ: Investors need to make sure that they take the time to understand what they are buying. Do some math—calculate how many cents or dollars per-share this thing is actually worth. Then compare that to what it is trading at and hopefully there is a big delta.
Next, find a good management team with a good project that has a number of catalysts that will serve for promotion. Try to understand the catalysts. Understand what a management team is going to do in the next six months to a year. And follow that company to see if it is delivering on those catalysts. Without catalysts, share price appreciation is not going to happen.
Ignore the macro picture. All it is going to do is make investors get overly confident, buy at the highs, get overly depressed at the lows and sell at precisely the wrong times. Investors need to develop a cast-iron stomach so they can handle the absolute extreme volatility that this sector offers. Investors literally want to be buying when they are throwing up, when they can no longer look at their portfolio. When they are at a cocktail party bragging to all their friends about how smart they are for buying this stock at $0.10 and now it's at $3.00, that is when investors should want to sell. It is so counterintuitive, but that is what they have to do. It is about discipline. Investing is not about being smart, although obviously having smarts helps.
TGR: That's really good. Thanks, Paul. It's been a pleasure.
Dr. Zweng is currently interim COE of Bellhaven Copper & Gold Inc. and a managing member of Resource Venture Advisors, LLC, the general partner to Resource Venture Partners LP, an investment partnership designed to invest in early-stage exploration companies. He was the COO and later President/CEO of QGX Ltd., a TSX-listed company with mineral projects in Mongolia. Dr. Zweng received two B.S. degrees with distinction in geology and applied earth sciences (Mineral Economics) from Stanford University in 1980, an M.S. degree in geology from Queen's University, Ontario in 1984, and a Ph.D. in applied earth sciences (Ore Deposits) from Stanford University in 1993. Dr. Zweng has published several articles and abstracts on geology and ore deposits in two languages in scientific journals. Dr. Zweng was a director and a founder of Antares Minerals Inc. (TSX-V: ANM) before Antares was purchased last December by First Quantum Minerals (TSX: FM).
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1) Brian Sylvester 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: Gold Canyon Resources Inc.
3) Paul Zweng: I personally and/or my family own shares of the following companies mentioned in this interview: Bellhaven Copper & Gold Inc., Goldgroup Mining Inc., Gold Canyon Resources Inc., Batero Gold Corp., First Quantum Minerals Ltd. I personally and/or my family am paid by the following companies mentioned in this interview: Bellhaven Copper & Gold Inc.