Michael Berry: When Picking Mineral Stocks, It's Management, Management, Management


Michael Berry Michael Berry believes the declining dollar is the real driver behind the gains in gold and silver and that silver is undervalued relative to gold. In this interview with The Gold Report, Berry, co-founder of Discovery Investing and pioneer of the Discovery Investing Scoreboard, discusses the factors that are now driving valuation and highlights some micro-cap stocks that the market has ignored.

The Gold Report: When you look at the PHLX Gold/Silver Index (XAU) between mid-May and mid-July, there's a perfectly beautiful double bottom. It looked like a big W. Since the beginning of October all commodities have broken down a bit, but that double bottom was so pronounced. Do you attach any significance to it?

Michael Berry: George, when we used to see a "W" pattern we would say "WOW" and when we identified a double top "M" we would say "Mother"! There is a dominant secular quality-of-life cycle in the world, a very long-term cycle, so in the short run, we're going to have runs up and then declines. The Federal Reserve is going to continue to attempt to inflate and devalue the dollar value relative to other currencies and relative to gold and silver. And it is going to do it for the next three to five years, for however long it takes. Just take a look at Japan for a view of the future. My sense is that there's a very firm bottom on both gold and silver that has been identified by the double bottom you are referring to.

TGR: Quantitative Easing (QE) 3 is gearing up. We know that central banks are now buyers of gold and not sellers as they were in the 1990s. How much inflation do you anticipate we could see in North America?

MB: The Fed wants to see asset inflation, particularly in housing; we're seeing a little bit of that now. A housing recovery is the big bet by the Fed. But we're also seeing inflation in food and energy, though that is not considered in the statistics. We're going to see more of it because ultimately as we go through this process of quantitative easing, demand is going to increase, as are prices. However, make no mistake, we're still on the knife's edge. The reason why Fed Chairman Ben Bernanke has said the Fed is going to keep short interest rates at zero for the next two to three years and is going to print $40–80 billion (B)/month is because he sees that the deflation possibility is not yet off the table. This financial repression not only punishes seniors who have bond portfolios but also life insurance companies and pension funds who are becoming more underfunded with the low rates. Recently several of the Federal Open Market Committee governors have even opined for even more QE.

The Fed wants to stimulate inflation to avoid a deflation at any cost. Printing money debases the currency. It's not so much that gold or silver have gone up in price, in spite of apparent downward manipulation in the futures markets. It's that the dollar has declined in value relative to other assets and currencies. We will see this inflation affect all hard assets and real money. Whether or not it will actually inflate the economy and create jobs—the new focus of the Fed—is another issue, of course.

TGR: Could we be looking at stagflation?

MB: Yes, we could be. We could also be looking at deflation. The more work I do, the more I see the Fed beating its head against the wall in an apparent liquidity trap. The more I see the economy moving sideways with growth that doesn't replace jobs, the more I'm worried about actual deflation. Remember that when you must de-lever (extinguish bad debts) in a no-growth or negative-growth economy, it is a very dangerous situation.

Deflation is a phenomenon that the Fed doesn't really know how to deal with because when you're in a deflation, you're trapped in a downward spiral and you have to create a new credit cycle, so you have to wipe out all the old credit or the markets will do it for you. We're not even close to that situation yet. Stagflation would be better than deflation. We will surely have some kind of inflation along with it. Investors are going to have to protect themselves, and that's why I think having claims on some of these hard assets, particularly gold and silver, is important.

TGR: With President Obama re-elected, is anything different going to happen in our economy?

MB: From an economic perspective, it wouldn't have made any difference if Romney had won rather than Obama, in terms of the ability to fire up this economy, to erase the bad debt and to move forward. Neither of them had or has a plan to move us forward to a new sustainable credit cycle. So in that respect, no.

On the other hand, I do believe that President Obama views the economy as an entitlement economy and that tax rates must increase. In my opinion, Nov. 6 effectively marked the formal beginnings of the U.S. economy as an "entitlement economy" where wealth transfers will be the dominant economic flows for years.

That is a very serious negative for U.S. investors at this time. I do think there will be a 12th-hour reconciliation on the fiscal cliff in which the Republican House will concede on higher tax rates. I recently spoke on the topic at the Hard Assets Conference in San Francisco; my presentation was titled "Fiscal Cliff, Sequestration and Discovery Investing." It's worth a read. President Obama wins on this issue whether we go over this "cliff" or he gets his increased taxation on the "wealthy." I am very much concerned that it will be hurtful in terms of stalling the U.S. economy.

The Congressional Budget Office estimates that an encounter with the Fiscal Cliff will cost the economy between 0.5% and 1% of GDP. I don't look for a very high-growth economy as we go down the road. There are trillions of dollars that must be taken out of it at this stage. In 2013, the Fiscal Cliff would remove $500B and the Alternative Minimum Tax (AMT) would cost another $200B for 28 million new AMT taxpayers.

TGR: Mike, I want to ask you about your 10-point discovery model for emerging companies. Have you revised anything about your model since the downturn of 2008?

MB: No, we just sharpened our focus since 2008. The system worked beautifully. There are no changes, just enhancements. There are 10 basic factors in the Discovery Investing Scoreboard (www.discoveryboard.com) (DiS) that address very different issues. We really wanted to better define those issues, so we worked on that. We have about 1,200 users on the system now. We cover about 840 companies—some biotech, quite a few mining and resource companies and some high-tech and infrastructure companies. We can access all companies on the Canadian, American, Australian and Hong Kong exchanges.

We still look for world-class assets, but most important, even critical, we look for world-class management. With emerging companies, mediocre management is anathema.

We break all these factors down into multiple sub-components. For example, a world-class asset would have sub-factors such as grade, tonnage, infrastructure and location and these may be further broken into components.

We look for catalysts for value change, either creation or destruction. We look for sustainability of operations—cash flow, royalties, etc. About a year and a half ago, we began to talk about the most important factor not being world-class asset availability but sustainability. Can a company sustain itself as the market for funds went dry? That is where we are today. Rather than changing the factors, in the DiS we simply allow the user to change the emphasis on the current factors to reflect what is really driving the market now.

TGR: In picking mineral stocks, what is the most important fundamental factor?

MB: It depends where you are in the economic cycle, but almost always, management, management, management—is the most important factor. A great management team can create value in a mediocre project. A lousy management team—there are a lot of them out there—can destroy value in a great project by diluting recklessly, by wasting money on overhead, by chasing the flavor of the day, by giving $0.05 stock to friends and family and by too much diversification with properties. So management expertise and track record are almost always the most important factors.

TGR: Does the market pay any attention to drill core results anymore, especially in micro-cap stocks?

MB: Yes and no. In some sectors drill results work today, and in some sectors they don't matter. We've gone through cycles in the '90s: There was the diamond bubble in the Northwest Territories, there was a bubble in uranium in 2004, followed by lithium, rare earths and now graphite. Part of this is a natural shift in technology, lithium ion batteries, for example, and part is an attempt by the junior space to capitalize on an opportunity. At any given point when we're in one of these technology sub-cycles, if a company gets good drill results, the stock appreciates and then recedes. One only has to see Molycorp Inc.'s (MCP:NYSE) share price journey to realize what happens when investors lose confidence in a sector.

My son Chris Berry, who works with me, tracks industrial minerals and notes there are now 75 companies in the burgeoning graphite space. At the beginning of the year there were about seven. We will end 2012 with 10 times the number of junior graphite exploration companies than we began the year with. This is clearly not sustainable. He will be presenting on the very topic at the Mines and Money Conference in London on Dec. 4 and the Industrial Minerals Graphite Conference on Dec. 5, also in London.

In other sectors, the copper sector, for example, this is not happening. A great copper drill result? Who cares, even though copper is really becoming scarcer every day and it's more difficult to find a world-class copper deposit. Even gold—with great drill results, a company still has to go out there and explain it and sell the world-class potential.

TGR: One thing on copper. It's around $3.46 or $3.50/pound (lb) right now. It appears to have solid support around $3/lb. Is that a profitable level for copper miners?

MB: It all depends. Is it oxide copper? Is it open pit? Is it underground? Are there by-products like molybdenum and gold? Is it a porphyry or a massive sulphide? What country is it in? Peru, Indonesia and some other countries right now are not very welcoming to copper miners. While $3.50/lb ought to work, it all depends on the grade and the factors mentioned above.

Normally, companies produce what we call a preliminary economic assessment that tries to do an early discounted cash flow with as much as we know about the deposit. For example, there are three companies at Yerington, Nevada, now: Nevada Copper Corp. (NCU:TSX) has a great deposit, Quaterra Resources Inc. (QTA:TSX.V; QMM:NYSE.MKT) owns the water rights and the center of the deposit, and Entrée Gold Inc. (ETG:TSX; EGI:NYSE.MKT) owns the Ann Mason porphyry. A major like Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) is likely to ultimately consolidate Yerington; it probably won't be any of these three junior companies. Copper at $3.50/lb works in the oxide portion called MacArthur that Quaterra owns, but I don't know if it works in the Nevada Copper case, where some of its deposit is going to be underground.

TGR: In the late summer, you commented that the market was scared, especially of the mineral mining micro caps. You said that you thought the TSX Venture Exchange, which is full of resources stocks, had put in a bottom. Even though these mineral stocks and commodity stocks have given back some over the past six weeks, do you believe this positive uptrend is going to continue?

MB: In the long run, yes. You want to be in a position where you have studied your companies, studied your commodities, and picked great management teams that will acquire great assets and you're ready. Most of these TSX Venture companies are all still extraordinarily cheap. I don't think they're going to get much cheaper. I do think the TSX Venture Index has put in pretty close to a bottom, but it could be a long time, a year or two, before we see the emerging world start to build out again. A lot will depend upon resolution of the Fiscal Cliff drama and Europe. I'm certainly a long-term investor. I'm prepared to wait, and I'm looking around for great values now. If a company can sustain itself through a year or two, I'm a big buyer at this stage.

TGR: Let's talk about the micro-cap companies that you've written about.

MB: Chris Berry covers industrial minerals. Northern Graphite Corporation (NGC:TSX.V; NGPHF:OTCQX), Talison Lithium Ltd. (TLH:TSX) and Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT) are a few he covers. Many of these metals or minerals have increased in price based on Chinese demand and also because they control production of much of these markets. There is a lot of opportunity but you have to find the right management team, find the right deposit and you have to be prepared to hang in there with it. This is especially true given the gloomy near-term outlook for economic growth (and hence industrial demand) in much of the world today.

Another company that I really like that generates cash is Revett Minerals Inc. (RVM:TSX; RMV:NYSE.MKT). Revett Minerals is a copper-silver miner in Troy, Montana. It is profitable and is producing positive cash flow. Revett has perhaps the best copper-silver concentrate in the country, and it sells it all over the world. It also has a second deposit that has been held up in litigation for a while. I think it is going to get the right to mine it. It's a beauty. It's a couple hundred million ounces silver and a couple billion pounds (Blb) copper. Here's a company that's trading for about $3.40/share today. It's worth a lot more. I know the management team, which has turned Revett around. It was a $0.07/share stock two or three years ago, and management has done a great job on it. I'm very pleased to be an owner of Revett as well, and I think it's cheap.

TGR: Three months ago Revett Minerals reconfirmed its adjusted production guidance levels for fiscal 2012 at 1.3 million ounces (Moz) silver and 10 million pounds copper. The company is valued at $117 million (M). All of these charts are ugly; it's not just this one. Is there a major disconnect?

MB: Companies like Revett are excellent fish bait. Larger companies like Hecla Mining Co. (HL:NYSE), Coeur d'Alene Mines Corp. (CDM:TSX; CDE:NYSE) and midtier producers have to be looking at Revett now and trying to figure out the Revett story. By that I mean that Revett owns Rock Creek in addition to the Troy mine. It is an extremely valuable asset for which it is not yet receiving any value because of environmental concerns. Revett is a cheap stock. Even though it produces good profit numbers, the market yawns it off. Revett is generating lots of cash. Rock Creek has 250 Moz silver and 2 Blb copper that I think it is going to get a chance to produce. However, I bet it's taken out before that happens.

In some cases, there is just so much undervaluation in the market right now that this is the time. If you can find great management—and Tom Patton at Quaterra, Steve Alfers at Pershing Gold Corp. (PGLC:OTCBB) and John Shanahan at Revett are indeed excellent managers—and then line up your 10 factors using the Discovery Investing Scoreboard, which we provide on a complimentary basis, then you're off to the races in a year or two.

TGR: Revett looks like a successful turnaround story.

MB: John Shanahan is the CEO. I know him very well; he's done a wonderful job. He has a happy crew. He has several hundred people in northern Montana that he's employing. It's just a good, all-around story. Revett is going to new resources within the Troy mine itself. He's done an extraordinarily good job in turning things around. When we first became involved with Revett the shares were trading for $0.07.

TGR: Give us another example, Mike.

MB: I have to mention Quaterra, which also doesn't get any love. Here's a company with 6–7 Blb copper in various levels of resource at Yerington, Nevada. Yerington is the next major copper district in the U.S.; Quaterra also has 35% of the Herbert Glacier discovery.

The last 23 holes on the Herbert Glacier averaged 0.5 oz gold. I think the Herbert Glacier discovery will have 0.5 Moz Measured and Indicated gold in an NI 43-101 in Q1/13. Quaterra is a company that has 35% of that discovery. It is a major, high-grade gold discovery within 20 miles of Hecla's Greens Creek and 30 miles from Coeur d'Alene's mine near Juneau. Grande Portage Resources Ltd. (GPG:TSX.V) owns the other 65% of the Herbert Project.

Quaterra also owns 50% of the Nieves Silver property in Mexico. The Nieves property has 110 Moz silver, open-pittable. We think it may be worth $100–200M in total. Furthermore, Quaterra just announced another major discovery hole on the Nieves property 2 kilometers west of the open-pit discovery. They drilled a hole with an interval of 0.8 meters of 54 ounces of silver. This suggests the Nieves silver deposit is much larger than the 110 Moz currently in the preliminary economic assessment, in my view.

Quaterra is a company with some tremendous discoveries; it is trading at $0.38/share. Again, nobody cares. It's up to Quaterra now to monetize some of these discoveries—the Herbert Glacier would be one, Nieves Silver would be another one—and focus maybe on the Yerington copper deposit. Again, I own a lot of this stock. I've owned it for years. I know CEO Tom Patton extraordinarily well. I believe in Todd Hilditch, a new director, and Steve Dischler, who is running the operation at Yerington for the company. Sometimes these things happen in their own time; that appears to be the case here. I should also point out that a group called Blackberry Holdings, of which I am a member, owns the other 50% of the Nieves project.

TGR: The Herbert Glacier, as the name implies, is under a glacier. It may be a high-quality resource, but can you get to it?

MB: Herbert Glacier itself has been receding since 1740, according to scientific studies from the U.S. Geological Survey. The six parallel veins are exposed and not under the glacier at all. I've been up there twice to monitor progress. The six parallel veins are mesothermal and they go very deep; they all appear to contain high-grade gold and silver and tungsten in some cases. Quaterra has identified both shallow high-grade and deep high-grade gold, so this mine will be underground. None of the veins that Quaterra has drilled to date is under the glacier. The only problem has been actually drilling it because it is pretty rough terrain. I believe it will be a mine, though there's a long way to go yet. Quaterra and JV partner Grande Portage will step back 10 miles from the glacier and go underground, if not a much larger gold miner. It won't have any impact on the glacier at all.

TGR: But is it very hard to reach?

MB: Two mines are already up there and in operation, Hecla's Greens Creek and Coeur's Kensington mine. So this will eventually be mined. There is a paved road to within 20 miles of the Herbert site. Currently all drilling is facilitated by helicopter. As I have said, it won't be mined, in my opinion, by either Quaterra or Grande Portage. It will take a major miner that has the wherewithal to affect things in Washington D.C., to get this into production, but it will be mined eventually.

TGR: So you're also positive on Grande Portage, which owns 65% of Herbert Glacier?

MB: I'm positive on Grande Portage because it's a $0.15/share stock, and I'm guessing—you can't hold me to this—that it could show 0.5 Moz gold in the Measured and Indicated early in the next year at Herbert Project. So right away, you're saying to yourself, this stock is awfully cheap. I think there are 80M shares outstanding. It's a minuscule market cap.

TGR: $11M. It's just unbelievable to see.

MB: The market doesn't care. There are many other examples like that at present. Grande Portage's problem could be that it could be taken out by somebody bigger for much less than it's worth, in the ground anyway.

TGR: And Coeur d'Alene is close by?

MB: Coeur d'Alene has the Kensington mine about 30 kilometers (km) north and I'm guessing it really would like to have this feed. Please remember that Senator Lisa Murkowski of Alaska had a lot to do with getting Kensington permitted and into production. Hecla is about 20–25km south at Greens Creek and is a volcanogenic massive sulfide (VMS) deposit. You could actually barge material from Herbert. At Herbert, you wouldn't even have to have a plant.

TGR: What about some silver companies?

MB: I like the silver producers. Silver is quite undervalued relative to gold. Ultimately, silver has more utility than gold because in a good market, silver is an important industrial mineral. It's a high-tech mineral. In a bad market, it's money. The gold/silver ratio is around 51:1, well out of whack.

A company like Alexco Resource Corp. (AXR:TSX; AXU:NYSE.MKT) interests me a lot. Alexco is mining very high-grade silver in the Yukon and it could be a consolidator, looking for other companies. I like the management team there. I don't own it yet, but I'm looking for an entry point.

I think Hecla and Coeur d'Alene are cheap. They've had some problems recently. Hecla is going to reopen its Lucky Friday property. Unfortunately, there was a death at Lucky Friday a year or so ago, and it was shut down. It has written off about $8M to fix that problem. I think Hecla and Coeur could be midtier consolidators as well.

Endeavour Silver Corp. (EDR:TSX; EXK:NYSE; EJD:FSE) is another company I like. It recently bought the El Cubo mine. It has done a great job. Endeavour has three producing mines in Mexico.

TGR: Any other silver producers?

MB: Actually there are two more gold plays I'd like to mention. I've owned Geologix Explorations Inc. (GIX:TSX; GIXEF:OTCQX) for a long time; it's a Mexican gold/copper play. I like the stock a lot. It vibrates around the mid-$0.20s/share with good deposits and has done a good job of raising money. It deserves better. It hasn't received those kudos yet, but I think it's worth owning. Geologix has learned to survive quite well, so I'm very positive on it.

One stock I should mention is Pershing Gold, a very interesting play. Its Relief properties sit at the bottom of the Black Ridge Fault in northern Nevada. It's in that line of companies that go north to south from Terraco Gold Corp. (TEN:TSX.V) to Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.MKT) to Coeur d'Alene's Rochester mine, on down to a second Coeur d'Alene mine, and then you have Pershing. It's elephant country for gold.

Pershing Gold has its own fully permitted leach pad and almost new plant. It has about a 250,000 ounce (250 Koz) resource. It's a really good opportunity now, one that people should be looking at. It's a cheap stock. Pershing spun off a company called Valor Gold Corp. (VGLD:OTCBB), and owns a significant position in Valor. Pershing Gold is a very early name, but it has huge potential.

Pershing Gold's chairman and CEO, Steve Alfers, ran the royalty business at Franco-Nevada Corp. (FNV:TSX; FNV:NYSE). He has an encyclopedic knowledge of the gold space, especially in Nevada, and has assembled a great team. I've been out to see the company's properties near Lovelock, Nevada. I think Pershing will have 700–800 Koz Indicated and Inferred gold in Q1/13, as well as an NI 43-101. Pershing Gold is definitely one to watch because it's in the right place, with the right team—and it is very cheap. Coeur d'Alene recently bought 10M shares of Pershing Gold. It's a very interesting play.

TGR: You mentioned Terraco a moment ago. Do you follow it?

MB: Terraco has a great management team in CEO Todd Hilditch, VP Charlie Sulfrian and Ken Snyder as the consulting geologist who's famous for discovering the Ken Snyder mine. Hilditch is young, aggressive, understands valuation and monetization. The company has the property called Moonlight just north of Midway Gold. For $20M Hilditch bought the Midway royalty from underneath Barrick Gold Corp. (ABX:TSX; ABX:NYSE) at Spring Valley. Today, the ownership piece of that royalty is worth $60–80M. The company is trading at around $0.19/share. It's one thing to monetize a deposit; it's another thing to monetize a royalty. We think Hilditch can monetize that royalty with any number of financial companies tomorrow. Todd also has the strong support of Haywood behind Terraco, which is quite impressive.

Terraco is a company you really want to have a look at. It has a good management team. It has about 1 Moz gold Indicated and Inferred in Idaho as well. It'll be open-pittable. It is doing metallurgical tests now to determine recoveries.

For somebody who doesn't want to take a lot of risk, you can put a little portfolio together of Geologix, Terraco Gold, Pershing Gold and Grande Portage, and you're going to get some value out of that portfolio down the road.

TGR: Thank you so much for your time. It's been a pleasure, as it always is.

MB: Thank you.

From 1982–1990, Michael Berry served as a professor of investments at the Colgate Darden Graduate School of Business Administration at the University of Virginia, during which time he published the book "Managing Investments: A Case Approach." He has managed small- and mid-cap value portfolios for Heartland Advisors and Kemper Scudder. His publication, Morning Notes, analyzes emerging geopolitical, technological and economic trends. He is a guest lecturer at the Federal Reserve Bank. Berry travels the world with his son, Chris, looking for discovery opportunities for his readers.

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1) George S. Mack 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: Northern Graphite Corporation, Revett Minerals Inc., Grande Portage Resources Ltd., Endeavour Silver Corp., Geologix Explorations Inc., Pershing Gold Corp. and Terraco Gold Corp. Ur-Energy Inc. is a sponsor of The Energy Report Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Michael Berry: I personally and/or my family own shares of the following companies mentioned in this interview: Northern Graphite Corporation, Revett Minerals Inc., Quaterra Resources Inc., Terraco Gold Corp., Grande Portage Resources Ltd., Geologix Explorations Inc., Pershing Gold Inc., Endeavour Silver Corp., Talison Lithium Ltd. and Franco-Nevada Corp. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

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