A look at the junior gold mining space...
LOW MARKET valuations for junior mining companies have Michael Ballanger, director of wealth management at Richardson GMP, feeling like a kid in a candy store. Ballanger has had enough years in the business to recognize the advent of gold fever.
In this interview with The Gold Report, Ballanger discusses his personal views and discusses how he looks for "well-incubated" companies that meet budget and timelines and raise funds without diluting shareholder value. He also shares why he sees junior miners as higher reward and lower risk than gold itself.
The Gold Report: Michael, can you tell us why you believe we are at the psychological and valuation bottom of the trough in the junior mining sector?
Michael Ballanger: Using the TSX Venture Exchange (TSX.V) as a proxy for the junior mining sector, the TSX.V between 2003 and 2007 traded in a range of approximately 1.5 to 3.3 times the price of gold. In the 2008 crash, it went down to 0.8 times the price of gold. Going back 15, 20, 30, 40 years, the TSX.V had traded on a 1:1 correlation with either the oil price or the gold price. Since the 2008 crash, there has been an immense aversion to risk in the junior mining space. At the end of 2012, trading was around 0.71 times the gold price. We have never seen valuations like this in the junior mining sector.
At the bottom of any bear market, sellers become exhausted so only survivors are left. If you accept that premise, it becomes important to see who has survived or who has the management capabilities, the financing and high-caliber projects to advance. Those are companies that will benefit from what I think will be a normalization of the Venture Exchange's ratio to the actual gold price. I think a realistic level would be 1.5–2.0 times the gold price.
Unlike most experts, I am far more bullish on the senior producers and on the junior and intermediate developer/producers and explorers than I am on the physical gold price. I think there is a lower-risk, higher-reward potential in the shares than in the metal right now.
TGR: Given the market performance in the junior precious metals sector and in the junior mining sector as a whole over the last couple of years, do you feel like the characters in the film "Groundhog Day," reliving the same events over and over?
Michael Ballanger: What is peculiar about this cycle is that we have not experienced the "mania phase" that typically happens at the end of a bull market.
You need to remember that the symbol for crisis in the Chinese language is made up of two symbols: the first one is danger and the second is opportunity. I see tremendous opportunity, but not without challenges.
In my work, I have to be very good at identifying management teams and projects that will survive and will excel in most environments. With market valuations so low, I feel like a little child in a candy store with $10 in my pocket. There is so much to choose from.
Due diligence takes longer, yes, but when I find something, I can hand my clients an awfully big rate of return if they are prepared to take the risks associated with the sector.
TGR: We hear a lot about management teams at junior mining companies. You have said that you prefer management teams that incubate companies to preserve shareholder value. Can you expand on that concept?
Michael Ballanger: The perfect way to incubate a junior mining company requires, first, a private company with a very small group of shareholders who are looking three to five years down the line. The caliber of the shareholder base is paramount. The ideal shareholder is one who has been successful in his or her own business and knows how long it takes to start up, develop and eventually reap the rewards of owning a start-up. Having shareholders with a three-to-five-year timeframe eliminates frequent turnover in the shares, which makes it a lot easier for the management to raise capital for development at progressively higher prices.
The second most important thing relates to raising money. If a company needs $3 million (M) for a project, it should not try to raise $10M. If a company raises only what it needs, it avoids diluting shareholders' equity. Do you remember the old expression "Friend or foe, take the dough"? In the last few years, junior mining companies have taken the dough, which is always associated with larger percentage fees charged by the investment industry, and companies have been trashed by the market. They have diluted shareholder equity.
A well-incubated company keeps its financing strategic, on a needs basis and at progressively higher levels. This minimizes dilution and enhances shareholder value. These companies can go to their shareholders first for financing. If they wrote a check at $0.10/share, they will write another check at $0.35 and another at $0.75 because they understand the business model.
TGR: How does an average retail investor find out who the shareholders are in a junior mining company?
Michael Ballanger: I wish I had a good answer to that. You might start by searching the company's press releases on its website or through SEDAR. You can cross-reference what the company financed at and measure that against how much it is spending on a month-to-month basis. If the company has executed its business plan and hit its benchmarks of estimated ounces, was that done on time and on budget?
That information will infer the caliber of the shareholder base and the kind of guidance the company is getting from its fiscal adviser. It will tell you how committed management is to preserving and enhancing shareholder value.
TGR: A lot of investors in this sector are employing strategies that worked in previous cycles in the junior mining sector, but seem ill-suited to today's market. Why is that?
Michael Ballanger: It dovetails with what we discussed about how you do your due diligence.
In 2000, coming off the Bre-X Minerals Ltd. disaster, junior mining companies could not raise money for any project regardless of its potential. It was easy to make money in the early part of that cycle because valuations were so depressed.
From February 2011 to the end of 2012, we were in what I call a "valuation compression cycle." Normally, you expect increased gold or silver prices to attract new investors when a company announces a discovery, and that demand will take a share price higher. In a compression period that does not happen. In a compression cycle, you have to make sure that your entry point is at a level that has already wrung out all the early or mid-range investors who bought it at the wrong price.
If you or your adviser has been investing only since 1991, 1998 or 2001, you may think that a company that has been in the range of $0.50 to $2/share, and that if you buy it at $1/share, the worst it can do is go back to $0.50/share. That is not the case; it can go back to zero.
There is an expression in this business, "there's no fever like gold fever." No one younger than 35 or 40 has any idea what a "mania phase" is like. And I maintain that we are heading into a mania phase for the junior mining sector.
I am not sitting here with a starter pistol, ready to tell you exactly when the mania will start, but there has never been a time when the gold price has advanced as it has over the last 12 years where the entire mining sector—junior, intermediate and senior—did not move to bubble valuations.
We may see gold at $10,000/ounce (oz) or $5,000/oz, but the lower-risk entry point now is into the abject, stark psychological depression that is the mining shares. That is the lower-risk transaction right now.
TGR: You follow the Chicago Board Options Exchange Market Volatility Index (VIX) and you track volatility. Should retail investors get used to more volatility as 2013 unfolds?
Michael Ballanger: They certainly should. Howard Marks wrote an article commenting on the high level of complacency in the market. People are buying into the equity markets because they see the Federal Reserve or the Treasury defending equity levels through interest rate policy or open market operations. That is why the VIX has come down so far.
I like seeing the VIX trade at a reasonable level—20 or 22—because it says to me that there is some fear in the market. A VIX under 15 tells me there is too much complacency. I would use VIX to hedge portfolio positions looking six to nine months out, particularly now that it is trading at a multiyear historical low, under 14.
TGR: What wisdom can you share with our readers from your 35 years in the business?
Michael Ballanger: A phrase I learned at the Wharton School has always served me well: "Never underestimate the replacement power of equities within an inflationary spiral."
All the central banks on the planet are doing their best to re-inflate their way out of their debt problems. When they all are doing their best to debase their currency, it is no different than a company trading on an exchange excessively diluting its shareholder capital. In the equity market, that is a negative for price. In the fiat currency world, currency dilution is punitive to the purchasing power, to the value of that currency. This makes currency the great short sale for 2013.
I recommend that people short sell or sell cash. The inverse of that is to buy assets. The integrity of the purchasing power of cash and cash equivalents is the greatest danger right now. People sitting on a pile of cash for retirement could wake up to a situation like Weimar Germany in 1921–22, instead of paying $1.20 for a loaf of bread, it suddenly costs $5 or $6. Inflation is like toothpaste, once it is out of the tube, it is impossible to get it back in.
Investors should be buying things, investing, taking their savings and making sure that they are selling or shorting cash. That includes owning companies that produce gold, silver, resources, farmland, anything that kicks out a rate of return on commodities and goods that people require.
In nominal terms, that means you could see a much higher equity market 12–18 months down the line without feeling it in the economy, because it is the currency that will have gone down, not the inherent value in the businesses or the shares.
TGR: Michael, thank you for your time and your insights.
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