Source: John Pugsley, Stealth Investor
Little has changed in the soap opera being played out in the financial sector. Three more banks failed last week, bringing the total number of 2009 bank and thrift failures to nine. There were 25 failures during all of 2008, and nine in the first six weeks of 2009. Yes, this is a trend.
Geithner, Bernanke, and the rest of the Obama economic wizards are frantically stirring their witch’s caldron of fixes for the banking crisis, trying their damndest to keep the trickle of failures from turning into a torrent. Geithner did such a poor job of convincing anyone that they even had a plan that the Dow Jones Industrials average, which had edged up about 4% last week in anticipation, fell dramatically, wiping out all of last week’s gains.
Meanwhile, thanks in part to rising gold, silver and copper prices, the average share in the active Stealth Portfolio gained smartly, moving up by about 9%. The active portfolio has been gradually recovering from the deep selloff in junior resource shares that occurred during the last quarter of 2008. It has gained over 30% in the past 60 days.
This week none of the companies we reviewed have met our requirements, but one of the companies in the portfolio is being bought out. Tusk Energy, has reached an agreement to be bought by Polar Star Canadian Oil and Gas for C$2.15 per share. The arrangement has yet to be passed by shareholders, but the chances are slim that it will be rejected. I will provide the details and my recommendation in a moment.
Finally, this issue brings you a series of success stories—an interview with one of the most successful entrepreneurs in the natural resources industry, Ross Beaty.
I met Ross Beaty, then President and CEO of Equinox Resources (TSX:EQN) (ASX:EQN), in 1982. I spent two days with him talking and touring Equinox’s American Girl Mine in Southern California and came away mightily impressed. I then recommended the company’s shares with enthusiasm in my newsletter, John Pugsley’s Journal. At the time Equinox stock was selling at C$1.80. I suggested that C$5.00 was a comfortable target, and my subscribers weren’t disappointed. The shares reached C$5.35 in March 1984. At that point Ross accepted a buyout offer for Equinox from Hecla mining.
For those of us who knew Ross at the time, the big question was, what would he tackle next? Tackle he did, going on to create Pan American Silver Corp. (TSX:PAA) (Nasdaq:PAAS), which became the biggest silver producer in the world, and one of the great success stories to come out of Vancouver in the past 30 years. And there’s more. You can read the rest of the story (still ongoing), below.
JP: Ross, thanks for taking the time to talk with me and my subscribers. First, would you share with us a bit about your start in the mining business after you got your degrees in geology?
RP: My pleasure, Jack. My roots in the resource development business go back to the 1970s when I worked for a number of large mining companies and quickly learned that I wasn’t cut out to be an employee. I have an entrepreneurial streak. I started my first geological contracting business in 1980, spent 5 or 6 years developing it, then started a public company, Equinox, in 1985. I took it public on the Vancouver exchange.
I guess that was when I realized that I was a good entrepreneur and corporate developer. Another word for that is a sleazy stock promoter. [He laughs, as do I]. I made a lot of mistakes in my first company, but generated good returns for all of our shareholders. We sold out to Hecla in 1994 for very good capital gain.
At that point I wanted to keep going and apply what I had learned. I kept my team, fell in love with silver, and founded Pan American Silver. My objective was to become the world’s most important primary silver mining company. We achieved that distinction in 2007 when we became the largest silver producer in the world. In 2008, Pan American produced 19 million ounces of silver and the 2009 forecast production is just about 22 million ounces. I should add that the title of largest silver producer was taken over last year by Fresnillo when that company spun off from Peñoles and became listed separately, so Pan American is now number two.
JP: Where are Pan American’s properties?
RP: We have 8 mines in 4 countries: Bolivia, Argentina, Peru and Mexico. We employ over 8,000 people, have 40,000 shareholders and market cap around C$1.6 billion (although a year ago it was C$3.2 billion). The company is in great shape with a strong balance sheet, no debt, over C$150 million in working capital. We’ve grown every single year since we started, and we’ve increased our production for 14 consecutive years. This month we raised another C$100 million through an equity sale that we’ll use to continue our growth. I’m very proud of what we’ve built.
JP: Pan American has been a phenomenal success, and certainly is a tribute to your vision and talent. You saw silver as an undervalued metal in 1994, and you were right. What is your current view of the future of the silver price?
RP: I founded Pan American on the premise that silver was bound to increase in price and if we built company with very large reserves, resources and production we would profit in the coming times when we expected the silver price to rise. I loved the fundamentals of silver then and I love them today. There’s a very strong demand outlook, but although there has been some increase in supply from new mines, lots of mines have shut down. There hasn’t been a significant change in supply for the last 15 years. The big new demand is coming from investors, and my belief is that this is likely to drive the price higher and higher.
JP: That said, I assume that you remain a believer in silver stocks.
RP: In silver, you have to buy the big ones. You first looked at us in 1994 when we were small. Now it’s big. We’re trading two million shares per day on a normal day. Today we should be trading a bit more since we just did the financing. Pan American is the one I can recommend for silver. If you want quality, buy the biggest.
JP: After Pan American’s success, you turned your attention to copper. I was testing the Stealth Investor strategy in 2004 and 2005, and one of the companies I put in the trial portfolio was Lumina Copper Corp. (TSX:LCC). By the time I had started formal publication of Stealth in 2006, Lumina was already too big to fit our model. Tell us how you segued from silver to copper.
RP: In 2002, when metal prices were at rock bottom, I wanted to gain exposure to the likely commodity boom that was coming, but because of the conflict of interest I didn’t want to do another silver company. I decided to follow the same strategy I followed in silver; that is, to search the world for large deposits that were known but were uneconomic at low copper prices. I formed Lumina Copper and took it public on the Toronto Venture exchange. The strategy was to buy large resources at the bottom of the copper cycle and sell them as copper prices rose.
We acquired 10 deposits. We then reorganized Lumina and divided the properties among four separate public companies, Regalito, Northern Peru Copper, Global Copper, and Lumina Resources. Between 2006 and 2008, we sold all four companies. We invested a total of $80 million and sold them all for $1.2 billion. It was wealth creation by good corporate strategy, successful exploration, good financial engineering and very close execution of a very simple business plan.
JP: What an inspiring story! But Lumina is still listed. What are you doing with it?
RP: We’re sitting on it, so it’s inactive. We sold 9 properties and kept one. When we feel copper prices are rising again, we will go back into that property, explore it, develop it and sell it. The company has six million in cash and a 10-year life on a slow burn rate. It’s not the time to be exploring for copper. It’s the time to be waiting these weak markets out. However, we expect that later this year or next we’ll get going and have another executable transaction that will create more wealth for our shareholders.
JP: In long term, are we looking at peak copper, a scenario similar to Hubbert’s Peak for oil?
RP: Absolutely. That’s one of the reasons I did this in 2002. The Hubbert’s Peak for copper was in the 1960s. There was a lot of copper found then, but very little since then in proportion what we’re consuming today. In 2002 I looked at the rate of discovery of copper globally and the rate of consumption globally and it simply was a disconnect. Copper ore bodies are hard to find, hard to develop, and take twice or three times as long to bring to production than they did ten years ago. We’re not finding nearly as much as we’re consuming and the inevitable result will be a price squeeze. Anyone that owns resources in the ground today should do very well.
JP: Everyone is focused on the financial meltdown, and trying to imagine what the future will bring. What’s your view?
RP: We’re all living through this financial calamity. It’s shocking, and clearly the result of terrible governance and greed. That said, it is a fact of life that we must accept. With the liquidity that’s being pumped into the world by various governments, most notably the U.S. government, one of the consequences will be re-inflation. Commodity prices will increase dramatically, perhaps not this year, but certainly in the next year or two.
I’m not bullish on the broader economy, especially the financial and services sectors, but in terms of commodity prices, I’m quite bullish. The likely devaluation of the U.S. dollar and the desire of investors to hold gold and silver as money will fuel higher prices for both these metals. There’s a very large demand both for physical silver and gold and for gold- and silver-mining equities, and as price goes up the demand is likely to increase not decrease. I expect we’ll see this happening in 2009.
JP: And rising production costs should exacerbate that.
RP: In the last few years we have seen tremendous cost increases in the mining industry. Five years ago the average cost of production of copper globally was only 80 cents or 90 cents per pound. Last summer, when you had a $4 copper price, the average cost of production globally was $1.50 or $2.00. At minimum, costs have doubled in the past five years. Having said that, in the past few months costs of things such as steel, cement, ocean freight, and diesel, have come down significantly from, say, one year ago. Nevertheless, it’s fair to say that costs are significantly higher than they were 10 years ago, and the trend is likely to continue or even accelerate based on the new money coming into the system. Ultimately this will have a negative effect on supply. As costs of capital goods and operations rise, mines will be less likely to be opened or reopened, nor will there be much incentive to explore for these resources.
JP: In regards to exploration, the Stealth Investor is attracted to prospect generators. Are you involved with any?
RP: The one company I’d recommend is Lumina Copper Corp. (LCC.V). It has strong management, an excellent property base, but it’s not exciting right now as it’s not doing anything. The company is waiting for better markets so it will be rewarded when it starts drilling again. This may take another year or so, unless we decide to make it an acquisition vehicle. This is something that bottom feeders are looking at. Lumina has approximately 34 million shares outstanding, is trading at about C$0.50 a share, and has about C$6 or C$7 million in cash. I think it’s a darn good investment. It should do very, very well once markets improve.
JP: Other than copper and silver, what other opportunities in natural resources are you involved in?
RP: I’m glad you asked. I haven’t told you about the new love of my life, geothermal, and my new company, Magma Energy Corp.
JP: Rick Rule told me you were getting into the geothermal field. Tell me about it.
RP: I’ve become attracted to it because I think geothermal is one of the great answers to our energy crisis. It’s the cleanest form if energy of all. It’s also the cheapest, it’s permanent, and the supply is free. Add to these advantages the fact that you’re not exposed to commodity prices, you’re not exposed to the dictators of the world, and you’re not throwing away your domestic product to foreigners. It’s just a great, great business. It goes forever, and it’s available in countries all around the world.
I started this business a year ago and I’ve worked very hard on it. It’s resource development in the same way the mining industry is—exploration, project development, financing, permitting, construction, and operation—but you sell electricity instead of metals. I love the business and I’m passionately active in it. We have a large pool of talent in the company and have now acquired 21 properties in Nevada, Utah, Oregon, Chile, Nicaragua, Peru, and Argentina. Magma has the largest property base of any company in the business. I’m applying the things that have worked in my career and not apply the things that haven’t worked. We’re well financed. We just raised $29 million two weeks ago. The object is to do the same thing we did in Pan American Silver: to build the biggest geothermal energy business in the world.
JP: Can we invest now?
RP: At this point Magma is private. We were planning to go public last year but we pulled back because of market conditions. We’re going to do an IPO, hopefully later this year, and hope to come up with a market value of $300 or $400 million.
JP: You can be certain that we’ll be watching and waiting! Ross, thanks for taking time from your schedule. I appreciate it.
RP: You’re very welcome.
[Afterword: Last weekend, after my Friday conversation with Ross, Amerigo Resources put out a press release announcing that the deteriorating copper and molybdenum prices have necessitated raising additional capital through a private placement. The company announced that it has arranged a non-brokered private placement of up to 37.5 million units at a price of $0.28 per Unit for gross proceeds of $10,500,000. (Each Unit consists of one common share and one share purchase warrant, with each Warrant entitling the holder to purchase one additional Share at a price of $0.33 in the first 12 months after closing and at a price of $0.40 in the second 12 months.) It turned out that the investor is Ross Beaty. Ross wasn’t able to mention this in the interview, as the news had not been released to the public. With his knowledge of the copper industry, this should confirm that Amerigo is deeply undervalued.]
John Pugsley entered the investment business in the late 1960s, and started sharing some of what he’d learned through his first book, Common Sense Economics. The book sold more than 150,000 hardcover copies. The second book he penned—The Alpha Strategy: The Ultimate Plan of Financial Self-Defense for the Small Investor—spent nine weeks on the New York Times’ bestseller list and is considered a standard reference on stocking up on food and household goods as a hedge against inflation. He started Common Sense Viewpoint, an investment-economic newsletter covering political, economic and investment topics, in 1975 and published it for 10 years. At it’s peak it had over 30,000 subscribers. He then wrote and published John Pugsley’s Journal, for another decade. A popular speaker and talk show guest as well as a prolific author and successful investor, he is currently pouring his experience and energy into The Stealth Investor, a weekly stock advisory that alerts subscribers to potential investments beneath the radar of the big funds and brokerage houses.