What Summer Doldrums?

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Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long MAI.V, BNAU.TO, NRN.V, PG.TO, ORO.V, NLC.V, CYP.V, LAC.TO, TLO.TO, FPX.V, CNC.V, EMN.V, MAXR.TO, TECK.B.TO, NTR.TO, AAV.TO, BIR.TO, CPG.TO, WCP.TO, CNQ.TO, YGR.TO, SDE.V, ATU.V, TOU.TO, TXP.TO, and CPI.TO

They usually refer to this time of year as the “summer doldrums”, when market interest and volumes dry up; but this isn’t your average year and this isn’t your average market. There is so much going on out there right now that it’s hard to even know where to start, but below I’ve touched on a decent handful of stories with the hopes of maybe shining a little light on some less-travelled corners of the market.

It’s good hunting season in the markets as overall global liquidity is outweighing economic fears. One thing that I’ll say that I’m hearing and seeing a lot of is a lot of pent up demand for products and services. Everything is on back-order, prices are firm or rising, many businesses are stretched to their limits, and just try to buy a sheet of plexiglass or a wood 2×12 right now… or maybe a home appliance. Backlogs are stacking up. All of that economic activity that just didn’t happen/isn’t happening in Q1/Q2/Q3 is going to mean that business are going to be running flat out to catch up and that’s going to last for a while. I’ll call it “deferred demand”. Whenever coronavirus fears officially fade into the background (novel threats only remain novel for so long), the consumer seems to be lining up to pull on industry in a major way. It’s going to be interesting to watch and should be good for a lot the “stuff stocks” that I’ve followed through the years. Remember gold, energy, fertilizer, natural gas, copper, nickel, uranium, and lithium (to name a few)? You know, those pesky materials and energy sectors? They’re baaaa-aack…

I’ve been quiet because there’s been a lot going on. It goes without saying that pretty much anything gold-related has been good. Minera Alamos (MAI.V, last at $0.73) which has been a long time favourite is now up more than 600% from when it was a dime and the only magical ingredient needed to make money there was patience… and with the hopes of being a >100,000 ounce/year gold producer in a few year’s time, some more patience may even pay a little more. Same goes for Pure Gold (PGM.V last at $2.07), which still screens well on broker comp sheets and is trading at a healthy discount to NAV. For those who like Pure Gold, but think it may have run a little too far might like to look at the rebranded Rubicon Minerals that now goes as Battle North Gold (BNAU.TO, last at $2.04). BNAU has a pretty tight capital structure and is planning to deliver a feasibility study on its Bateman Gold project in Red Lake by the end of the year. One of the things that I like about BNAU is the fact that it has massive tax pools, sunk capital of nearly $800 million in infrastructure, and is a “turn around story” that hasn’t re-rated. For those who forget, Pure Gold was once a turn-around story and currently has 3.5x the market cap of Battle North… just saying.

Galway Metals (GWM.V, last at $1.68) and Northern Shield Resources (NRN.V, last at $0.155) have both caught my attention in eastern Canada, the former being in New Brunswick and the latter in Nova Scotia. GWM is well-advanced on what it calls a camp-scale discovery and enjoys the backing of Eric Sprott on its list of holders (he’s been busy lately), while NRN is waiting on assays from what could be “the” discovery hole at its Shot Rock gold project. GWM had some flashy visible gold in its Hole #65 at Clarence Stream for which assays came back this morning, while NRN reported some good looking rock in hole 20SR-11 over 15 metres, including 8 metres of multi-phase more-or-less massive quartz vein (assays pending). NRN’s gold mineralization is not expected to present as visible gold, but if the assays come back with significant gold over that most-heavily-veined 8-metre-thick (core thickness) interval it could mark a turning point for the project. In New Brunswick, think that GWM is hoping to join the billion-dollar explorer’s club (aren’t they all?), and the overall setting of the project might just lend itself to that. The mineralization appears to be adjacent to a large intrusion and zones that were previously independent seem to be linking up. There’s a good video with VP Exploration Michael Sutton linked here, which gives a good overview of the project. Drilling is ongoing and targets are plentiful, so GWM’s $20 million in cash should make for a steady stream of infill and exploration results out of Clarence Stream.

Premier Gold (PG.TO, last at $2.75) is a relatively new addition for me based on the prodding of a smart guy in our office who pointed to a sum-of-the-parts view that I found compelling. PG is contemplating the spin-out of its Nevada assets into a separate vehicle, which would be an attractive company in its own right. Hard Rock JV partner Centerra Gold turned down PG’s offer for its 50% of that project earlier this year, which should also provide some indication of what the value of that asset is at a minimum. PG has a clean balance sheet and trades around 0.6x consensus NAV.

And then there’s New OroPeru (ORO.V, last at $2.39). The stock has performed well as some early-mover gold market participants recognized the potential in this lightly followed name, but I think it’s still cheap and it has a very tight capital structure with only 26 million shares out. ORO owns 100% of the Tres Cruces deposit in Peru, roughly 10 kilometres from Barrick’s idle Lagunas Norte operation. Tres Cruces is a 3.2 million ounce gold resource that remains open to expansion laterally and at depth, where the deposit has only been drilled to a depth of around 300-350 metres at most. Many holes bottomed in high grade mineralization at depth and observations from core suggest the potential for undrilled high-grade feeder zones at depth. Tres Cruces has an oxide cap that should be broken out from the global resource estimate for the first time in the not-too-distant future in an updated resource estimate. The oxide cap represents an early, low-capex, high-margin starter operation. For perspective, the oxide ounces could have margins in the US$1000/oz range at US$1600 gold, so I believe their potential value is significant. The fact that Lagunas Norte is out of oxide ore and just 10 kilometres away means that not a lot of imagination is required in terms of seeing how this might play out. At its current share price, ORO trades with a ~US$45 million market cap, which is only US$14/oz on the 3.2 million ounce total resource. I look at a lot of comp tables and projects, and ORO would plot amongst the cheapest of all of them on an EV/oz basis, and most of the comps aren’t 10 km from an idle mining operation that needs ore. Recall that Barrick has an option to acquire 70% of the Tres Cruces deposit by funding it through to production, after which ORO would own a 30% (carried) interest and a 2% NSR over the whole deposit. Pan American Silver owns 18.6% of ORO on a partially diluted basis and holds a 1.5% NSR on the project. The stock is illiquid, which keeps fast-money types away, but I’ve run this project by a lot of serious mining sector participants and feedback is consistently positive, so I’m very happy to watch this play out. Given that Barrick has until just December 31st of this year to make a decision, and with gold at $2000/oz, the timing for ORO couldn’t be better. If my downside case is that Barrick walks and lets ORO keep 100% of the deposit, I’m quite okay with that. The Tres Cruces 43-101 suggests that shipping a pyrite (gold) concentrate might be an option for the sulphide ounces given the project’s relative proximity to tidewater. If ORO is able to keep Tres Cruces on a 100% basis, I think there’s a very strong case for a standalone oxide heap leach project (think of something like STGO, or MAI) that piles up free cash flow during the years that sulphide development is being planned. That oxides-followed-by-sulphides is a standard play in the Mining 101 playbook and the geology of Tres Cruces appears to be very well-suited to it.

The battery metals are cool again and my elements of choice are lithium, nickel, and manganese. For lithium, I’m sticking with Neo Lithium (NLC.V, last at $0.75) and its massive, high quality “3Q” brine project in Argentina as my go-to name in the pre-development category. Honourable mentions to Plateau Energy Metals (PLU.V, last at $0.34), Critical Elements (CRE.V, last at $0.29), Cypress Development (CYP.V, last at $0.50, up on an Epstein Research note yesterday), and Lithium Americas (LAC.TO, last at $12.13). LAC is a common top pick in the lithium producer category, while the other three are all pre-development. For nickel, I’m sticking with Talon Metals (TLO.TO, last at $0.255), FPX Nickel (FPX.V, last at $0.485), and Canada Nickel (CNC.V, last at $1.80)… all are pre-development. FPX has me the most excited given its unique deposit characteristics and potential for short-circuiting the production process of nickel sulphate. FPX added a very good (ex-Vale) director yesterday and has a relatively stacked board for little nickel company that almost no one (except for those with long memories) had ever heard of before a few weeks ago. As for manganese (a lesser-discussed battery metal), there’s only one project that makes my list and that is Euro Manganese (EMN.V, last at $0.075). EMN is essentially a remediation project that would simultaneously clean up a historic tailings dump in the Czech Republic while producing manganese for the coming wave of European battery plants. It’s a tiny penny stock with a lot of shares outstanding, but the concept makes too much sense for me, so I’m long a small position in it to see what happens.

Taking a totally different tack, I’ve come to like Maxar Technologies (MAXR.TO, last at C$35.63) quite a bit. This is a space-technology play that trades a little under 9x EV/EBITDA, which I think is way too low of a multiple for the sector that this company is in, behind a moat as wide as Maxar’s. Maxar was the subject of a short report last year as its debt ballooned during a big capex cycle, but earlier this year, Maxar sold its MDA business for a billion dollars, putting it well within debt covenants and setting it on course to a higher orbit as its capex-spend cycle winds down and its cash flow growth takes off (which means that its balance sheet leverage (5x debt/EBITDA) would ease). Maxar is a leader in Earth imaging, space robotics, satellite construction, and data management/transformation. The company plans to launch its new Legion constellation of Earth observation satellites in H1 2021 (that’s part of what the capex/debt was for), which will have the ability to capture high-resolution images of the Earth with as many as fifteen overflights per day in some locations (most of the lower-48 in the U.S.). Earlier this year, MAXR acquired 100% ownership of Vricon, a 3-D data and analytics firm that dovetails big time into MAXR’s imaging capabilities. Vricon’s technology allows it to take satellite image data and generate a 3-D model overnight, which has a variety of defence and civilian applications, including 5G network planning (5G networks require more antennas as the signals do not penetrate buildings effectively, so a 3-D model of the terrain and buildings is key to network design ability). Autonomous driving, disaster response, and land use optimization are all disciplines that are enhanced through the use of accurate (and rapidly updatable) 3-D models. I listened to the MAXR Q2 conference call recently, and while the company has yet to lay out 2021 guidance, I got the sense that management is pretty confident about the path they are on. With the foundation now laid for years of growth, it seems to me that it’s time for MAXR to reap the fruits of its labour in the years ahead. I can’t really explain the low EV/EBITDA multiple that MAXR trades at relative to other tech companies. I view MAXR’s industry as a high-growth one, with MAXR uniquely positioned as a well-established sector leader that is about to hit a step-change in capability. One of the intriguing things about MAXR is that it is one of the most heavily shorted stocks on the TSX. Between the U.S and Canadian markets, there were some 9 million shares short as of the end of July. That means that nearly 1/6th of MAXR’s stock has been sold short. Personally, I think the short thesis here is broken and that the shorts are about to find out how hard it’s going to be to cover 9 million shares in a company that only has about 62 million shares outstanding. Because of that tight share structure, according to (admittedly bullish) analyst Tim James at TD, every point of multiple expansion on EV/EBITDA adds US$9/share to MAXR’s share price. So if MAXR traded to even 12x EV/EBITDA, that would be US$27/share higher, which is 100% higher than current levels. I’m putting this into the category of “things that make you go hmmmm” and am long a good chunk as a result. This does not mean that MAXR is a slam dunk. Any time you are launching satellites, there’s risk involved, but “hoping that something goes wrong” is hardly a strong short thesis, so I’ll take the other side of the short’s bet.

On the energy front, an improving gas outlook has buoyed my favourite gas name, Advantage Oil and Gas (AAV.TO, last at $2.14) recently, along with a broad swath of other gassy names. I own some Birchcliff (BIR.TO, last at $1.56) and Spartan Delta (SDE.V, last at $2.90) to round out my Canadian gas exposure and am cautiously adding some oil exposure as well. I’m still long Altura Energy (ATU.V, last at $0.175), which reminds me a lot of Rock Energy back in the day (that one had its hero and zero moments as well along the way, but always had a scalable, coherent resource) and have added some Whitecap (WCP.TO, last at $2.85), Crescent Point (CPG.TO, last at $2.69), and Tamarack Valley (TVE.TO, last at $1.07) to the mix. I’ve got a little bit of Yangarra (YGR.TO, last at $0.64) as a massive-discount-to-NAV play and am riding with the biggest bet on boring old Canadian Natural Resources (CNQ.TO, last at $26.77, with a 6.3% dividend yield). Tourmaline (TOU.TO, last at $17.63) is still an office favourite, with its Topaz spin-out set to happen by year-end, but for new money I’m looking for things that haven’t moved quite as much. I don’t own Arc Resources (ARX.TO, last at $6.63) right now, but that one is well-liked by many. All in all, after so much pain for so many years, only the strong have survived, so a lot of these companies are looking good in a world where the rotation from growth into value (with inflation in mind) is underway. Oil is probably more of an H2 2021 story, but it’s going to be quite a story, so I’ve added some exposure with the hopes of having the brains/guts to just ride it out.

With gas on my mind, I come back to Touchstone Exploration (TXP.TO, last at $1.22), which is being hailed as the largest onshore discovery in the history of Trinidad in local media. I’m not sure if that’s technically true, as I thought the nearby Carapal Ridge field from the early 2000’s was bigger, but I’m splitting hairs at this point. It’s a big discovery already based on Cascadura alone, and with Chinook drilling underway (it started drilling on August 13th) it’s going to be an interesting 4 to 6 weeks. Chinook-1 is supposed to take 38 days to drill and is targeting a fault block adjacent to Cascadura-1. CEO Paul Baay has referred to Chinook as a “broader” structure, which to me would indicate that I should expect less vertical column height but perhaps larger areal extent. The well is being drilled up-structure from an old Shell well from the 1950’s much like the old Shell well that set up the Cascadura-1 location, so that mitigates some risk, but hey, it’s still exploration. Immediately after Chinook, Cascadura Deep will be drilled from the same surface location as Cascadura-1, targeting a deeper untested thrust sheet in the same structure. The high-impact Royston gas target is in TXP’s sights in 2021 when the roads dry out, and that’s a pretty exciting looking target. In the near-term Chinook is what matters most, as does the Cascadura Deep well and the outcome of gas sales agreement negotiations for the anticipated Cascadura gas volumes. I’m sticking with my potential value matrix from back in May on this one and so far it’s served me well in terms of assessing what I think my risk-reward looks like. TXP is tough because if they miss Chinook, you just know the stock is going to get hit, but it’s arguably not yet priced for Cascadura so what’s a guy to do? Decisions, decisions.

Oh, and if you want my craziest international story, look no further than good ol’ Condor Petroleum (CPI.TO, last at $0.53), which is looking to land a deal in Uzbekistan. You read that right, Uzbekistan. You may be thinking, “Malcolm, why on Earth would I care about a gas play in Uzbekistan?” I hear you. It’s not for everyone. I like it because CPI holds 75% of its market cap in cash and I think that the scale of the Uzbek deal could be reminiscent of Hurricane Hydrocarbons/PetroKazakhstan for those with long memories. There are obviously big risks and uncertainties here, but the rewards are great enough, and the EV is low enough, that I’m willing to take a shot on Condor delivering. Gas pricing could/would probably be similar to that of Touchstone in Trinidad, and the fruit is very low hanging. This is basically a Soviet-era gas field revitalization project. Those who know how much meat was left on the bone in these old Soviet fields in the ‘stans will know that this might be worth considering. It’s a flier, but I like the long-tail risk-reward situation here, especially given the valuation.

On the large cap side, I’ve got Teck Resources (TECK.B, last at $15.56) in the boat as well as a healthy dose of Nutrien (NTR.TO, last at $51.43). These are just kind of rounding out my reflation/inflation trade exposure and both also play into the theme of rotating from growth into value. If I see Nutrien go through the C$52.50 level I’m going to buckle in for a while as that would signal a major breakout on the chart, and when “ag” stocks run, they really run. Teck constantly screens as trading at a healthy discount to NAV and has a modest single-digit P/E multiple that I don’t mind owning in an inflation minded world, with broad commodity exposure.

Broadly speaking, I’m not fighting the tape and am remaining observant of established and emerging trends. Gold, energy, copper, battery metals, base metals, and agriculture all have my attention, with gold probably being in the most established trend. As readers know, I do take microcap fliers along the way, but generally I see enough upside in less-risky pastures to feel like I can still hit it out of the park without taking on too many wild-ass exploration risks. Having said that, I’ve got plenty of exploration driven stories, but their relative sizes in my portfolio are modest, even when combined. Arguably I have too many names on the go right now (this might cover half of them), but at times like these, in markets like these, I don’t mind spreading the bets a little more broadly. That way, I figure I can capitalize on the last 15 years of reading and due diligence which has given me a pretty good idea of where the bones are buried in the the sectors and stories that I’ve followed. New names pop up on the radar from time to time, but I’m trying to keep the rainbow chasing to a minimum these days as I wait for the bets that I do have out there to pay off. In markets like this, the buying and the holding is easy. It’s always the selling that’s the hardest part when things are working.

My thinking these days is somewhere between “you never go broke taking a profit” and “the money is made in the waiting, not the buying or selling”. It’s been a long drought in the resource sector, but it would seem the rains have finally come.

Happy hunting.