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 every stock in this post. (Image credit to Karan Mandre on Unsplash)
Sometimes you really have to wonder if the universe has a sense of humour. 2021 was the Year of the Metal Rat in the Chinese zodiac and, as the story goes, the rat came to be the first sign in the zodiac by winning a race set up by the emperor amongst all of the animals. The rat — being opportunistic, resourceful, imaginative, and quick-witted — hitched a ride on the back of the ox across a river and then jumped off the back of the ox to cross the finish line first. If you didn’t have your wits about you in 2020, it was easy to get whipsawed, but opportunities were plentiful if you were quick.
The fact that the ox — dependable, unyielding, methodical, and conservative — follows the rat, seems appropriate given my feelings about 2021. If a person managed to have some rat-like characteristics in 2020, there was surely money to be made, and I’m feeling that 2021 could be rewarding simply by being ox-like and staying the course. For me, that course consists of a healthy dose of energy and materials, aka “rocks, trees, and dirt”. Energy and materials companies have both been out of favour for a long time, more or less in survival mode, but are now getting visibility on generating significant free cash flow as commodity prices across the board recover. This is the natural order of things when it comes to commodities. The boom years make you forget all about the busts. I’ve made my case for things like oil, gas, copper, and nickel in the recent past and see no reason to change my views, other than the fact that I might add uranium to that list. Nothing goes straight up, but I feel good about the underlying combination of macro trends and historic underinvestment in energy and materials, pretty much across the board. Being an ox next year will mean being conservative and committed to the hunt for value, with a healthy dose of determination when it comes to trying to ride a resource bull market without getting shaken out. With the large US investment houses only recently calling for a commodity bull cycle, the money has only started trickling in as most funds (and banks) have decimated their resource expertise over the last few years. I haven’t heard about any new mining or energy investment funds opening up yet and, if I’m right, the coming years will see plenty of those funds during the scramble for materials as the effects of the Great Restart ripple through the market. As Frank in our office likes to say, “I’m trying to stay focused on the destination, and not worry too much the journey”. That’s a very hard thing to do, but if any conjured animal spirit can do it, it’s the Metal Ox.
Being an ox isn’t going to mean that I’m going to don my blinders and ignore risks. In fact, an ox is less likely to devote much time or energy to wild speculation and is drawn more towards paths to value. The long term trend in copper is undeniably bullish in light of the electrification theme and aging existing mines. Same goes for nickel for the same reasons. Oil and gas companies, while out of fashion, do remain the lifeblood of modern civilization… and while they might be “the new tobacco”, they are going to continue to supply the products demanded of them by the market for decades to come.
Uranium equities are showing signs of life, which may be foreshadowing a coming (and long overdue) move in the physical market. As an aside, current uranium prices are a joke relative to what it costs to bring new supply on… and demand keeps rising. It’s a completely unsustainable situation globally, and every so often the dam bursts when utilities scramble to secure supply for long-term contracts. Utilities like to try to negotiate hard over uranium prices, but given how minuscule the cost of fuel is in the grand scheme of a nuclear power plant, they don’t have a leg to stand on. It takes a long time to bring on new uranium supply and when you need it, you’ll pay what you have to in order to get it.
All in all, I’m trying to balance a basket of producers, developers, and exploration stories in the resource sector with emphasis on the first two. I see plenty of value out there in the resource sector at current commodity price levels, never mind where I think those prices are going, which makes me feel optimistic about the year(s) ahead.
As I close out 2020, Touchstone Exploration (TXP.TO, last at $2.06) has been a wonderful performer. When the sh*t fully hit the fan in March and April, TXP was one of the names that I really stuck to… and once the smoke started to clear in May, the stock never looked back. With the stock up over 400% from its lows, prudence has me reducing my position in TXP as I look to diversify some of those dollars into other stories. To be clear, I love TXP. After running some cash flow numbers based on an assumed project plateau of 200 mmcf/d and a TCF of gas in hand, I land around CDN$75mm of after-tax cash annual flow net to TXP, most of which would be free cash flow — outside of a few exploration wells a year and G&A expenses. TXP’s current enterprise value is about CDN$400mm and I think a dividend yield of 10% (assuming TXP pays out $60mm a year in dividends once at plateau rate) would put TXP at an EV of CDN$600mm. At a 5% dividend yield, TXP could look at an EV of as much as $1.2B. All of that is putting the cart a little before the horse as this stage though (my assumptions far exceed current “known” capacity and volumes), so I don’t mind taking some chips off the table to see what takes shape with the remainder. Among other things, TransGlobe Energy (TGL.TO, last at $1.10) has been a beneficiary of my TXP dollars recently as I look for stocks with clean balance sheets and good leverage to oil prices. I wrote a note on TGL recently and had the chance to catch up with management in the past week. Everything is as I thought it was. Even after the recent price move, I think that Transglobe may be the cheapest oil stock in the market, period. Usually that is for a good reason, but that is no longer the case for TGL. The new “Petroglobe” deal, which consolidates three PSCs (production sharing contracts) into one, extends the term significantly, and improves netbacks significantly, is truly a game changer. The consolidated contract will have a new 15+5 year term (a significant extension) and the netbacks on the barrels produced during that term are far more valuable than they were under the old contracts. Because of those two changes to the PSC, a larger portion of the ~600 million barrels of the original oil in place (OOIP) is now economically recoverable, adding some 60-80 million barrels of potential on top of the pre-existing ~26 million barrels of reserves. TGL has only 72.5 million shares out, giving it a market cap of CDN$80 million, with ~CDN$17 in positive working capital (i.e., a CDN$63 million EV). At 11,000 bopd (i.e., stabilizing production in 2021 before shifting to growth in 2022 and beyond), Egypt alone should cash flow ~CDN$70 million at $50 Brent (Brent is currently at $50.75). That puts TGL at less than 1x EV/CF. If I imagine a $60 Brent world in 2022 and assume modest production growth of 20-30%, I see TGL getting close to CDN$120 million in annualized cash flow. Historical capex in Egypt has run around US$30 million per year (call it CDN$40mm), which leaves me to conclude that (sometime in 2021) the market will have visibility on TGL generating free cash flow on the order of “multiple tens” of millions a year, depending on how much capital they want to spend. If I peg that “multiple tens” of free cash flow at CDN$40 million in 2022, I don’t think it’s crazy to imagine TGL trading at a 10-20% free cash flow yield (cash that would be available for dividends, something that TGL would like to reinstate), which would imply a share price in the CDN$3-6 range. I’m not sure when the market figures it out, but I have faith that it will, and spreading my TXP winnings into something that I feel as comfortable with as I did with TXP at 40c (after the Cascadura discovery) feels good to me. TGL’s “Cascadura moment” was the renegotiation of its Eastern Desert PSCs, and while it didn’t involve the drilling of a single well, the impact of the deal is equally material in my eyes. TGL should see its new deal ratified in H1 2021, which might be the “ah ha” moment for the market, but I see little risk on that ratification given TGL’s long and respectful working relationship with EGPC and the government. Keep in mind that I simply “ignore” TGL’s Canadian assets in my discussion above, but they are not a zero. If I can base my case on Egypt alone and get Canada for free, all the better. In time, I think the market comes around on this… in the meantime I can wait.
On the domestic side, I’m keeping it simple with names like Tourmaline (TOU.TO, last at $16.99), Birchcliff (BIR.TO, last at $1.84), Advantage (AAV.TO, last at $1.77), and MEG Energy (MEG.TO, last at $4.30). I own the first three for their natural gas leverage while keeping an eye on the weather (January is going to be important for the “seasonal” gas trade). MEG is by far my most leveraged oil name (aka highest balance sheet risk), but MEG has significant tax pools and a concentrated asset base that could make it an attractive take-out target next year. I still own my Altura (ATU.V, last at $0.12) as a bet on a quality oil asset with high torque to the oil price run by a very conservative, capable, and highly vested management team and have a nice chunk of Tag Oil (TAO.V, last at $0.215), which has been creeping higher as of late as it hunts for a deal in the Middle East/North Africa region. I’m thinking of adding other Canadian energy exposure, but am staying a little cautious for now in case oil decides to dip before it rips.
Although the uranium price hasn’t moved much yet, a look at any uranium equity chart will tell you that the market is anticipating a price move, and usually the market gets what it wants, so I’ve got one foot in the water there (i.e., more than a toe). My biggest bet, representing the best undeveloped uranium deposit on the planet, is on Nexgen (NXE.TO, last at $3.46), with other positions in names like Denison (DML.TO, last at $0.73) Encore Uranium (EU.V, last at $0.85), Azarga (AZZ.TO, last at $0.265) , Global Atomic (GLO.TO, last at $1.06), International Consolidated Uranium (CUR.V, last at $1.32), and Uranium Royalty Corp (URC.TO, last at $1.22), with a dash of out-of-the-money calls on Cameco (CCO.TO, last at $17.13) for mid-2021. In aggregate, I’m probably 5-7% uranium on any given day. I’m not going to get into all of the reasons why I think nuclear is a critical part of the world’s energy future for the next 50 years, but anyone that looks at the numbers involved, in terms of the joules of energy that modern society needs to function, will see that there is just no way we’re doing that with windmills, solar panels, and batteries… especially where the sun doesn’t shine enough and the wind doesn’t blow. Just for perspective, in Canada, electricity only represents about 20% of the total number of joules of energy that the country uses in a given year. Refined petroleum products provide about 40%, with natural gas providing about 35%. How are you going to get the electrons to power cars, devices, and machinery if you don’t want to burn hydrocarbons to do it and/or have massive redundancy in the system? We are talking about tackling an amount of energy use that is nearly four times the scale of the current electric end-use demand. Of the renewables, hydroelectric provides great base load power and the only other carbon-free base load power source (“niche” geothermal aside) outside of that is nuclear. You can poke around at the state of the industry and the power it provides, here: https://www.world-nuclear.org/information-library/current-and-future-generation/nuclear-power-in-the-world-today.aspx. The nuclear folks are pretty realistic about the state of the energy market. Maybe public opinion mighty finally come around as well. Even without western public opinion onside, there are nearly 100 new reactors planned around the world, mostly in Asia, so nuclear will be around for a long time. For the right here and right now, I’m keeping an eye on the uranium spot price and for news of financial players entering the market.
I don’t have much new to say about base metals. By now, copper and nickel should be two of the most well-known ways to play the electrification theme, but so far I’m only reading about copper and almost no one is talking about nickel. That’s interesting because nickel is at a 52-week high and looks set to test its 5-year high of ~$8/lb, which I think it will leave in the dust. High-quality nickel projects are far more difficult to find than copper and projections I’ve seen talk about needing to increase nickel supply by some 50% over the next ten years to meet demand from electrification, and that’s a tall order for nickel. Honourable mentions to the rare earths, lithium, manganese, metallurgical coal, and zinc, but there’s only so much a guy can write about and it’s all part of the same theme of new demand catching up with underinvestment.
I’ve got some Teck Resources (TECK.B.TO, last at $22.87) given its status as the “go-to” name for generalist managers looking for metals/materials exposure, and my biggest copper bet is on Copper Mountain (CMMC.TO, last at $1.80) for its leverage to copper (and gold) and cheap valuation relative to its NAV. I could drone on about CMMC for some time, but to me it represents exactly what I want in a copper producer right now and I think it comes at an attractive valuation. I probably own half a dozen other smaller coppers, but this is getting long already, so I’ll just give honourable mentions to Dore Copper (DCMC.V, last at $0.91) and Foran Mining (FOM.V, last at $0.68) as potential “rebirth” stories that I like.
For nickel, it’s still FPX Nickel (FPX.V, last at $0.68) and Talon Metals (TLO.TO, last at $0.38) rounding out my top two, followed not far behind by SPC Nickel and Magna Mining, both of which should be trading in Q1 2021. I have some Palladium One (PDM.TO, last at $0.245) which is a Ni-PGE combo story depending on the project/area. It’s hard to get nickel exposure, so my nickel stocks are all quite specualtive… TLO is the largest by market cap which counts for something on its own and it does have the kind of high grade nickel that the market likes to see. FPX is still really, really, interesting to me. A multi-decadal asset with ~$3/lb nickel production costs… nickel which, as the story goes, would not need to be smelted in order to get to a battery-ready product.
Silver and Gold
Silver is interesting because it has a dual “precious/industrial” personality. Silver is used in solar panel production, so enough said there about the market’s potential excitability on the metal, but it also trades along with gold as a store of value. On silver, Gatos Silver (GATO.TO, last at $12.22) recently caught my eye as a new kid on the block and I like the smell of it, but would like to get it cheaper if I can. In gold, Premier Gold (last at $3.14) and New OroPeru are really my two main names, with a dash of Karora Resources (KRR.TO, last at $3.96) on the side because of 1) its attractive multiples, 2) its recent reserve update, and 3) recent drill results at Spargo’s Reward. Premier is currently the beneficiary of Equinox’s attention from an M&A perspective, and I like the Nevada spinco here quite a bit, so I’m sticking around. I made the New OroPeru (ORO.V, last at $2.99) case earlier this year (and a couple of times afterwards) and I still like this one a lot. As a bolt-on or a standalone, the Tres Cruces project is one of the cheapest gold resources (3.2mm ozs M+I+I) that I am aware of in the market today given its quality. The deposit has a low-strip oxide cap that will be a veritable windfall (say, USD$1000+/ounce margins on 300,000-400,000 ounces… both guesstimates on my part) for whoever develops it, without even considering the underlying ~3 million ounces of sulphides that are open to depth. I say “whoever develops it” because I just can’t see a deposit of this scale and this quality, with as much exploration potential as it has at depth, sitting out there for long. M&A is starting to tick up in the golds and ORO is like an antique lamp sitting on the shelf, forgotten by all but the most elephant-minded shoppers. Barrick has a role to play in how this all resolves through its Lagunas Norte mine, which was rumoured to be for sale as per an article in the Mining Journal in early November, so I guess we’ll see what transpires. With a little polish, ORO could shine some more.
In a market like this, it’s easy to forget about value, but I do try to keep some industry bellwether names around like Enbridge (ENB.TO, last at $41.13) and Nutrien (NTR.TO, last at $61.16). I get paid to wait, and these are huge, well-established companies with a history of dividend growth so I like owning them if we’re going into a broad-based old-fashioned commodity bull. TECK.B falls into this category as well, but it just happens to also be the market’s go-to “materials” stock. I’d like to think I will one day own some CNQ, but I guess TOU is my CNQ these days and I have no lack of energy exposure.
Yep, I broke down and bought some of Canada’s newest bitcoin ETF QBTC.TO (last at $38.52) a few weeks ago and am just sitting on it. They say bitcoin is “millennial gold”, so I figure I have to have a little in case its goes crazy and I’ll leave it at that. It’s a tiny weighting, but it’s there… just in case bitcoin goes to Tulip Town… again.
Crazy Tech Ideas
Being a geologist puts me at a certain disadvantage when it comes to evaluating tech stories, but it doesn’t stop me from trying. Maxar Technologies (MAXR.TO, last at $43.88), while bumpy, has been good to me and I still like the space theme so I still like it. Few companies have the technical capabilities (space robotics, earth observation, satellite construction, space propulsion, and space infrastructure) and relationships like Maxar, and the space biz is expected to grow significantly over the coming decade. Maxar specifically should transition to being a free-cash-flow-generator in H2 2021/H1 2022. It trades around 9-10x EV/EBITDA.
Poet Technologies (PTK.V, last at $0.71) is a semiconductor/chip stock that I’ve followed for at least a decade. They’ve been working in a field called photonics, which is basically using teeeeeny-tiny lasers on chips to send information around in a computer. PTK’s technology allows for very high data transfer speeds, at a lower cost, and by using less power than the current industry standard for the particular component that PTK has developed, called an interposer. This has far-reaching applications in data centres and communications applications, but I’ve heard that story before. The thing that really gets me with PTK is that this team has been through this development and commercialization process several times in the past and this time, they have a JV with one of the largest chip manufacturers in the world (Xiamen Sanan) to commercialize the technology. I mention it today because the stock is moving on volume and I respect charts when it comes to breakouts.
The last one is a company called Versus Sytems (VS.C, last at $15.62). Having seen what’s been going on in the online advertising space, Versus looks to me to be the right story that was just waiting for the right time. I met with the Versus team a couple of years ago and was really impressed by the team and technology, but the market never really cared. Versus is rewards-points-meets-real-world-prizes that players/participants play for. This e-advertising sector is all the rage as consumer spending and entertainment habits change and companies want to get into those channels without generating negative goodwill… and playing for prizes by choice is more likely to generate positive goodwill, if anything. Coming out of the gate, Versus has a multi-year alliance agreement with Sparx Technology to integrate the Versus real-world-prize platform into Sparx’s existing fan/viewer engagement platform (Sparx is a firm that counts the NBA, NHL, MLB, NBC, ABC, Disney, and CNN as its clients). VS is a crazy stock as it has been rolled back 16 for 1 recently and is getting ready to “go to the show” with a full NASDAQ listing imminently. Let’s see what the U.S. market thinks of it once it’s live and trading there. Recent performance in, and focus on, the sector has me optimistic about the prospects for VS going forward, but I’m rolling the dice here.
I could go on, but if you’re read this far, you’ve already attained ox-like abilities in your endurance, so thank you. That about does it for 2020… all the best in the New Year and, as always, happy hunting.