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 AOI.V, CCE.V, CRE.V, EMM.V, FIL.TO, FOM.V, HBM.TO, NAN.V, NICU.V, NPK.TO, NPR.V, NSE.V, NXE.TO, NETZ.C, POE.V, RPX.V, STRR.V, SPC.V, SURG.V, TAO.V, TNZ.V, U.UN.TO, VLE.TO, XYZ.V, and YGR.TO (Image credit to Lukas Tennie on Unsplash)
Last year I decided to take a cue from the Chinese zodiac and plowed ahead like an ox through the fields of energy and materials… and a lot good things were turned up. So much happened last year that I can’t even try to recap it, but for me, if there was main a theme for 2021, “energy” was probably it. Having been left for dead, energy stocks staged remarkable comebacks, showering faithful investors with triple-digit returns in the process, while the market recognized just how cheap they had become. Coal, uranium, copper and lithium also presented some big wins with what felt like relative ease; with the latter two showing the power of the electrification theme. Gold was a tougher place to be (though not without its big wins) and fertilizer was a stealth winner — Nutrien is over $90 as I write this. Nickel is in a stealth bull market, trading at over $10/lb currently (a 10-year high), while zinc still seems to be the Rodney Dangerfield of base metals despite being at 5-year highs. They say diamonds are forever, and while the stocks of most diamond companies have had terrible years (just look at Mountain Province (MPVD.TO, last at $0.75) and Lucara (LUC.TO, last at $0.58)), rough diamond prices are (also) at ten year highs … hmmm. Also in the things-that-make-you-go-hmmm category, I haven’t heard many people talking about the rare-earth-element sector lately… something that almost no one thinks about, but is critical to the world’s electric-motor-driven future. All in all, from my perch, “stuff stocks” felt the best they have for years, but broad investor sentiment is still tepid at best. Decisions, decisions. You never want to stay at the party too long, but it hardly feels like anyone is swinging from the rafters, so could it be that things are just warming up?
Like most people, I’m not sure what to make of the overall market or where to be overweight. With inflation taking its coat off and getting comfortable by the fire, it looks like interest rates are going up, but the question remains… “How fast?”. I have no idea, but the breadth of the move in the commodity complex reminds me of the last, and most profitable stage, of the bull markets seen in 2004-2007 and again 2009-2011 (coming out of the 2008 financial crisis). To me, it feels like 2022 could be the year that money really sloshes into hard assets (like energy, materials, and gold) as investors look to get exposure outside of the heavily-owned and highly-valued US tech sector; perhaps getting better protection from inflation in the process.
On the supply side, no one thinks much about commodities until they realize that the prices are going up and supply takes time, and capital, to respond. And these days, it is not getting any easier to find, permit, finance, or develop new mines or hydrocarbon accumulations. Layer on production shortfalls from existing operations, across a broad spectrum of the commodity complex — for a broad spectrum of reasons — and you’ve set the table for scarcity. Psychologically, scarcity creates that auction market I was talking about over a year ago… and loads of liquidity in the system means that buyers don’t mind paying up for surety of supply now.
Speaking of liquidity, now comes the Fed’s balancing act of not tipping the market into recession while still trying to rein in inflationary pressures. I’m not sure how this market cycle is going to end, but I doubt it happens in the first few rate hikes. If my gut is right, at some point, the Fed will be under criticism for hiking rates “too slowly”. If I start hearing the word “overheating” in the context of the economy, I’ll start looking over my shoulder, but right now, the omicron variant and its impact on Q1 is all anyone can think of, so I’d say there’s probably some time before anyone starts talking about things getting too hot.
If I have to pick a place where things could get crazy, it’s the oil market. EV adoption rates aside, the sheer volume of the existing (and still growing) ICE fleet means that oil demand isn’t peaking this year or next, or even the one after that. Meanwhile supermajors are far less likely to sanction new, long-lead, exploration and development projects, which leaves relative minnows to try to make up for the void they are leaving. State-owned oil companies aren’t likely to save the day either, having to deal with things like (a) pressures at home over more pressing immediate matters brought about by covid (e.g., stability, health care, employment, food), (b) woke-left pressure to constrain the role of public and private capital in hydrocarbon development, or (c) tired old oilfields which are already producing at maximum capacity. Energy stock price charts are telling me that the market is starting to take energy seriously again; and I think that some portfolio managers are starting to strap on energy as a bit of a “hedge” against the disruptive effects of a good old-fashioned energy price spike.
All I know is that it’s not materials and energy mania out there. A lot of people have made a lot of money in a lot of places over the last couple of years and as a result, having no energy or commodities exposure hasn’t hurt their performance. With a lot of the ETF/crypto/tech crowd now looking around at what other games there might be in the casino, I have to think that there might be some gas in the tank of the materials and energy trade. I’m not planning to just keep plowing ahead with blinders on, but I’m willing to keep my mind open enough to see if the market is really ready to pick up the commodities torch and run with it, again, as The Latest Next Big Thing. A friend who’s been in the market as long as I’ve been alive recently told me that typically you’ll see the Dow and the TSX at the same value before the end of a market cycle… and for that kind of relative outperformance to happen, he says that the energy and materials sectors have to be working, full stop. Here’s hoping.
Here’s a run down on some old names and some new ones. As always, I’m long and therefore biased, but I see lots of opportunity in the year head.
Small Cap Energy Special Situations
Africa Oil (AOI.V, last at $1.95)
I’ve followed AOI since it was formed, and maybe even a little before that. AOI is a “Lundin vehicle”, so it gets an automatic checkmark from me in terms of management quality. For those who have lost track over the years, AOI recently bought a 50% interest in Prime, a corporate entity that owns separate 8% and 16% non-operated interest in two Nigerian deepwater platforms operated by Chevron and Total SA respectively. The assets were purchased from Petrobras in a deal made in November 2019, and I don’t think a lot of people paid attention at the time. Combined, the two developments that Prime has an interest in produce some 450,000 bopd — this is not a Mickey Mouse operation. Fast forward to today, and the debt that AOI took on for that acquisition has already been paid off… and now it’s time to harvest sweet, free cash flow. AOI’s interest in Prime looks set to deliver somewhere around CDN$1B of free cash flow (net to AOI) by 2025 at US$75/bbl Brent (Brent is currently US$87/bbl). There are some remaining hedges through April 2022, after which AOI is unhedged on its ~30,000 bopd of production. Sustaining capex appears to be in the tens of millions per year while free cash flow is in the hundreds of millions per year. Look, I know that Nigeria isn’t everyone’s cup of tea, but the valuation is low enough — and the free cash flow potential high enough — that I’ve got a decent position in the boat. If this was in the Niger Delta, I’d likely stay away for security and HS&E reasons, but deepwater offshore is like operating on the moon — and the operators don’t come any better. One thing that caught my eye during my DD on this one was the Chairman’s Letter from December 2021, in which Mr. Craig highlighted the fact that AOI is now debt free and that the company expects to start talking about returning capital to shareholders (dividends +/- buybacks) when it reports its annual results in February of 2022. Sure the stock is up almost a buck since this time last year, but I don’t think this is on a lot of people’s radars yet. I polled probably a dozen people who would be the most likely to know AOI and not one of them was current on the story. Not one. Hmmmmmm. In the worst of it, AOI got down to $1/share, so at two bucks, I don’t think it’s done with its ongoing re-rate. I have AOI trading at around 60% of the after-tax NPV10 of its reserves (Prime interest only), with no value attributed to any of the rest of its substantial portfolio of African exploration and development projects/holdings. Volume has been picking up lately and the OBV indicator suggests that the stock is under accumulation, so it would seem I’m not alone in my view.
Tenaz Energy (TNZ.V, last at $2.80)
Tony Marino and his team haven’t been idle. With the recapitalization and rollback complete, TNZ has just 27 million shares outstanding and a market cap of about $75 million. The company has about $25 million in the bank, and its Leduc Woodbend oil field is objectively worth $50 million considering the sale of 1/8th of it for $7 million not that long ago, but in a far worse oil tape. That means there’s no “promote” in TNZ. I don’t know when a deal comes, but if TNZ can pick up even just a single point of multiple expansion in the market on its coming asset acquisition(s), the accretion to the equity value could be significant. TNZ has big plans and I have big dreams for it, so get get ’em Tony. I owned SDE right after it recapped, and boy do I ever wish that I just held onto that one rather than trading it away for a buck. I don’t plan on doing that again when there’s a management team that I believe in and a good energy tape. When TNZ gets its first deal that will be the beginning of the story for me, not the end. Likewise for TAO below.
Tag Oil (TAO.V, last at $0.37)
Yep, still waiting… but at least the administrative plumbing of the energy sector has been moving in Egypt (e.g., Transglobe (TGL.TO last at $4.12) had its new production contract ratified recently), so I can’t help but wonder if Q1 is the quarter that TAO finally shows that it can get deals done, and good ones at that. Anything that takes this long must be worth waiting for, right?
Valeura Energy (VLE.TO, last at $0.435)
This still trades at around 75% of its cash value. It’s not a huge position for me, but if they get a new deal, VLE could very well be “born again” in the eyes of the market, and energy stocks are half-way to cool again. At such a big discount to cash, I’m content to hold it.
Pan Orient Energy (POE.V, last at $1.30)
This week, POE shareholders will vote on paying a 40 cent per share special distribution. This will reduce POE’s excessive cash on hand as it prepares to wind itself down, perhaps into an exploreco. The company says it should release reserves on its well-performing onshore Thailand oil assets in early February, which will probably set the table for the monetization of said assets later in the year. I hold a small position here and will watch to see if it gets “too cheap” after the special distribution, but I expect the pending reserve report will make the odds of that less likely.
New Stratus Energy (NSE.V, last at $0.50)
Well, Jose Arata got the deal closed and has taken Repsol’s place in Ecuador with a 35% operated interest in blocks 16 and 67, netting little NSE about 5,000 bopd of production. Mr. Arata has talked about big capital and production plans in the media over the last month or two, so I’m long a modest position to see if NSE can help Ecuador to revitalize its dismal domestic oil production profile. Most people have still never heard of NSE, but I used to work as a geo in the very basin (the Oriente Basin) that NSE has just bought into… a basin where I believe there is likely to be a lot of low hanging fruit if you can navigate the politics.
Yangarra Resources (YGR.TO, last at $1.84)
I have nothing new to say, but YGR is typically early with its reserve reporting, which I think could be enlightening this year. By my guesstimates, YGR is trading at around 50% of the value of its PDP (proved developed producing) reserves and at less than 20% of the value of its 1P (proven) reserves. YGR’s Cardium wells boast quick paybacks and high IRRs — and the company had no hedges to speak of as of last report. With a fairly predictable, and stated path to returning excess free cash flow to shareholders once debt-to-cash-flow gets to 1.0x, YGR looks like a very compelling small cap value play in the energy sector. Management-shareholder alignment is excellent here as management owns 18.5% of the company (25.8% on a fully-diluted basis). CEO Jim Evaskevich fully understands the importance of returning cash to shareholders, and he’s the biggest one, so I’m being patient with this one.
I’m a broken record here. My two main positions are Nexgen (NXE.TO, last at $5.79) and the Sprott Physical Uranium Trust (U.UN.TO, last at $14.78). It’s starting to don on the market that nuclear might be the greenest energy option of them all, but even if western countries don’t get it, China does. Soon China will overtake the U.S. as the world’s largest producer of nuclear energy. Uranium is a “future facing” commodity and it currently trades well below its marginal cost of production. Not a mining or energy company in the world would face criticism from its shareholders if it were to buy Nexgen. The U.S. market drum should beat loudly for uranium this year given the momentum of, and interest in, the Sprott Physical Uranium Trust and its pending U.S. listing. Utilities are going to need to start contracting for long-term supply soon and without new production, things would get really dicey towards the end of the decade. I’ve seen the uranium price spike before, and with the backdrop in pretty much all materials across the board, I think the market’s interest level has a lot of room to build.
Anacortes Mining (XYZ.V, last at $1.40)
This one has somehow landed into the “broken story” bucket for me, which is remarkable given the quality of the deposit, the upside potential at depth, and the pending PEA that could highlight this as “Prime Mining 2.0” (PRYM.V, last at $3.89). I really, really mean that. Tres Cruces is as good as deposits come. The oxide resource is low-strip and high grade, the jurisdiction well-established and open to mining, and the new CEO, Jim Currie, has real mining chops. Some of the recent selling is likely a case of “selling begets selling”, but at some point, XYZ will run out of sellers and it’ll feel like the skies have parted. It might happen after the PEA comes out, it might happen after the company shows what kind of holes this deposit can produce, or maybe it might happen after some corporate event. With the PEA expected in about 6 weeks, I guess I’ll get my first answer then. Drilling probably starts in April (best guess) and that might be what really gets the story “lit”. I’ve been following this story for so long that I’m bored of it, but today, if you showed me drill holes like the ones that were drilled at Tres Cruces some fifteen years ago, I’d be taking a hard look at it, I know that. As they say, sell ’em when they’re flying and buy ’em when they’re crying.
North Peak Resources (NPR.V, last at $2.28)
I’ve been long NPR for a long time, but recently it took off so fast that I got whiplash. The stock ripped higher on the back of news that Brian Hinchcliffe, with his geologist Mike Sutton, settled on the Black Horse gold property in Nevada as the company’s core asset. The Black Horse property is the site of 41 historical shafts and adits where Old-timers mined gold from high grade veins over a hundred years ago. Subsequent drilling by (prolific) prospector Gary Grauberger to shallow depths over a portion of the prospective trend proved up a 350,000 ounce oxide gold resource with a grade of 1.2 g/t, which is high for Nevada oxide gold. The mineralized system appears to be 2 miles long and gold is present in both disseminated and high-grade mineralization overlying a fault zone that has feeder-zone potential. This could be a monster of a project and, with only 21 million shares outstanding, NPR has one of the tightest share structures you will ever come across. Given the success of Mr. Hinchcliffe at Kirkland Lake Gold, I suspect that he and his shareholders (many of whom were likely large holders in Kirkland) will have no trouble attracting capital or interest when it’s appropriate. Drilling should start late in Q1 at Black Horse and will target both high grade zones and bulk tonnage oxide ounces. That’s enough of an introduction to a story that’s still in its early days, but now you’ve heard of it, so keep it on the radar. I have big dreams for this one given the share structure, so here’s hoping.
Red Pine Exploration (RPX.V, last at $0.50)
This explorer is a relatively new gold position for me and I’m still waiting to see what kind of legs it has at its Wawa gold project, which is naturally near Wawa, Ontario. The project ownership was split for a long time between RPX and a family trust/estate for years, but that ownership quagmire was solved about a year ago when RPX finally became the sole-owner of the project. The Wawa gold project hosts a historical resource of 230,000 ounces indicated plus 470,000 ounces inferred at an average grade of about 5.5 g/t, but it’s barely been drilled below 300 metres. To that end, RPX has been busy drilling and has already extended mineralization some 500 metres down dip of the existing resource and also has doubled its vertical extent with high-grade hits as deep as 550-600 metres in new and existing zones. With four rigs running and lots of cash (~$10mm) in the bank, RPX is going to have a lot of new data (~25,000 metres) from drilling in 2022 and the geology is such that I think it could attract real attention if mineralization continues at depth. There are multiple prospective shear structures here and some very interesting hits are being found where the structures intersect one another down-dip of the existing resource. Smart money says this could be the next Island gold mine, and in that context, Alamos Gold’s (AGI.TO, last at $9.22) 19.3% equity holding would seem to make quite a bit of sense. Pierre Vaillancourt from Haywood is currently the only analyst with coverage on RPX with a $1.40 target price, but I’d expect others to join him in 2022 if pending results look anything like the early ones that have come back from Wawa. RPX is overdue to release assays from intervals bearing visible gold (VG) in holes completed in 2021 so stay tuned.
Critical Elements (CRE.V, last at $1.42)
Nothing new here… despite having its federal approvals, CRE is still waiting for its provincial approvals. Sometimes I wish that the workers in these departments realized that the market is a dynamic place where the saying “time is money” actually means something… and that taking longer doesn’t equate with doing a better job. The delays that the province has caused for CRE have undoubtedly held up project financing, offtake agreements, and potential strategic partnerships. As a Canadian, it’s embarrassing to see needless delays like this. The federal approvals were in place five months ago and this is an environmentally benign mining project that is supposed to help Canada benefit from the world’s Great Green Transition. What has happened to CRE is an illustration of the kind of inefficiency that has permeated government offices and decision making processes. With that venting out of the way, what I will say is that lithium prices are on fire and CRE is the best development stage asset that I can think of given its location, scale, modest valuation (at least I can thank the government for that) and a potentially short timeline to significant catalysts (starting with provincial permits, which although slow in coming, should come soon). CRE’s spodumene deposit is located in Quebec and is a key component of the province’s “battery metals complex”. 2022 should be a good year for this one as it starts to hit institutional radars. Given the move in lithium prices, the NPV of CRE’s Rose project likely exceeds $1B based on my back of the envelope math and that’s just for “Phase 1”. As a result, I’m content to sit with my stock and grumble about the government in the meantime.
Giyani Metals (EMM.V)
This is literally a copy and paste about what I said about this company in my last note as my view remains the same… Manganese. It’s the “M” in NMC lithium-ion battery chemistry. We’ve heard lots about cobalt and nickel, but no one talks about manganese… except people like the management team at Giyani. This company has a near surface, free-digging, very high grade manganese deposit in Botswana that checks all kinds of feel-good EV supply chain boxes. Updated economics on the project are due any time now, so battery metal enthusiasts will want to bookmark this one. The first pass on economics here looked very impressive. If the pending new study is as strong, I expect EMM will jump on the battery market train to higher levels.
Commerce Resources (CCE.V, last at $0.23)
This is in my farm-team category as I look for bottom-fishing ways to play rare-earth elements (REEs)… these are the elements that are needed for making the magnets that will power the electric revolution. REE supply is grossly concentrated in China and this has created an uncomfortable position globally after what we’ve just learned about the fragility of supply chains. CCE’s Ashram deposit is a big one (~250 million tonnes), is located in northern Quebec, and has been extensively studied as it moves towards pre-feasibility in Q4. The project is conventional in that the main REE host is monazite, a mineral that is coveted for its high Nd and Pr content. CCE did a PEA on Ashram in 2012 which showed a >$2B pre-tax project NPV on about $760mm in capex. Given that (a) the key revenue generating REEs have doubled or tripled in price since that PEA was done and (b) the PEA did not include a potentially valuable fluorspar byproduct (fluorspar is used in EV battery manufacturing), I’m thinking the PFS due in Q4 could be quite compelling for someone looking for a large, non-China, source of REEs. I may be wrong, but to me, this looks like a strategic mineral deposit located in a great jurisdiction; so I’m in the bleachers with a small position and cheering for it to get noticed by the market… just in case the sector heats up. I need to do more work on this, but looking at the chart I feel like I’m probably buying closer to a bottom than a top.
My only real “ag” exposure outside of Nutrien (NTR.TO, last at $90.31) is Verde Agritech (NPK.TO, last at $3.78). I’ve mentioned NPK before, so I won’t run through it again, but what I will say is that the chart has been as pleasing as the recent news from the company. On January 10th, NPK guided for 700,000 tonnes of sales in 2022 with full-year EPS of $0.50/share then and guided for 1.4 million tonnes of sales in 2023. That puts the stock at about 7.5x 2022 EPS and perhaps 3.5-4.0x 2023 EPS if all else is equal. There’s a significant ESG factor here that I can’t quite value, but even with its move up I can’t say that NPK looks expensive if you believe in the (fully financed) tonnage ramp that management says is on the horizon.
A Nickel for Your Thoughts
After a bidding frenzy for Noront Resources (NOT.TO, last at $1.08) and its currently-stranded Eagle’s Nest deposit that ended with a $600 million offer from Wyloo, I started thinking about nickel again. My current exposure to nickel comes via North American Nickel (NAN.V, last at $0.57), SPC Nickel (SPC.V, last at $0.155) and Magna Mining (NICU.V, last at $0.50). I still like the idea of FPX Nickel (FPX.V, last at $0.59), but the market seems to be slow to accept it. Maybe some other time I’ll dig more into the nickel names, but I mention nickel briefly here because there are not a lot of ways to play it and it’s through $10/lb already, so I think it’s time to start paying attention.
Lastly, I’d be remiss in not mentioning Talon Metals (TLO.TO, last at $0.74) here. Talon recently signed a nickel offtake deal with none other than Tesla (TSLA.US, last at $1,049). Granted Talon still has to permit, finance, and build its Tamarack project located in central Minnesota (the financing will probably be easier than the permitting), but having Tesla as a customer probably can’t hurt the process. Resource expansion drilling has been going well, with some remarkable high grade hits outside of the existing resource. Now that the initial Tesla-news-bump is a few days old, I may have just talked myself into buying back a little bit of this one.
Copper is acting well as continuing jitters about Chile and Peru have buyers thinking ahead. I can’t make a macro forecast for copper, but I know we are going to need a lot more of it in an electric future and that the way to expand supply tomorrow is to make today’s price higher. So far so good in the copper price department and names like Teck Resources (TECK.B.TO, last at $42.59) and Freeport (FCX.US, last at $44.08) are showing real leadership. My copper basket moves around a lot, but off the top of my head it currently includes Hudbay Minerals (HBM.TO, last at $9.88), Filo Mining (FIL.TO, last at $15.06), Foran Mining (FOM.V, last at $2.64) Arizona Metals (AMC.V, last at $6.11), and Surge Copper (SURG.V, last at $0.35). In their respective order, that stable of names includes a larger cap story trading at a big discount to NAV (with good zinc and gold kickers), an emerging global giant deposit/district in Argentina led by the Lundin Group, a Big tonnage VMS deposit in Saskatchewan backed by Prem Watsa, a Big tonnage VMS deposit in Arizona, and a right-sized copper deposit just waiting to be plugged into mothballed existing infrastructure at Imperial Metals’ (III.TO, last at $3.66) nearby Huckleberry mine complex.
It looks like the carbon market is going to be gigantic, so it’s time to start thinking about ways to play it. To me, “carbon” feels a lot like weed did before legislation made weed a real business (i.e., a handful of companies with business plans based mostly on projections of things that haven’t happened yet). At this point in time, with Carbon Streaming Corp (NETZ.C, last at $14.05) wayyyyy in the lead, the 2nd place trophy (outside of Advantage Energy, AAV.TO, last at $7.39) appears to go to Kevin McLean’s Star Royalties (STRR.V, last at $0.66) which is starting to do carbon deals through its partnership with Bluesource, a North American leader in the carbon offset credit market. Star Royalties has gold royalties as its “main” business, but it has created a fully-owned carbon-focussed subsidiary called Green Star Royalties which would seem to be a prime spin-out candidate sometime down the road. Green Star’s value could easily eclipse its parent company if it can capitalize on the coming opportunity in the carbon sector.
I can never cover it all, but if you’ve read this far, thanks so much for the continued interest. While 2022 could be a challenging year for the broader indexes in a rising rate environment, I’m optimistic that the case for hard assets remains strong. Yes, the Fed will raise rates and ease off the liquidity pedal this year, but in past cycles the market “breaking point” rarely occurs in the first few hikes, which suggests to me that once the covid cuffs are off there could still be some swinging from the rafters yet. I’m running with about 15-20% cash on any given day as I know there’s going to be a big tax bill coming this year, but while I’m keeping one eye on the exit (just in case), so far things are ticking along just fine. Like I said in the title — I figure that if it ain’t broke… don’t fix it…