Gold Stocks Poised for Breakout
Commodities / Gold and Silver 2010 Jul 08, 2010 - 01:24 AM GMTBy: The_Gold_Report
Chen Lin is an independent investor living the dream. Since December 2002, he's turned slightly more than $5,000 into nearly $1M through value investing and exceptional market timing. Now he believes gold producer shares are poised for a breakout. "Every gold producer is making an incredible amount of money, and the market doesn't appreciate that much. That's a very interesting phenomenon. One thing will happen—either gold has to come down significantly or gold shares will go up significantly. I believe it's the latter," Lin says. In this exclusive interview with The Gold Report, Lin shares some favorite gold producers and explorers, as well as some pulp and paper stocks he thinks have some upside.
The Gold Report: In 2002, you turned a little more than $5,000 into a portfolio worth close to $1 million in 2010. I am sure many people ask how you did that. Do you think you could repeat that success again in the current market conditions?
Chen Lin: It's one of the many accounts I am managing; in general, the accounts I manage have had similar performances; some more, some less. The results of my wife's IRA are published on miningstocks.com. There you can see it's pretty much consistent—about 100% a year average in the past seven or eight years. There are down years, like 2008; I was down by 5%; but in 2009, I was up 500%, so it was a very big year. The average is still at about 100%, maybe a little more.
TGR: You were down only 5% in 2008? That's pretty good for that year.
CL: Yeah, you can see the exact figure on the site. I lost about $50 of every $1,000 invested.
TGR: Do you think you could do it again in the current market?
CL: There's always a bull market somewhere; I am hoping this can continue.
TGR: What would it take to do that? How would you go about it?
CL: I don't focus on only one stock; I buy stocks in the sector that I really like. I compare all the sectors, their fundamentals and the stock valuations and the company's earning power, then I decide where to put my money.
TGR: And what did you decide?
CL: There was a period when I was in energy a lot and another when I was in base metals. Earlier this year, I was in energy and paper pulp. Those were actually a pretty big success. Right now, we have the Greece problem spreading all over Europe; and because of that gold will do very well.
In May, I started to advocate that people take money off the table. In early May, I was very rapidly selling. And then, when we had cash, I started buying gold stocks; I started recommending those in late May and in June.
Why was that? Because there was a very big market correction, and a lot of people were scared. People seemed to think there would be a repeat of 2008. However, I believe gold has much stronger fundamentals. And then people were selling in May and going away, just like many people on CNBC were saying. That created a very good opportunity to buy gold stocks in late May and June. When they finished selling, we went in and bought cheap stocks.
TGR: Another thing you mention in your newsletter is that after the Great Depression, gold stocks started their climb after the second market correction.
CL: Exactly, yes. That's another thing that really makes me feel confident gold stocks will likely soon take off.
TGR: When do you see that second correction happening?
CL: Oh, the second correction has already happened in the general stock market. You can see that the market's been very, very volatile since the Greece crisis, and spreading to the PIIGS (Portugal, Italy, Ireland, Greece, Spain). I believe the second correction is starting and, in the Great Depression, the major gold stocks took off just after the second phase. I hope that will repeat, maybe even be better; because before the Great Depression, we had gold-backed currency. This time, they're fiat currencies—paper currencies. And once people start to lose faith in paper currencies, gold actually is the only place for them to go. And during the Great Depression, gold had a fixed price; this time, the gold price can go much higher.
TGR: Your portfolio is heavily weighted in precious metals; what are some other sectors you like?
CL: One particular sector I really l like is pulp and paper. It's a unique sector with not a lot of people paying much attention. But there's a couple of trends that are very favorable for pulp; since the crisis in 2008, all the new pulp and paper projects were cancelled or delayed indefinitely, so there's no new pulp projects coming until 2012. In the meantime, the largest pulp and paper consumer is China. It's growing about 10% a year. You can see it's a surprising amount. Without much supply coming into place, the pulp producers can make a lot of money in the next three years.
TGR: What are a couple of pulp names that you're into?
CL: My pulp and paper picks are Tembec Inc. (TSX:TMB) and Mercer International Inc. (NASDAQ:MERC). Both stocks were my top picks earlier this year, and even with all the crises—with the crash—they're still trading much higher than my original recommendation, which I published just a day after the Chilean earthquake, which actually was devastating to the pulp industry. A lot of pulp mills were destroyed; that actually elevated those prices.
TGR: Alright, your portfolio has gone up something like 16,000% since 2002. You've identified precious metals as a sector that you want to be in. You see the second market correction as happening now, much like what happened in the 1930s after the big crash in 1929. But anyone can invest in gold stocks and not have your kind of success. What do you looking for in companies that makes you trigger on those stocks?
CL: Actually, you raise a very good point. Individual gold stocks didn't go as high as gold. The gold stocks are lagging gold, which is a very interesting phenomenon. You know, we've traded commodities for a pretty long time, and usually commodity stocks go up exponentially to the commodity price, because each time the commodity price goes up, the profit margin just goes up exponentially. For example, gold producers' average cost right now is probably around $500. Back a few years ago, in 2007 the gold price was $600; you make a little bit of money. Then in 2008 you have $800, and you make a little bit more. Now it's at $1,200. Every gold producer is making an incredible amount of money, and the market doesn't appreciate that much. That's a very interesting phenomenon.
One thing will happen—either gold has to come down significantly or gold shares will go up significantly. I believe it's the latter; so, we could have a phenomenal gold run. I don't know when, but it could happen this year; it could happen next year. People will look at it and say, "Wow, that's a great run on gold stocks." It hasn't happened yet; we have actually seen gold stocks come down from the beginning of the year. As I was telling my subscribers, "Okay, just buy these bargains, buy these gold stocks." Traditionally, gold stocks are weak in June, July and August. In these three months, I want to load up as much as I can on gold stocks and I'm looking for a breakout after.
TGR: But are you looking at cash flow, earnings per share, ounces in the ground, management, jurisdiction, metallurgy—what are you looking at?
CL: That's a very good question; it's changing from time to time. Of course, jurisdiction is always very important because if someone comes to confiscate your mine, you're finished. Right now, we are in a bear market; cash is king, so I want to look at cash flow more heavily. If you have a significant cash flow—especially free cash flow—after all capital expenditures are paid, that's real money. That is very important to a company.
However, if market conditions improve and we have a blowout gold market, then you may want to look at how many ounces are in the ground—those will weigh more and more heavily (in an investment decision). But right now, we're in a defensive mode; so we're putting more weight on cash flow.
TGR: Another advantage you have over other newsletter writers is that you know people on the ground in China. We're told all kinds of things about China here, some of which are true, some are partially true. What's really going on there?
CL: The Chinese government has tried to put on the brakes, to slow down the red-hot economy. At some point this year, they're going to let their foot off the brake; they don't want the economy to really go down. They just want to slow it down. They're trying to crack down on the real estate speculation; the housing prices are coming down, which is a good thing. They probably want it to correct 20%–30%. It's creating some interesting opportunities for traders.
TGR: You said it was creating some interesting investment opportunities. What are some of those?
CL: Well, Wall Street and CNBC always exaggerate—they see a small correction, and they say it's a crisis. Part of it is the news media always wanting to catch your ear. But if you know what really goes on, you can buy when everybody thinks something is finished. Then you sell when sales start turning up, and then everybody in the news media says, "Oh, the correction is over!," and you can take profits. So, that's how we create a lot of trading opportunities.
TGR: You go against the popular sentiment? Is that what you do?
CL: It's not exactly against; I go with my own sentiments. When I see it is overvalued, I sell and, when I see it as undervalued, I start to buy. The more undervalued, more I buy. But sometimes when it goes down, you don't know where the bottom is.
TGR: What are some companies that are benefiting from the current economic conditions in China?
CL: Pulp and paper stocks will benefit. And the energy stocks—I owned some, and I want more focus on land-based drilling after the BP disaster. Actually, I sold all of my ocean drillers when news of the BP disaster first came out. When they first said the oil leak was 1,000 barrels, I started selling everything because I know it is impossible to leak only 1,000 barrels per day (bpd) in that gusher. I'm a pretty cautious person and, when I see that something goes wrong, I try to get out as soon as I can. That's my own money.
TGR: Your largest shareholding is in OceanaGold Corp. (TSX:OGC; ASX:OGC). In describing that company, you said in a recent newsletter, "It's not a homerun, but it's an easy double." Tell us why folks can double their cash with OceanaGold.
CL: My subscribers know that I recommended Oceana last year at $0.43. Right now, it's trading at about $3. It was my top pick last year; it will continue to be my top pick this year. The reason is pretty simple—this company has become a unhedged producer, producing about 300,000 ounces a year in gold. The company's (cash cost) guidance was $500/oz., but I think they tried to under-promise. They were producing at about 300,000 oz. last year at a lower cost. Compared with other producers on that scale, you can put OceanaGold neck to neck with other companies, like Semafo Inc. (TSX:SMF),New Gold Inc. (TSX:NGD; NYSE.A:NGD), etc. These companies are trading at $2–$3 billion market cap right now, and Oceana is at $700 million. That's why I say it could easily double.
Part of the reason is that they just unwound all their hedge contracts; this quarter will be their first unhedged production. Their base is in New Zealand, a very politically safe place. The company just got over a crisis; because of the credit crisis, they couldn't finish a mine. But now, they have three mines producing—all doing very well, and two of the three were built in about as many years. They have brand new mines generating incredible cash; I calculate more than $200 million per year at the current gold price. They're trading at about 3x cash flow, which is incredible; and each year, they have more than $100 million in free cash flow—that's after all the expenses. They're just going to continue to grow; and they can organically grow their existing projects and increase their gold production.
TGR: Do they have some debt? That might be one thing keeping their share price down.
CL: The total debt is $165M Australian (AUD), but it's due in two to three years and they generate more than $200M cash flow per year; so that debt can be easily serviced. I was talking to the company to see if it had the cash to buy back those debts, which are actually convertible at about AUD$4. I don't want to see those become converted; $4 per share is higher than current stock price, but I still don't want to see the dilution.
TGR: Is there growth potential?
CL: Yeah, they have another 120,000 oz. gold mine fully permitted and half built. They were forced to stop it in the midst of the credit crisis when their credit line was very tight. Now, they have a lot of cash so have a lot of options.
TGR: What mine is being ramped up?
CL: It's called Didipio—a gold/copper project in the Philippines. They also have three mines in New Zealand. They own a very, very large property in New Zealand where some 20 million ounces of gold have been mined before. Then there's very large exploration potential; they can do a lot of good things with their cash flow. They can do a lot of exploration; they can make their current milling more efficient to increase production. I wouldn't be surprised if New Zealand production increased by 10%–20% in the next couple of years. It should be clear that that's their future, so that's why I feel very comfortable about them.
TGR: Well, not too far away from New Zealand is Australia where Crocodile Gold Corp. (TSX:CRK; OTCQX:CROCF) operates. Its shares have been down a bit lately, but you still see upside. Tell us a little bit about that company.
CL: The reason I like the stock is because it's gotten cheap. When I talked to the company a few months ago, the stock was trading at twice as much as it is now. Right now, it's around $1.20. The company recently closed a private placement (at a price of CDN$1.30 per common share for aggregate gross proceeds of CDN$20,020,000), so it seems to me a good area to buy the stock. Of course, in the summer anything can happen; the stock could fall even more. I would love to see that and buy more. To me, the beautiful thing about the company is that everything is put together. Right now, they have three mines producing, with one mill running. Later this year, they'll have another mine and another smaller mill going. This year it's 100,000 oz. of gold at $700, and next year it will be 200,000 oz. of gold below $600. That's with two mills, and they can continue ramping up the production all the way to 400,000 oz. of gold production. It generates very good cash flow; the only thing that can bring the stock down really is the gold price. If you believe the gold price is not going down, then even at the current gold price they will make a lot of money.
There are three mines, so it's not like if there's an accident your operation shuts down. They will have two mills, four mines by year-end. I envision it will be a big, very nice gold operation. Unless there's something really, really screwed up, which I doubt will happen.
TGR: Cash costs of $700/oz. That's a bit high.
CL: Next year, it will be 200,000 at below $600. It is leveraged to the gold price. As Crocodile goes to more mills, more mines, it wouldn't surprise me if the costs come down even further.
TGR: Another name you own is Premium Exploration Inc. (TSX.V:PEM), which is about to release some drill results from its project in Idaho. You buy it, you sell it, you hold it—tell us about your Jekyll and Hyde approach to that company.
CL: I bought it at $0.32, and then I thought they lowered the private placement to $0.25/share, so I sold some. But I am keeping the rest. I think it did dip to about $0.30, and now it's about $0.36. It's doing well, so I intend to hold it. It doesn't matter if they lower the private placement. I am afraid that those people who took the private placement will flip their shares. If they flip, then the $0.25 will be the new bottom; around that, maybe $0.26, $0.27, and you buy it at that price.
TGR: But that's a little different than your usual style because Premium is an exploration play—not a producer.
CL: Exactly, exploration plays; I never put as much money into exploration as a producer. With a producer, I know the cash flow, I can feel comfortable, and I can put in 10x more money in the producer than the explorer. With an explorer, you have to be nimble to ensure you have a solid bottom, and then you hold into the drilling results. As you mentioned, Premium has some very exciting drilling results coming out, and I hope they are good.
TGR: What are some other gold companies you're following?
CL: The top holding is OceanaGold; I'm also very hot on Metanor Resources Inc. (TSX.V:MTO). They're going to have a 43-101 coming out; it should be at the end of this month. This will be a very, very important milestone for the company. I believe they have a huge gold discovery there. So, I am pretty bullish and buying a lot of shares ahead of the 43-101. They're already producing about 30,000, 40,000 or 50,000 ounces a year; but it's more about this new discovery they have.
TGR: Any others?
CL: I also have Alexco Resource Corp. (TSX:AXR;NYSE.A:AXU). It's going into production in a couple of months at very low costs—almost zero if you use their base metals as credits, and it's very high grade. I like this company, this kind of stock. It's a low-cost silver producer that's not very dependent on the silver price.
The other one is Golden Minerals Co. (TSX:AUM; NYSE.A:AUMN). They have some very exciting discoveries down in Argentina and very good drilling results like 5,000 grams per ton (gpt) over three to five meters.
TGR: How much?
CL: 5,000 gpt silver. It's one of the highest grades in the world, and they continue to drill and continue to make high-grade discoveries. That's also one of my top silver pick.
TGR: Any thoughts before you leave us today?
CL: I am holding Alexco, Golden Minerals, Crocodile and the other gold stocks I like. We could have an incredible run for gold stocks; it will happen at some point. It could be this year or it could be next year, but I see it coming.
Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc., publisher of J. Taylor's Gold, Energy & Technology Stocks newsletter and Roger Wiegand's Trader Tracks. Using his wife's Roth IRA account, Lin invested $5,411 in December 2002. That same account was worth $869,846 at the end of May 2010, without any adding any cash to it. You can see his portfolio chart here.
A doctoral candidate in aeronautical engineering at Princeton, Chen found his investment strategies were so profitable that he put his Ph.D. on the back burner. Chen worked in the Internet and computer area where he founded a few start-up companies. After the tech bubble burst of 2000, Chen was able to move his technology portfolio into the resource sector with considerable success. Chen employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis. To subscribe to Lin's What Is Chen Buying? What Is Chen Selling? newsletter click here, or call Claudio Bassi at (718) 457-1426.
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DISCLOSURE:
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Crocodile, Evolving Gold, Alderon, Rodinia, Strathmore and Timmins.
3) Peter Grandich: I personally and/or my family own shares of the following companies mentioned in this interview: Evolving Gold, Silver Quest Resources and Alderon. I personally and/or my family am paid by the following companies mentioned in this interview: All.
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