Unbelievable Values in the Commodities and Resources Sector
Commodities / Resources Investing Nov 21, 2008 - 04:35 PM GMTBy: The_Gold_Report
In this interview with The Gold Report, Sprott Resource Corp. President and CEO Kevin Bambrough—who is also Market Strategist for Sprott Asset Management Inc. —talks about signs of decoupling he sees, commodity price fundamentals he doesn't see, and a catalyst to reignite the markets he hopes to see. He also talks about once-in-a-lifetime opportunities in the resource sector on the horizon for investors. He's proven his mettle in this market as well as his eye for excellence in investments. In a feat as worthy than any alchemist in history, the company managed to turn a $55 million investment (in PBS Coals) into about $240 million. Kevin readily admits, “We've done—in this market—phenomenal things.”
The Gold Report: Your website says that Sprott Resource Corp. (SCP) enables individual investors to gain access to private investments in the natural resource sector by partnering with companies on projects that require funding and development. Given current capital constraints in the marketplace, either you are exceptionally well positioned or there's a delay in how you allocate capital. Can you just speak to what you're doing in the short term here and then about long-term plans?
Kevin Bambrough: Short term we're basically sitting on a pile of cash that we've built up a number of ways. This summer we had a warrant incentive program that brought in close to $90 million and we spent little of it because we saw the market turning. When we took control of the Resource Corp. last September with about $66 million in cash, we invested the majority of that money in PBS Coals (PBS.TO) . We then sold our stake in PBS Coals in two stages this year—first to the public on a secondary offering and most recently we sold our remaking stake to OAO Severstal out of Russia on its takeover of PBS Coals for total proceeds of around $240 million.
So a substantial amount of cash came in this year and we're in fantastic shape. We put a bit of that money to work—a little bit of a gold ETF and a silver ETF, along with a small portion, probably about 5%, in some public securities. As for the precious metal ETFs, we plan to convert them into actual physical gold and silver as a sort of a long-term cash alternative. We view gold as cash.
TGR: How about partnering with companies on projects that require funding and development? Have you put that on hold for the time being?
KB: No. We recently funded an oil and gas company, Waseca Energy Inc., with about $27 million and we own almost 80% of that company. It is essentially cash at this point, but it is looking to begin drilling some of its existing properties this fall and will also be looking to make other acquisitions.
Essentially, we're all cash and a bit of gold. The companies in our public portfolio that are not non-gold stock related or actual metals consist mainly of cash as well. I just think we're in the best position that we could be in considering what's happened in the market. Having a quarter of a billion dollars available to put to work now is like having a billion dollars or more last summer.
Ironically, when we first took control of the company last fall, our stock traded up to around $3 a share we had only about $1.50 in book value, so it was trading at two times book which was almost all cash, in a very frothy market with not a lot of great opportunities to put money to work. I guess it's a sign of how optimistic people were then. We've done—in this market—phenomenal things. We basically started the year with $66 million and realized a gain of over $180 million on PBS alone.
TGR: Unheard of in this market.
KB: We're very pleased at the gains we've made but it's a shame that the market is rewarding us by trading us close to 60 cents on the dollar relative to book value and we think we should be trading at a significant premium to book. The long-term track record of Sprott Asset Management and in turn Sprott Consulting justifies that. People are getting a great opportunity to purchase our stock at such a discount to its value. In fact, the opportunities opening up to us in the next six to 12 months are once-in-a-lifetime opportunities in the resource sector.
TGR: Before you tell us more about those once-in-a-lifetime opportunities, could you put on your market strategist hat and give us your thoughts about the timeframe in which the market will turn around and start rewarding companies like yours — well-situated companies that are trading even below cash now—with an appreciation of stock prices?
KB: I hope to close this valuation gap in our stock in the next few months. Part of the reason I think we'll be able to do that is that we've basically been in a quiet period. I've been avoiding interviews since about mid-May when PBS, our main asset, was going public and then engaging in negotiations to be sold to Severstal and right up to getting that deal closed.
Our earnings just came out. When people look at our balance sheet and see what we've done and the word gets out about our strategy going forward and that we've been successful—extremely successful—in implementing our strategy and people appreciate our opportunities to be even more successful, hopefully they should be at least optimistic enough to trade us close to book value. Ultimately, as the market turns and we announce where we've put money to work, I expect people to become very optimistic on our prospects of delivering profit and value growth for shareholders over the next few years.
TGR: Could you segment your views on those once-in-a-lifetime opportunities into two areas? First, when do you see the natural resources sector turning around, and will that be sooner or later than other sectors? Secondly, what are specific companies in the sector will provide these opportunities?
KB: One of the reasons I first started the Resource Corp. is that I didn't find much value in the public markets last year and I was looking for opportunities to arbitrage between private and public markets. The world's changed so much since then; there are now just unbelievable values in the public markets. A number companies out there have spent considerable amounts of money over the last number of years—vast, vast sums—building infrastructure, mines and mills, making huge capital investments. Now they're trading at pennies on the dollar to what they've spent and the assets they've accumulated. In the current metal pricing market, they're cash burners and uneconomic because things are so depressed. I'm not concerned that these prices may stay depressed for some time. I'm more concerned about the long term.
There are always cycles in the commodity markets and you get opportunities to buy assets extremely cheaply during the lows. That's when you want to put your capital to work. So we're cashed up and ready to put our money to work. If we can buy a company for pennies on the dollar for, say, its mill and I get the ore body and the infrastructure for free and I can let it sit on care-and-maintenance until times improve, I think we may get the chance to make 10 or 20 times our investment over a five- to ten-year period—an absolute killing. This is the market that I've been waiting for and hoping for.
I was surprised how far the first big run in the bull market in commodities went. I'd been very cautious and waiting for a correction for quite some time, and now we're getting it. Going into this year, I was really only excited about metallurgical coal and agriculture, which is why I focused on PBS and getting our phosphate asset in Peru moved along. I still am very optimistic about the long-term value that's going to be shown in that asset because the fertilizer market looks very bullish long-term.
TGR: What are some of the other commodities you're optimistic about?
KB: At this time, I actually like the fundamentals of only a very few commodities in terms of the chances to make money producing them. But I think that things will change over the next year or two. It will take some time, but now is the time when you have to be smart with your money and accumulate—buy dollars for 10 cents and get a lot of Blue Sky for free. That's what we intend to do.
TGR: What would you advise investors, our readers? Is it company-specific without looking at the broader sectors? Or do you think some sectors will turn first and then they should be company-specific within those sectors?
KB: I have a lot of trouble giving investors advice because it is such a difficult market. It is a difficult time. It's really a once-in-100-years situation that's going on and it is so volatile. There is so much risk in anything you do and you really have to be patient. I think most people should be giving their money to a good money manager with a great long-term track record to take advantage of this market and invest in good companies with strong balance sheets.
I think oil and gas is going to do very, very well over the next five to 10 years. I believe in peak oil and I think the theme will play out. Buying quality operating companies that are reasonably low-cost producers is the way to go in a depressed market. You don't need to gamble and go for the high-cost producers that give you more torque to the upside.
In these times, you're better off playing safe, making sure you survive. It's sort of like avoiding margin. You shouldn't be buying stocks on margin. You should be buying the lower-cost producers when they're this beat up and survive this market. Perhaps, move into some higher cost producers later, once you can really see that the market's turning. But there's not much sign of that yet in any of the commodity markets that I see. I think definitely uranium has been rinsed out; there's some value there, and we're starting to look at companies and nibble away. But there are very few prospects that I have a lot of enthusiasm for.
TGR: In the uranium sector?
KB: Even in the uranium sector. In other sectors I have almost no enthusiasm.
TGR: You liked coal as we were moving into this bearish market in '07. How do you feel now that we're really in the middle of a bearish market?
KB: I get tempted when the stocks are down 70% or 80%. Again, I would avoid higher-cost producers. They may get into real financial difficulties because it looks as if some settlements for next year's metallurgical coal prices and even thermal prices will be significantly lower. You just don't know how long companies are going to be in a position where they're forced to burn cash. There's such a dramatic drop in demand that supply hasn't even begun to be reduced enough to balance the market out. When we were investing in PBS Coals last year, many companies were on the ropes and mines were shutting down. PBS was one that was going to survive no matter what. We got a gift with so many troubles cropping up in the coal market. Such as problems in Australia and South Africa and China that really helped light that coal market on fire and give us a chance to exit with a big win.
In a general sense—you name the commodity—I want to see the market improving before I invest. Unfortunately, there's almost no commodity market that looks today as if the fundamentals are improving for it. Our balance sheet and our position show that view. We're sitting in cash and we're waiting. There's a chance of a really sharp rally at year-end, but I don't think it's one where I want to commit a lot of capital because I'm focusing more on being long-term oriented and guaranteeing as much as I can that we will make money and continue to grow and be very profitable going forward.
TGR: People have pointed out that you're quite knowledgeable about geopolitical and geographical areas. While you've explained that you don't really see signs of commodity markets improving and want those signs before you invest, how do you weigh in the China factor?
KB: Wearing my Market Strategist hat, the latest fiscal stimulus package China has put forward could be something we point to years from now as the first real sign of decoupling between the USA and Europe and China and other emerging markets—especially the commodity-producing markets. Over the next year, I think China will take stronger steps than what they've disclosed, and ultimately, when China decides to spend hundreds of billions of dollars, they're spending hundreds of billions of U.S. dollars because they have a big cash buildup in Treasuries, GSE debt, things they have no business owning. The thought that their GSE bonds and long-term U.S. government debt will have greater buying power in the next 10, 20, 30 years—I just don't believe it. They need to put that money to work now; it would be very smart for them to go out and acquire things.
If China pursues big infrastructure projects it will end up helping commodity producers. They'll do more business with Australia, Africa and Brazil. That's where the flow of funds will have a beneficial impact, and if anything, it will drive up prices and hurt the USA. At some point, it's also going to affect long-term interest rates in the United States if China no longer buys U.S. government debt. That's why I see this as the start of the decoupling, where China spends money that helps the commodity-producing countries, but bit-by-bit leaves the U.S. out of trade loop between China and these other countries. I think that this is potentially a real sea-change event.
TGR: If China takes your advice and basically starts investing its U.S. dollars in infrastructure, would that mean that those providing the infrastructure—Africa, Brazil, India, Australia—would have to do business in U.S. dollars? And, if so, does that keep the U.S. dollar high relative to other currencies?
KB: I think the U.S. dollar becomes almost like the hot potato no one wants to hold. As soon as a country gets dollars, if they don't want to build up the reserves, they move them off. I think we'll start to see that trend. I'm very, very bearish on the U.S. dollar and most Western currencies over the next decade or two. The biggest bubble, which doesn't get spoken of enough, is the fiat currency bubble—the fact that paper currencies, especially the U.S. dollar, are given so much buying power when they're just being run off a printing press. That's ultimately the biggest bubble of all. There will be a day of reckoning for it for sure.
TGR: Do you put the Canadian dollar in that very bearish camp as well?
KB: I think the Canadian dollar is going to be much better off than the U.S. dollar just because it is viewed somewhat as a commodity currency, but it will weaken against gold and all commodities over the long run. If countries like China diversify away from their government bond holdings, increase their holdings of precious metals and realize that there aren't enough precious metals to go around for them to diversify in a really meaningful way; I anticipate them putting more effort into building strategic reserves of other commodities, whether it's increasing their oil reserves or other metals. There's been a lot of talk lately about China stepping up and starting to replace its copper reserves at some point in the next year. I mean, really, why not stockpile these things instead of U.S. government debt and GSE debt? They really have to deal with all the Fannie and Freddie paper; why see value in that, I don't know.
TGR: If China starts increasing strategic reserves, wouldn't they also want to wait on some commodity market improvements you alluded to?
KB: That is definitely one of the catalysts I'm looking for and since most commodities are already trading below average operation costs now is as good a time as any. There's been some talk about Russia potentially pushing down money into some of its major companies such as Gazprom and giving them capital to go out and spend. That's an excellent strategy that China and other Asian countries should employ instead of creating sovereign wealth funds.
The trend now seems to be hiring a bunch of money managers and giving them vast quantities of money that they're supposed to go out and invest. They'd be way better off giving capital to large companies and let them put it to work by going and acquiring. Give your major oil and gas companies capital and say, “Go out and grow. Go out in the world and buy more reserves for the long term use of the country.” There's more chance that those companies will put the money to use wisely than the typical sovereign wealth fund manager. If you look at some of the big decisions that have been made by the sovereign wealth fund managers over the last year, they've typically been bad decisions—funding banks and brokerage firms and they are taking big hits on those investment.
TGR: If you look out three or four years, what geopolitical regimes will emerge from all this turmoil as the leaders?
KB: Are you asking if China and Russia will be super-powers?
TGR: Yes. Will they come out having a greater impact on the financial markets than they do now or will it be some other countries—like Canada?
KB: Going forward it's going to be mainly China, Japan, and countries with large cash balances or with large reserves built up. I also think of the influence of Russia as the largest oil producer in the world, along with Middle Eastern countries; they're going to have a lot of say with respect to currency and trade.
In a general sense, they'll be a lot of growth in Australia, Africa and South America in terms of their commodity production and their influence. But I think that really the nations with current account surpluses are the ones most likely to dictate how things are going to develop and, potentially, how deep this global recession is going to be. If they decide to really start spending the money they've built up, they're the ones that can do it, to really reignite the markets.
In my mind, the monetary actions being undertaken are just so irrelevant to the underlying problem, which is complete demand destruction from global consumers that have been spending beyond their means for many years. The only way to reverse the course in the deleveraging process and the problems in the financial system is to have massive fiscal stimulus and fiscal spending where the government is replacing the drop in consumer spending in a large way that will, in turn, create jobs, allow people to keep spending at least what they're spending today. On the whole, you'll be able to create a growth in demand for things. Right now we're on a deflationary path unless these measures are put in place very soon.
TGR: Do you think our new administration in the U.S. will be able to do that?
KB: I believe they're going to try, but potentially things will have to get worse before they step up to the measures that are really needed. The amount of the spending that needs to be approved—we're talking trillions of dollars over a few years in spending packages. It would be unpalatable, I think, for most members of the Senate and House to approve these types of measures in the timely fashion, so we'll have to get more desperate first. There will have to be more weakness forcing people to take drastic measures. What I anticipate is another round of weakness in 2009, and more shutdowns. We've already seen many projects getting canceled or delayed. Supply will finally catch up to demand in terms of shrinking enough, and finally governments will give up just the monetary measures they've been doing and really start stepping up on the fiscal side.
Then it'll overshoot the other way, in terms of triggering commodity shortages that will set up—for late 2010, 2011, 2012 maybe—really wild markets to the upside for commodities as the world tries to deal with shortages. And I think they'll be competition again for resources and diversification out of bonds into things. People are going to realize that that's the trade for the next 20 years. They'll get out of long-term bonds, accumulate real assets and not worry about nominal prices because of the volatility. You'll want to just own things; at least you feel comfortable if you own things debt-free. That's wealth. Let's just forget about what the prices of things are on a day-to-day basis, as things swing like we see the markets doing every day.
TGR: Earlier on, you indicated that you have some holdings in gold ETFs and that you're considering converting those to physical. What's the impetus for that?
KB: It just comes down to trust. We've seen a lot of drastic moves and restrictions in the past. Gold ownership has been restricted in the past. I'm concerned that restrictions will be put on it again at some point, that one day the powers-that-be tell us we can't short stocks that they'll tell us what we can and can't own. If you want to hold a portion of your money in gold for the long run like I do, hold it in actual gold and hold it yourself. Hold it where it's least likely to be taken away from you.
TGR: What about alternatives such as James Turk's GoldMoney and the CEF in Canada?
KB: These are likely sound products for some people and there are reasons to own some of these things in a 401(k) or RRSP. But from my perspective—I mean, I have the ability to just own the physical and it's not a huge cost relative to the extra security it gives me. I prefer to own it.
TGR: Any last comments?
KB: Only that Sprott Resource Corp. is perfectly positioned capitalize on this market melt down and make exceptional returns going forward. We couldn't be in any better position than we are.
Kevin Bambrough earned his stripes as a marketing strategist focused on coal and uranium mining sectors for Sprott Asset Management—which he joined six years ago as a research analyst. Then he took on the additional roles of President and Chief Executive Officer of Sprott Resource Corp. in September 2007, just after its evolution from General Minerals Corporation. SRC makes direct and indirect investments in the resource sector, including minerals, oil and gas, water, forestry and agriculture. Always on the lookout for new trends and investment opportunities, Kevin also pays close attention to global economic activity, geopolitics and commodity markets. Global Resource Investments founder Rick Rule describes him as a “smart guy…the one guy who didn't get caught naked when the tide went out.”
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