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Oceanagold: Don’t Confuse the Headline with Cash flow

Over the last few weeks I have bought back a reasonably sized position of OceanaGold. This after having been out of the stock since the day of their Q2 update. When the Q2 update came out I took one look at the cash cost number ($900+) and one look at the production number (60,000 oz) and figured it was best to run to the sidelines and wait for the inevitable shakedown to pass.

That turned out to be a good decision.

When I read bad news, I have found it is usually better to sell first than it is to wait for the reaction to play out.  It is better to “panic”.   Why you would buy and hold a stock that you know is sure to go down, even if it is only in the short run?  In OceanaGold’s case, it was clear that at $2.70 or even $2.50, the share price was too high given the severity of the quarter.  The stock had traded to $2.20 only weeks before news of the quarter came out.  Certainly one could expect it to trade to at least $2.20 once such news was public.

And it did. The stocks traded all the way down to $1.80 in fact. I was glad that I had “panicked” on the morning of the press release and gotten out at $2.58.

But one has to be careful not to confuse the reaction with the facts. The initial market reaction can be based on the inefficiencies of investors/speculators who do not read past the headline, do not know what they own, or are selling on technicals. The trick, I think, is to understand enough to both know how bad the bad news will be taken, as well as how bad the news actually is.

In OceanaGold’s case, the perception was clearly going to be a short term drag on the stock. The headline numbers were awful and that is what is most important to most investors. Equally important though, was the knowledge that the details of the quarter were not quite as disasterous as they appeared at a glance.

The majority of the miss from the quarter can be attributed to three reasons. First, the New Zealand dollar appreciated far further than I think anyone has expected. Second, the mine plan is causing the company to expense more costs. Third, they lost some of their underground workforce.

There is, of course, nothing OceanaGold can do about the New Zealand dollar.

However the latter two problems are worth expanding on.

The issue with mining costs took place at Macraes open pit. The problem, as the company explained it, had to do with a change to the mine plan and the effect it had on the accounting treatment of strip mining. When the company is pre-stripping a new orezone, the company can capitalize that strip. It will show up some time later as depreciation on the balance sheet. However once the company reaches a new orezone, all strip needs to be expensed as it is incurred.

What happened in the second quarter is that there was far less pre-strip incurred then has been the case in previous quarters. And so most of the costs of mining were expensed directly on the income statement as opposed to having some of those costs expensed.

More specifically, the original mine plan had the Company mining an area (stage 4) of the open pit that, after drilling, was determined to be uneconomic.   Some of the mining fleet was supposed to be utilized prestripping stage 4 but because the area was determined uneconomic the fleet was used instead for waste mining of stage 5.  Because the ore from stage 5 is already accessible, this waste mining could not be capitalized and had to be expensed.

As an aside, it’s interesting to note here how this scenario demonstrates how cash costs are not really cash costs. Cash costs are actually the expensed portion of costs for that particular period. Depending on the accounting treatment, a company could spend much more cash in a quarter than what gets attributed to cash costs.

In the case of OceanaGold, the best way to see this effect is to look at the total cash outflow that OceanaGold has been spending on producing its mines over the past few years. This cash outflow includes both expensed production costs (the costs on the income statement) and capitalized production costs (the pre-stripping that only shows up on the cashflow statement). This is shown in the chart below.  Now unfortunately you can’t just look at Macraes alone.  The cashflow statement gives the combined capitalized costs of all operations.  But still, you get the basic idea of how costs were higher in Q2, but not as much higher as the cash costs would suggest.

The key point to be made by the graph is that while cash costs per ounce increased a whopping 25% quarter over quarter, total mining costs, as shown in the graph, increased 6%.

To get an idea of just how much money was deferred in the second quarter, when compared to previous quarters, the following chart plots total capitalized production costs on a quarterly basis. You can see how relatively little was capitalized in the recent quarter.

So really, from a cost of mining perspective, OceanaGold did not have nearly as bad of a quarter as the headline appears.  Make no mistake, it also wasn’t a great quarter, but it wasn’t nearly as bad as the headline.

At Reefton, management said the problems are entirely attributable to workforce turnover. They had a bunch of their miners quit, and the new miners weren’t as efficient. So they had to mill low grade stockpiles. You can see the low grade milling in Q2 versus previous quarters below.

What is somewhat puzzling about the reason given is that when you looking at the mining output at Reefton over the last few quarters, it really doesn’t suggest that severe of a deficiency in ore.  And from the figure above, mined grade for the quarter was actually quite a bit higher than milled grade (~1.8 g/t versus ~1.4 g/t).

I’m not really sure what to make of this.  Either A. they’re lying about what the problems are, or B. the problems were more temporary than the company is letting on and recovered even during the quarter (they said Reefton wouldn’t fully recover until Q4)

I think the more likely explanation is  that they are quietly hedging their future expectations.

Management also said they are bringing on-line the smaller Souvenir deposit at Reefton. This is somewhat interesting. Souvenir is a fairly narrow, almost vertical vein that hosts about 10,000 oz of reserves and another 30,000 oz of resource. The grade is somewhere between 3g/t and 4g/t; based on drill results it is probably closer to 4g/t but because there is sparse drilling at Souvenir the auditors decided to err cautiously.

Souvenir should help make a dent in cash costs at Reefton by bringing up the overall grade through the mill. But given the small size of the deposit, this is not really a long term solution to the labour force issues. Those need to be (and hopefully are being) addressed.


The thing about OceanaGold is that they are just so cheap compared to their peers. Therefore, if you can’t discount the company’s value because of major operational issues (which I have tried to show is not the case) then there is just no reason for it to be trading as cheaply as it is.

BMO wrote a great report on the gold miners a week ago.  OceanaGold was included in the comparisons.  Below I have cut and paste a couple valuation metrics that BMO used in a recent report on precious metal miners. These comparisons show clearly just how undervalued OGC is relative to its peers.

The company trades on metrics that are only comparable to low caliber junior miners and larger miners with high cost operations that cannot generate cash flow. Heck, there are some miners that haven’t consistently generated cash flow that trade at a premium to OceanaGold. Its ridiculous.  OceanaGold has consistently been generating between $30M and $40M of operating cash flow.  They should be able to bring on their next project Didipio, without having to raise any money and while maintaining a decent cash balance.

As I’ve tried to point out above, while the company has had some operational issues, these are by no means debilitating. Moreover, the company has a strong growth profile, with Didipio expecting to add to gold production at low costs (because of copper by-product credits) in a little over a year. The company should, if anything, be trading as a growth story, not at the tremendous discount that it is given.

So I bought a position. We’ll see how it goes.


Week 8 Portfolio Update


My portfolio is down a little more than 5% since its inception on July 1st.  Given the ill-time nature of that inception, that is not too bad. The TSX is down about 9% in the same time frame.

As I have previously discussed, this week I sold all of the Leader Energy Services from the Portfolio.  I also sold my stake in Xenith Banchsares and half of my stake in Oneida Financial.   I added to my position in Argonaut Gold on Wednesday when it dropped back below $6.  I also added to OceanaGold on the same day.

My cash position is still lower than I want it, and it is lower in percentage terms than my cash position in my actual account. There are two reasons for this.

The first reason is that I keep adding to my gold stocks.  I’ve built up a large position in Argonaut Gold now, and I have a reasonable position in OceanaGold again. I want to write up on both of these stocks at some point soon.  For the moment suffice to say that Argonaut Gold is trading at a valuation below its peers yet has a above average growth profile for the next few years.  OceanaGold is trading at a valuation well below its peers and its second quarter results, which crushed the stock, were not as bad as they look at first glance.

The second reason, which I have already alluded to in a previous post, is that in my actual account I like to trim positions over time, selling 10% every day or two, rather than all at once.  This doesn’t work great in the practice account, because the amounts are small (its only a $100K account), and the commissions are higher (they are $9.95 versus the $6.95 that I actually pay).

In the first month I was following my account moves exactly and I found that I spent over $200 on commissions in the practice account.  That’s over 2% of the portfolio annualized.  So that wasn’t going to work.

Therefore, in the practice account I have decided to buy an  sell stocks in larger blocks.  The downside of this is that I can end up with smaller or larger positions in the practice account than I would like.  This is the case at the moment.  In my actual account I have smaller position percentage-wise of Equal Energy, Lydian International, and Arcan Resources right now.  I have a larger position of Jaguar Mining where I have been buying on dips in small amounts.

…Couldn’t Stay Away

I couldn’t stay out of Gramercy.  I bought back in yesterday at the end of the day, at $2.80. I sold more Oneida Financial to keep my overall cash position the same.

I know, my decision making is flailing a little here.  I admit, I’m finding it difficult to make decisions here.  I see plenty of opportunities out there.  Even beyond the stocks I own.  There are oil companies, for example, trading at a third of what they were a few months ago.

Take Emerge Oil and Gas (  Does it deserve to have been cut down by 60% in a few months?  Oil prices are still at $80/bbl after all.  The company’s production has declined slightly but nothing too severe.  Still, a 60% decline in share price?

There are lots of stories like that out there.  Lots of stocks that I would jump on in normal times.  But as I wrote about last week, I don’t think these are normal times.

The latest evidence I’ve read describing the lack of solidarity in the Eurozone came from this FT article.  Don Coxe said on his call this week that the default of any European sovereign would be “a nightmare”, except that the analogy was flawed because you do eventually wake up from a nightmare.

Scary stuff.

So I bought back Gramercy.  I saw the volume over the last few days and I have heard the company say themselves that they are getting closer to a settlement of realty, and so I was loathe not to be long the stock coming into a Monday morning where news might be sprung.

But that hasn’t changed my outlook or my strategy.

What I’ve Been Doing

On the weekend I posted the reasons why I am very afraid that the situation in Europe is about to get a whole lot worse.  At the end of that post I highlighted a number of things that I planned to do to deal with this risk.  Over the last 3 days I have mostly completed these items.

  1. Get out of Gramercy – I sold out of Gramercy today at $2.56.  In retrospect I could have waited and sold out 10 cents higher.  We can’t know which way the market will go on any given day.  I may regret this.  Gramercy is likely coming ever closer to the day they settle their Realty division issues with their lending consortium.  The stock could make quite the pop on that day once the deal is announced.  I will be watching the news very closely for that day and will pounce if it settles positively.
  2. Trim Oils – I did this in my actual account but not in the practice account.  In my actual account Arcan, Coastal and Equal Energy were all trimmed by 10%.  I am dealing with somewhat larger positions in my actual account, so trimming is a more reasonable proposition.  I have found that using my strategy of taking off little bits at a time leads to extraordinarily high commissions with the practice account.  If and when I get to the point where I want to trim these positions to 25%, I will do the same in the practice account in one move.
  3. Cut the Banks in half – Oneida Financial was cut in half.  I held onto all the Community Bankers Trust that I own.  I sold all of Xenith Bancshares.  I don’t think I will regret these moves.  The US economy, at best, will be sluggish for the next few months.  I don’t expect big moves in the banks for a while yet.
  4. Cut Leader Energy Services by as much as I can – In my actual account I cut the position by half.  In the practice account I had a stink sell order at 69 cents and low and beyold it got filled today so I am out of Leader entirely there.  Some might say this is hypocritical.  How can I write up Leader a few short weeks ago and then suddenly turn around and liquidate my position.  All I can say is that when the facts change…  look I underestimated the crisis that is occuring in the Eurozone.  Leader Energy is in a cyclical business and has a lot of debt.  This is a good company to be in during a economics expansion and especially during a time when oil prices are highly profitable.  This is not a good company to be invested in during a time when debt markets tighten.
  5. Watch Gold Stocks Closely – I haven’t done a lot here, though I did lighten up on Jaguar on Monday and add to Argonaut Gold today.   I’m still of the mind that gold stocks are breaking out and have higher (maybe much higher) to go.  But I reserve the right to change my mind here. I am wary of how far this gold correction will go.  However, the stocks never priced in the move anyways.  To take an example, should Newmont be crushed as gold moves from $1900 to $1600 when its price is lower than when gold was $1200?  Its ridiculous.

We’ll have to see how the next few days play out and what Bernanke announcement comes out of Jackson Hole.  But for the moment I feel a lot more secure after having made these moves.

Time to Get Out?

So I’ve been doing some reading (lots of reading) and ‘ve come to the conclusion that this situation in Europe is most likely going to end in a disaster…

I’m going to start this post with Europe, and I’m going to end it with my portfolio.  From the macro to micro, so we begin:

First of all, lets separate the immediate problem from the almost immediate problem.

The immediate problem is the concern that there is stress in the European banking system and that this stress is going to intensify and some bank is going to blow up.

This was brought to the forefront in this WSJ article on Thursday: Fed Eyes European Banks. The markets tanked on Thursday and were stressed on Friday because of this article.  The basic problem that can occur is this.

Foreign banks that lack extensive U.S. branch networks have a handful of ways to bankroll U.S. operations. They can borrow dollars from money-market funds, central banks or other commercial banks. Or they can swap their home currencies, such as euros, for dollars in the foreign-exchange market. The problem is, most of those options can vanish in a crisis.

If you are a little bank in Shreveport Louisiana you rely on deposits for liquidity.  Unless your depositers decide to pull out all their money you don’t have to worry about having enough money to fund your operations.  If you are a big bank that has foreign operations but no branches in that country to take deposits, you rely on debt markets for liquidity.  When debt markets get worried, there is no more liquidity.  Then you are screwed.

When you are a too big to fail bank and have no deposits and the debt market gets worried, then we are all screwed.

The actual or perceived stresses have led to further actual stresses (perception is reality in the finanical markets no matter what the EU Officials will have you believe):

The cost of protecting European financial debt surged to an all-time high today. The Markit iTraxx Financial Index of credit-default swaps linked to senior debt of 25 banks and insurers increased as much as 12 basis points to 243, a record based on closing prices, according to JPMorgan.

So the important question is, how immediate are these funding stresses and are they about to go parabolic.  From a Bloomberg article on Friday:

“Our funding stress indicators continue to flash amber,” Citigroup Inc. analysts led by Kinner Lakhani said in a note to clients today. “Most indicators weakened yesterday, but remain below the highest levels of last week.”

Another Bloomberg article quotes Dominic Konstam, the New York-based head of interest-rate research at Deutsche Bank AG:

“Banks are still funded, they’re well funded,” Konstam said during a Bloomberg Television interview on “Surveillance Midday” with Tom Keene. “I think the investors are more worried about funding than the banks themselves are.”

FT Alphaville, who I believe broke the story on the ECB funding being tapped, points out that the amount that it has been tapped for is not a lot (thus far):

$500m is not massive it’s still bigger than the $50m dribs and drabs that were allotted the last time the ECB swap was in use, around February. We think that use was about a bank taking a few precautions rather than needing the money.

It doesn’t sound like funding problems are going parabolic.  Yet.

I wouldn’t expect them to really.  I mean nothing has blown up yet.  Right now we are just at the point where the specter of something blowing up is coming closer.

Which leads us to the almost immediate problem.

This problem was put succiently by JP Morgan in a recent report.

The JP Morgan report excerpt, titled The Maginot Lines, outlines the options that Europe has to deal with their sovereign debt problems.   This has been posted in a few places but I read about it on Zero Hedge.

If you read through the list it does not provide a lot of hope.  Expand the EFSF to a trillion euros or more?  Get the EU to agree on Eurobonds?  Get the IMF to backstop everything?

How is this going to end well?

Moreoever, JP Morgan drops the reality hammer with the following statement.

What we do know is that these steps are unlikely until there is some kind of market riot, which means asset prices may be much lower by the time they happen.

Lets bring this back home.  What am I going to do with my investments on Monday, on Tuesday, and for the rest of the week?

To summarize the above points, the immediate problem of bank insolvency is probably not going to escalate in the immediate future.  The almost immediate problem of national insolvency is likely to escalate in the next few weeks.  So there is some time (hopefully) but not too much.

After perusing my portfolio, I’ve drawn the following conclusions:

  1. Gramercy Capital has to go
  2. All oil stocks need to be trimmed
  3. Oneida Financial needs to be cut in half
  4. Leader Energy Service needs to be cut by as much as I can cut it without affecting price.
  5. Gold stocks need to be evaluated based on performance.  If they continue their breakout: hold.  If not: trim.

I’m going to start to do this on monday.  I hope that I am right that I have at least a few days to finish these changes and that Monday is not a watershed event.

They Know Nothing!

In the summer of 2007 Cramer came out and gave one of his most famous clips.  His They Know Nothing clip.

The Europeans appear to know nothing as well.

I get concerned with this kind of talk.

Van Rompuy said unwarranted panic sparked the selloff of Italian and Spanish bonds that led the European Central Bank to intervene earlier this month….“Markets aren’t always right,” Van Rompuy said. He cited purchases of the Swiss franc, which jumped 14 percent in value this year, as an example of investors overreacting to European debt concerns and the U.S. credit downgrade by Standard & Poor’s.

Its like they think they can show the market who is boss.  Right, and markets can continue with unwarranted selloffs and not being right all the way until they have dragged the european banking system into insolvency and taken the world into another recession.

But nope, this is a time to be ideological, stand by your principles and ignore the reality of what is actually happening.  Consequences be damned.

What does “right” mean?  You’d think that europeans, given their history, might have a better grip on the existential nature of that question then they are exhibiting.


This is a very difficult time to invest in stocks.

I am torn. I want to stay invested in companies that I believe will grow their business in a normal, even slow growth, environment.  And I want to get out of all stocks because I have no faith that the situation in Europe will return to a normal environment any time soon.

On the bright side, the gold stocks that I own broke out yesterday.  Jaguar Mining was up 6%.  Argonaut gold was up 4%.  Lydian International was up 4%.  Even OceanaGold was up 4%, and at one point was up more than 10%.  When I saw Jaguar Mining up first thing in the morning I added to my positions in Argonaut and OceanaGold.  I reasoned that if Jaguar is on the move, then something must be up.

The chart of Argonaut Gold looks particularly good.

Jaguar Mining is potentially on the verge of breaking out.

The positive move in gold stocks yesterday more than offset the losses I had in my non-gold holdings.  Coastal Energy and Arcan Resources were both down  a couple percent.  Gramercy Capital and Equal Energy were down less than a percent.  Leader Energy Services is looking more and more like a terrible mistake, and was down more than 5%.  My small position in Community Banker Trust took a drubbing, down 10%, though I don’t know why?

I changed the composition of my short positions yesterday. I exited my short in St. Joe and in Migao, and I added shorts to a number of banks.  I shorted Citigroup, HSBC, and UBS.

As for the gold stocks, I had a friend remark yesterday that he was finally seeing his gold stocks act as a hedge of his positions.  My reply was:

I hope you are knocking on wood, crossing your fingers, stepping between the cracks, holding a rabbits foot and wearing your clothes inside out when you say that.

Gold stocks have had so many false breakouts and so many months of disappointment that its hard not to be skeptical.

Having said that, I think that there are a few legitimate reasons here for gold stocks to move higher.

First, you have to always remember that the best environment for gold stocks is a low growth economy.  Gold stocks do best when the price of gold is doing well, but the prices of the basic inputs for gold mining (oil, metals, labour) are not doing well.

You saw this last year.  Gold stocks did great from August to October, when the economy was still perceived to be sluggish and a double dip was still on the table.  Once oil and other costs began to take off, gold stocks faltered.  The market rightly perceived that costs would rise for gold miners.  They did.  The market is smarter than you think.

So now, as growth expectations are ratcheted down and as oil prices come down, expected margins for gold producers are  expanding.  The market is probably anticipating this.

The second cause could be the expectation that Bernanke will react next week at Jackson Hole.  The following is an excerpt of a Goldman Sachs report released yesterday.  Goldman discusses what Bernanke might propose at Jackson Hole.

The Fed has three main easing tools: 1) communication; 2) asset purchases; and 3) cutting the interest rate on excess reserves. At the August meeting, it exercised option #1 by making a conditional commitment to keep the funds rate low until mid-2013. Option #3 is often mentioned but in our view is unlikely for several reasons. That leaves only option #2, asset purchases.

We believe Bernanke’s Jackson Hole speech will include a detailed discussion of the potential for more easing through large-scale asset purchases. A variety of indicators suggest many investors already expect more QE. For instance, a recent CNBC survey shows that more than $300bn of purchases may already be priced in. The sharp decline in forward real rates is also partly related to QE expectations, in our view (Exhibit 2).5 Based on our conversations with clients, we believe investors would be very surprised if the speech did not include a discussion of asset purchases.

We see two main reasons why Fed officials may prefer to change the composition of the balance sheet as a first step. First, as we showed in Monday’s US Daily, if used aggressively this could have a sizable impact. For example, if the Fed were to sell its Treasury securities that mature over the next two years and buy securities in the 10- to 30-year part of the curve—apportioning them based on amounts available in the market—it could take a similar amount of duration risk onto its balance sheet as in QE2 (around $350bn in 10-year equivalent terms, or 80-90% of QE2). The policy could be scaled up further by weighting purchases toward even longer maturities, or by changing the mix of the mortgage portfolio.

Second, policies that keep the size of the balance sheet (and excess reserves) unchanged may be less controversial among politicians and the broader public. A detailed discussion of possible changes in balance sheet composition seems a likely component of the Jackson Hole speech.

Bernanke may of course also discuss conventional QE. Arguments in favor of this approach include a less complicated exit strategy—if securities mature faster, the Fed may not need to sell actively—and potentially a larger impact on confidence and expectations. We do not think Bernanke will signal anything more unconventional, such as a higher inflation target, price level targeting, or a long-term interest rate target.6 However, these ideas may turn up in the FOMC minutes published on August 30. 

While listing the easing options looks probable, Bernanke is very unlikely to pre-commit to taking action next week. This is a monetary policy decision, and any announcement would come at an FOMC meeting. In addition, core inflation continues to accelerate, and Fed officials seem to have a rosier outlook than our forecast or the consensus. While we expect additional QE and the odds are rising at the margin, it is not yet a done deal.

So what GS is expecting is not the same type of QE that occured last time.  They expect a rearrangment of the Federal Reserve balance sheet to longer dated securities.  True QE means an expansion of the Fed balance sheet, so what is expected to be proposed is not true QE.  So its not directly supportive of higher gold prices.  What these sort of policies would be supportive of is lower long dated rates.  In other words lower interest rates for a longer time.

I remember reading Mish Shedlock a number of years ago.  He was (still is?) of the mind that gold prices at the time were in for a rough ride because interest rates were headed up and the real rate of return on treasuries were going to get more positive.  His basic reasoning was that if you can get a real return from a safe interest bearing asset you will move out of gold into that asset.  Conversely, if the real rate of return is close to zero (or negative!) you will tend to prefer gold.

At the margin demand for gold is determined from the real rate of return on other (perceived) safe haven assets.

What the Fed would be doing is effectively lowering interest rates across the curve.

That should be supportive of gold and good for gold stocks.