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Feb 12

Atna’s New Pinson Resource

Atna released an updated resource on Pinson on Monday. Over the next 3 days the stock fell about 15%.

The release of the Pinson resource produced one of those bizarre situations you happen on in the market from time to time whereby you had a company valued at a price that wasn’t really reflecting anything near the value of the assets in the first place, but on the other hand the value of the assets has disappointed on the downside so clearly the company must be worth less today than it was the day before the news was released.

So the stock goes down and the assets are even less reflected in the price of the stock. C’est la vie.

Was it that bad?

Lets look at the details. I don’t think numbers are that bad. The underground number is still robust, and the open pit number is intriguing.

The reasons for the sell-off is that compared to the previous resource on Pinson (done ages ago in 2007), the numbers were a little disappointing. Two ways they were disappointing.

The first disappointment

The underground ounces went down.

Now the lost underground ounces are compensated by the gained open pit ounces. Kind of. I mean the open pit is a whole other animal. It needs its own permitting, it needs big yellow trucks, and while the grade is decent (a little over 1 g/t), its not the kind of knock your socks off grade that the underground is. In fact, I think the open pit was maybe what Barrick was looking to make Pinson attractive to the larger miner. Just to recap the history with Barrick, and perhaps shed some light on the open pit, here is a short timeline of those events, as presented by sequential Atna MD&A and press releases.

The history of Atna’s official comments about Pinson

Press Release August 8th 2008: Initial results of PMC resource optimization studies indicate the potential for an open pit concept that could combine the underground resource with un-mined resources remaining in and around four of the historic Pinson mine pits, into a large pit concept… Simultaneous work is being conducted on optimizing underground mine design and economic trade-off studies on the benefits of mining the high grade resource zone by underground methods or proceeding with the project using a large scale open pit concept.

Q2 2008 MD&A: However some of the remaining MAG pit material is believed to be refractory and may require autoclave or roasting preoxidation to be amenable to conventional cyanidation.

Q2 2009 MDA: PMC recently concluded the expenditure of US$30 million at Pinson to earn its 70 percent equity position. The results of that work are being evaluated to determine the feasibility of development and a future plan for the project. The property has been placed on care and maintenance while the technical study is completed and until a decision is made concerning the future of Pinson. Dewatering of the underground facilities will continue during this decision period to protect the partners’ investment and facilitate re-start, if warranted.

Q3 2009 MDA: Drilling reported by Barrick included a significant number of infill drill holes within the Ogee, the CX-West, the Range Front (and hanging wall splays), and Mag Pit mineral zones. This new information, along with the existing drilling data developed by Atna and prior operators, has been included in PMC’s evaluation of the project’s potential. On the basis of this evaluation, PMC has determined that the open pit potential is not viable. The joint venture is discussing alternatives for the project. The joint venture has agreed to a property budget that allows for continued dewatering of the underground workings while the technical evaluation is being completed.

Q4 2009 MD&A: The joint venture is discussing alternatives for the project. These alternatives include the development of high grade gold resources at the property by underground methods. Atna is in discussions to potentially acquire Barrick’s interest in the project and Barrick may be considering this offer, but they may also solicit other offers or they may continue to hold their interest. Atna holds a preemptive right to match any third party offer should Barrick decide to sell their interest. The joint venture has agreed to a property budget that allows for continued dewatering of the underground workings until a final development or divestiture decision has been reached.

Q1 2010 MD&A: In general, the drilling program did not extend any of the known resources significantly. Drilling was suspended in December of 2008. In 2008, underground exploration drifting was re-started with 2,010 feet, of drift excavation completed. The underground excavation contract was terminated in January of 2009. Over 4,000 feet of underground drift and workings have been completed at the site… PMC has completed an in-house review of the project for both underground and open pit mining potential. They are currently reviewing their strategic options in regards to the project, which may include sale of their interest.

Q3 2010 MD&A: PMC has completed an in-house, unpublished review of the Pinson project for both underground and open pit mining potential, but did not develop a project that was immediately attractive to Barrick for development. Atna believes that the underground development potential at Pinson is attractive. As a result, the MVA partners are engaged in an active dialogue concerning the future direction of this project.

It sounds to me like Barrick lost interest in the project when it looked like the open pit was a no go. Now of course, the open pit was a no go when gold prices were under $1000 per ounce and Barrick was probably using $700-$900 per ounce as its target price for development.

Of course the Pinson open pit is undoubtably viable at these gold prices. And Atna is anticipating bringing it into the mix. So its good news that the resource is robust. It just doesn’t necessarily compensate for the loss in underground ounces… or in grade.

The second disappointment

And that is the second disappointment. The grade was lower. What is not completely clear to me fromthe press release is whether the grade was lower because the more recent drilling just outlined lower grades, or because the new grade estimates are taking into account more realistic dilution of grade now that the company has a firmer grasp of the mining methods that will be used. I have just emailed the company about this (I should have thought of it sooner). Atna vaguely alluded that this might be the case in the press release:

The Block model was divided into five statistically related zones to accommodate statistical search parameters appropriate for individual mineral styles.

But its hard to say what that sentence is saying. I will update if I get one from the company.

Taking a look at Atna’s most recent presentation, the company has changed its costs at Pinson from (I think) the $700 to $750 per oz range to a wider $700 to $850 per oz range. That increase in the upper end range is probably reflective of the lower grade, either because of a decrease in the ore grade itself, or an expectation of a higher dilution of that ore through the mining techniques expected to be employed.

When I did my estimates I assumed what I thought was a restrictive dilution of 30%. To refresh, the parameters I used in my analysis were:

A 15 year mine life, beginning at 350t/d and ramping to 750t/d by year 4.
Total produced ounces of 940,000 oz over LOM
0.4 oz/t resource over the mine life, diluted by 30% with 90% recoveries, resulting in gold production beginning at 50,000 oz and ramping to 75,000 oz.
Mining costs of $110/t, milling costs of $50/t and G&A costs of $11/t
Cash costs of $687/oz over LOM

I went back over that analysis and looked at the sensitivity to dilution. Turns out that Pinson is quite sensitive to that dilutive factor. You would need to see about 45% dilution at my original grade of 0.4 oz/t to get up to $850 per ounce costs (these are the $2100 per oz gold price estimates. I used the high end number so that I could see just how big the differences in dilution could amount to in terms of NPV):

You could run the same sort of sensitivity with grade and you’d get about the same thing. Dilution and grade are really two sides of the same coin; the outcome of the two combined is the actual grade of the rock being mined and processed.

Its all academic

So you can run the numbers and get an idea of the sensitivity to grade and dilution and of how the change in reserves affects the present value. That’s nice. But in the end what’s it come to?

Sometimes you have to step back and look at what you got instead of focusing on the details. Pinson is probably worth at least double Atna’s current enterprise value (about $125M). You add onto that the value of Briggs, of Reward, and of Columbia, and they are probably worth at least the enterprise value themselves. Put that together and it seems rather stupid to be talking pennies about whether Pinson has gone up or down 10-15%.

Bottomline: Atna remains the best opportunity in the gold space over the next year, in my opinion.

Feb 9

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Canaco’s Magambazi Deposit

Last week I decided that I would abandon all other research and devot my spare time to evaluating Canaco’s Mogambazi deposit. I have been thinking more about Canaco recently because the stock has fallen from such heights that even now, after the recent 50%+ move, the stock is less than a third of its highs.

I noted last week that Canaccord Capital has said that they expected the soon to be released NI 43-101 report to show 2.3 Moz at around 3 g/t.

I thought it would be an interesting project to come up with my own estimate. So that’s what I did. As you will read, I had some difficulties, was left with a big question mark, but learned a lot along the way that will help me evaluate Canaco and Magambazi going forward.

But first a bit about Canaco

While Canaco has fallen rather dramatically over the last year, the still stock commands a rather large enterprise value for an company exploration company.

Even after subtracting the current cash on hand of $115M, the stock still sports a valuation of $200M. For $200M you need to be getting a lot of gold to make the upside worthwhile.

The gold is at Magambazi

Canaco is a one trick pony and that one trick is Magambazi. Magambazi is in the eastern part of Tanzania.

There has been a lot of gold found in Tanzania but it is all in the northwest. There has been almost no historical exploration in the eastern part of Tanzania. That is because the geological intrepretation was that the Sukumaland Corridor, which is the belt that holds all of the gold on Tanzania, extended only to the western part of the country. In 2007 this changed, and academic research began to reinterpret the geology as extending much further to the east. It was around this time that Canaco stake claims around Handeni, and soon after that they returned their “discovery hole” at Magambazi of 53m of 4.32 g/t.

The deposit

The Magambazi deposit consists of a number of zones, or what the company calls lodes, that run any where from a few hundred metres to a kilometre along strike.

The most prominent of the lodes is the Main lode. The Main lode hosts the original discovery and also a number of other impressive intercepts with rather eye-popping numbers.

When you look at these drill intercepts your first reaction is that there must be a massive amount of gold here. Numbers like 48 metres of almost 15 g/t are extremely high numbers. The problem that I have found in the course of my evaluation, and perhaps this is why the stock has done so poorly over last year, is that the gold is erratic. More often than not, that long high grade intercept will be right next to a much shorter or much lower grade intercept, suggesting a quick pinch off, or even to a barren hole entirely, suggesting a fault line that ended the mineralization.

The numerous faults present in and around the deposit make any evaluation complicated. They create sudden start and stops to the mineralization that are difficult to pin-point exactly without dense drilling. I have to wonder how this will affect the Ni 43-101 that is going to come out in a few months? Will the evaluator be forced to make conservative assumptions with respect to where mineralization begins and ends?

The deposit also has a number of very quickly narrowing finger like strands. These also make it difficult to evaluate without a lot of drill holes. Take for example the following section from the company’s presentation. In particular, focus on hole 265. Here is one of those fairly monster like holes, grading a little over 3 g/t over 56m. But notice hole 6, only a few meters away. The mineralization goes from robust to not even reported in the presentation very quickly.

Another example of the same sort of quick pinch out can be seen from hole 134. Taken alone, at 34m of 2g/t, you would think that it has discovered another lode comparable to the main lode. But 225 quickly demonstrates that the lode pinches out quick to the east, and 220 shows that the lode ends abruptly due to a fault to the west. The overall ounces present in such a lode are not as impressive as the single intercept would suggest.

The point here is that you simply can’t take a bunch of drill intercepts and extrapolate the robustness of the deposit. You probably shouldn’t do that in general and you definitely can’t do that with Magambazi. You really have to look at it in detail and make out what the actual orientation is. So that is what I did.

The Power of Corebox

Corebox.net is a website that hosts a powerful and rather surprisingly free tool to help you evaluate mineral deposits. The tool holds a database of drill results for more than 100 different deposits. It displays those drill results in 3-d form, making it really quite simple to look at each cross section individually and evaluate continuity, overburden, etc.

The Magambazi project is on Corebox. This greatly simplified my work. Its a very empowering (dangerous?) tool because it lets you attempt evaluate a deposit to a degree that you would otherwise only be able to guess at. I have tried to do this sort of work before on other projects where I didn’t have Corebox. There isn’t a great way to graphically display the angles correctly, so in the past I ended up using a crude approach whereby I summed up lengths and multiplied by what the total width of the end holes were. This isn’t very accurate. Corebox eliminates the need for such simplifying assumptions. It also gives you the great advantage of being able to visualize where the deposit is with respect to topography.

My Process

Evaluating a deposit is time consuming, getting the information is a struggle, but overall it is not a complicated process. Basically I had to go through the following steps.

Determine a volume of the deposit. You do this by simply figuring out the length x width x height of the ore bearing gold
Use the volume to determine a mass of the deposit. Mass is simply volume multiplied by density (or specific gravity)
Make an estimate of the average grade of the deposit and multiply that by the mass to determine the amount of gold in-situ
Convert the grade from grams to ounces and you are done

Step 1: Determining the Volume

This is the step where corebox really helps out. Canaco has drilled the Magambazi deposit at 40m spacing. The birds-eye view of this drilling is shown below.

With corebox you can look at each of these cross sections and try to deliniate the deposit.

How did I do that?

First I used the Microsoft program Snipit to snip the screen shot of the section. So I got something like this:

Next I had to find a program that would allow me to draw the deposit in free form around the drill holes but (and here is the tricky part) then tell me what the area of the resultant irregular polygon was. This proved to be difficult to find. The first program I used was a app on the web called SketchandCalc. It worked fine, you can import the image, you draw your shape and it calculates the area and as long as you have a reference block on your image of known area you can scale that block to determine the actual area of your shape. With a section like the above one, the reference block is the 130m x 130m grid block so you just sketch deposit, record the area and scale appropriately.

I probably would have stuck with SketchandCalc but I ran into some problems with my results not being quite what I expected (more on this later). This led me to question the validity of the area being calculated by the program. I went out searching for a second program to use as verificiation. As it is, it turned out to be rather fortuitous because one thing SketchandCalc doesn’t let you do is save the sketches so you have no record of your work. After much searching (there is truly a dearth of programs available on the web for calculating area) and many failed attempted to determine the area using Powerpoint (you can’t do it), I figured out that another Microsoft program, Visio, works extremely well for the task. By the way, it turned out that there was nothing wrong with the calculations by SketchandCalc, my Visio results matched up well to my original SketchandCalc work.

My Visio sections

Its really easy to draw and get the area of a section in Visio. You just have to do the following:

Import the screen capture of the cross section into Visio
Draw out the shape of the deposit to align with the intercepts
Under the tools add-ons there is a Visio Extra that allows you to calculate the area and perimeter of an irregular polygon. Use this to get the area of the shape and of the reference block

What you end up with (for example with section 200 that I showed above) is something like this:

What a Orogenic deposit should look like

So clearly there is some interpretation going on here. And I am not a geologist so you do have to take my personal interpretation of the deposit with a grain of salt. With that said, before drawing out a bunch of squiggly envelopes I did do some research into the type of deposit at Magambazi to get a better idea of how one might expect the gold to be disseminated.

Of particular help was a fellow named D.I Groves. Groves is referenced numerous times in the 43-101 and I think it is fair to call him an expert on deposits of the Magambazi type. Magambazi is a Orogenic gold deposit. An orogenic gold deposit is a type of mesothermal deposit, which means a deposit that was created by the influx of water from deep in the earth’s crust that has been heated and risen through cracks and fissures, taking some gold along with it. Where this water find “traps”, meaning non-porous barriers that prevent it from rising further, it stops, and over time the water dissipates leaving behind the minerals it carries.

It used to be (and maybe still is in some circles) that all mesothermal deposits were called mesothermal deposits, but Groves wrote a few papers on the subject arguing that these deposits should be further categorized based on a bunch of technical geological attributes that aren’t really that important to what I am trying to accomplish. One such deposit type was named an Orogenic deposit, and the term must have stuck because in the NI 43-101 filed on Sedar by Canaco, the deposit is referred to as being of the orogenic variety.

Most importantly to what I am trying to accomplish is that Groves provided some descriptions and a few useful pictures about the specific nature of an orogenic deposit, how it evolves and thus how one might expect the gold to be deposited. One such picture is shown below.

What you would expect to see at Magambazi is a number of thick, organ like veins with small branches jutting up from the deeper sources. This is exactly what you get in Canaco’s own interpretation as illustrated in a couple of the cross-sections they make available in their February presentation. At Magambazi there is the added complexity of vertical faults along strike throughout the deposit, resulting in sudden terminations and offsetting of the mineralization.

For reference, the interpretation I used for these same two sections are below:

With Section 280 (on the left in both pictures) you can see a few spots where corebox wasn’t perfect; where the complete drill result wasn’t shown in the cross section. I was careful about this, and whereever there was a discontinuity where it didn’t seem there should be one I checked the actual drill results against what corebox was showing to make sure corebox didn’t miss one of the shorter or lower grade intercepts (in a few cases it did).

Overall though it did a nice job.

There were 25 sections in the deposit spaced 40m apart. I basically spent my lunch hours last week drawing funny looking shapes in Visio (and/or SketchandCalc) for each one of these sections. I have a link to my visio sections here.

Because I am not trying to be excessively detailed, to compute a volume I made the simplifying assumption that each cross section was valid for a 20m strike in each direction, meaning that each cross section represented 40m of the deposit. Volume was therefore calculated by multiplying each cross section by 40m.

Organizing the intercepts and getting an average grade

The other tedious task was taking the long list of drill intercepts and determining which cross section each belonged to. Canaco provides a list of all the drill intercepts here. Basically I took the PDF file and turn it into an excel file (something that turned out to be more complicated then it should have been), and then went to each of thecross sections, found all the intercepts that lay within that cross section and grouped those intercepts together.

Now if I had been doing the analysis with the detail of an actual report I probably would have broken up each cross sectional volume up into smaller blocks, determine the average grade in each block and then determined that amount of gold in each block discretely. But that is too much work. Instead I made the simplifying assumption that the average grade in each cross section is constant throughout the section. I determined the average grade per section by summing up the length weighted grade of each intercept and then dividing by the total length.

I have a spreadsheet that I have tried to make available here with the data.

I calculated the overall average grade for the deposit as a whole as being 3.66 g/t.

Figuring out the density

As it turns out, determining the density is was BY FAR the hardest part of the process.

The density that we are interested in is the density of the rock that immediately hosts the gold mineralization. The density is typically defined in terms of specific gravity, which is the ratio of the density of rock to the density of water. I have exhaustively researched what to use as thespecific gravity (also sometimes referred to as bulk density) and to be honest, I’m just not sure. This is a real sticking point and what it means is that I can’t report my results as a single estimate. Instead I’lll have to give a range of ounces depending on the specific gravity assumed and we’ll just have to see how it turns out when the actual resource comes out.

My initial assumption was that the density was simply the density of quartz, or maybe a little bit more. Quartz has a density of 2.6. According to the initial NI 43-101 put out by Canaco (Page 8):

In situ gold is spatially associated with quartz vein zones within silica and garnet altered amphibolite gneiss. Mineralization is commonly associated with arsenopyrite (possibly also loellingite), pyrrhotite and graphite. Visible gold is commonly present in drillcore.

And then later on, talking specifically about the Magambazi zone (Page 9):

Gold is spatially related to quartz veins within silica and garnet altered amphibolite.

So its quartz. Plug in 2.6 and its end of story right?

Wrong. Or at least I think so. The problem is that if I use 2.6 as my density I don’t get anywhere near as many ounces as I should. A specific gravity of 2.6 gives me a little over 1,000,000 oz of gold.

This is where the real work began. As I mentioned early, the first thing I thought was that there must be something wrong with my cross-sections. Enter visio and a rigorous re-evaluation of each intercept (sometimes 3 times!). Eventually I was satisfied that my original cross-sectional estimates were fine, and that this wasn’t the problem. Next I thought I might be using the wrong spacing. Was it 80m (my number was about 1/2 of what I would have expected). But no, its not, the spacing is 40m. I also checked all my units (intercepts are recorded in metric, gold is reported in grams per metric tonne, specific gravity is in tonnes/m3) so no that’s not it either.

The only parameter I am left with uncertainty about is the specific gravity.

My theory is that the gold is hosted in a quartz that has a lot of heavier pyrite (basically iron sulphide) in it. Maybe its even all pyrite. There is some evidence that leads me to this.

First of all from the NI 43-101:

Page 42: Mineralization is characterized as vein‐related structurally‐controlled orogenic gold associated with pyrrhotite, arsenopyrite, and locally graphite

Page 100: Mineralized zones at Magambazi and Magambazi North are distinctively mineralized with pyrrhotite and arsenopyrite, with graphite and chalcopyrite present locally. Additionally, graphite appears present in significant quantities related to major fault structures.

And second of all, from the original discovery press release:

The 293 metre drill hole (MGZD 001) has intersected a broad, intense alteration zone and sulphide mineralization (pyrrhotite, arsenopyrite, pyrite and chalcopyrite) with trace amounts of visible gold in eight separate metre intervals

Pyrrhotite, arsenopyrite and pyrite all have much higher specific gravities then quartz.

Therefore if the rock has a significant amount of pyrite in it, the specific gravity would be higher, which would help to raise the ounces to an amount more consistent with the Canaccord estimate. I scoured the net looking at the NI 43-101 of other projects that appeared to have the gold hosted in pyrite. Unfortunately I wasn’t able to find a single instance where the vein was not dominated by quartz and thus where the specific gravity was significantly higher than 2.6.

Finally I emailed the company and asked them if they would tell me what sort of specific gravity to expect. Unfortunately they wouldn’t give me a number but they did say:

We don’t have an exact number yet for the specific gravity of the rock but it’s hard silicified material, so likely a higher density than your average mineralized system.

Exactly how much higher remains an open question.

Summing up the resource

I’ve already mentioned the spreadsheet that I built to sum up the resource. Basically all I did was take the volume for each individual section and convert that volume into a mass using the specific gravity of the rock (in this case 3 scenarios with a range of specific gravity’s between 3 and 5). Once I had the mass, I multiplied that mass by average grade of gold in that section (as determined by by weighted averaging) and then converted that gold from grams to ounces.

What I ended up was the following:

All 3 of these estimates are lower than I would have expected. To be honest, I’m not sure what to make of that. I don’t know how much I trust my own work given the uncertainty with specific gravity and obviously the low-tech tools I am using. But before I draw any conclusions about the results, I want to talk for a second about some of the potential sources of error.

Sources of error

Even my high specific gravity estimate is on the low side of the estimate provided by Canaccord (they estimated 2.2Moz). I suspect the actual specific gravity is closer to 4, which would mean that my estimate is really quite a bit on the low side. I am of the opinion that Canaccord probably knows more than I do, so I am pretty sure there is something being under-estimated by mine. With that in mind there are a few other potential sources of error in the calculationsthat could be responsible for the discrepancy.

First, as I mentioned already, there is a lot of interpretation involved here, and perhaps with Visio I was making the connections between drill holes too narrow or too short. I do admit that I was consciously erring on the side of conservativeness when I drew out each section, though I didn’t think that doing so would have such an effect. I played around with this a bit to see how sensitive the resource is to changing the cross sections. Its actually not that much, not unless you start getting really creative and adding mineralization where there clearly isn’t any. If you are just tweaking the known areas to make them a bit bigger, you might be able to add 200,000 oz but you would have trouble adding more. My conclusion is that this can’t be the only issue.

A second potential source of error is that the high grade intercepts are surrounded by a low grade halo of gold. Canaco didn’t report the low grade numbers in their press releases or in the 43-101 so its really difficult to get a handle on their significance. The 43-101 did have this to say about the low grade:

What is apparent from sectional review is that significant gold is present outside of acknowledged ‘main zones’ of mineralization, or key intercepts as documented, and the mineralization system is in areas, seemingly pervasive. While separate internal gold intercepts exist that would be considered high‐grade in terms of underground mining assessment, the overall type of mineralization can be difficult to quantify, and requires assessment as a potential pitable target.

If you look at the cross sections Canaco provides you get an idea of how significant the low grade is. The halo is the light red areas.

Based on what the 43-101 says, I think the halo likely has a grade of aroud 0.3g/t. Perhaps if you add this up over the entire strike of the deposit you might get another 500,000 oz, which would put you more inline with what Canaccord is estimating.

A third source of potential error is that corebox isn’t scaling correctly. I tried to verify this by taking a number of intercepts and measuring the depth of the intercept versus the length, and seeing whether the ratio was correct. In all the cases that I tested it matched up. But that does not preclude the possibility that some of the cross-sections I used to estimate area had error.

What other conclusions can you draw?

Aside from the resource number, I can draw some other qualitative conclusions about the Magambazi deposit.

1. This is not evenly disseminated gold.

The point here is that with an open pit project it is going to be difficult to maintain a consistent mill feed. The project dips from north to south, with the north being the closest to surface. Unfortunately the north has the lowest grades and the shortest intercepts. If you look at the deposit section by section, the northern most third of the deposit has on average 16,000 oz of gold per 40m width. This compares to 49,000 oz per 40m in the central part of the deposit and 70,000 oz per 40m in the southern part. Its not a uniform deposit and the deepest part of the deposit is the most economical.

2. The strip ratio is going to be pretty high

I didn’t calculate the strip ratio but it is clear from looking at the cross sections such as the one’s I have highlighted above that much of the gold is deep and vertically oriented, which is going to mean that you have to move a lot of waste to get to it. The ore at the northern end of the deposit is near the surface, but towards the central and especially southern portions that deposit deepens significantyl. To give just a couple of examples, taken from the company’s own cross sections:

You can see just how much waste lies above the gold.

3. The widths and grades of mineralization vary significantly

Perhaps one of the reasons that I struggled to match my estimate to Canaccord was because the mineralization changes so suddenly. While stepping through the deposit I found again and again the situation where a long, high grade intercept was offset by a shorter or much lower grade intercept. This has a consquence for the eventual mining operation of course but it also has a consequence for the upcoming Ni 43-101. There is certainly some wiggle room for the evaluators to mark up or down the resource depending on the interpretation they use. It’s not necessarily a good or bad so much as a risk.

What am I going to do?

At the end of the day I do this sort of analysis and it really comes down to a decision of whether I am still going to hold the stock or whether I am going to sell it. At the price level that Canaco is currently at I am inclined to hold. I would be reluctant to buy much more though.

As Steve T pointed out in one of his comments the other day, you really are holding a stock like Canaco for the potential that they can grow the deposit beyond its current size. At its current market capitalization I would say that the company is probably fairly valued for the resource it currently has, but there is certainly upside potential as the resource expands. Management gave a good presentation on the potential of the land package around Magambazi at the Denver gold conference this year. There are plenty other anomolies around Magambazi that are left to be explored, these anomalies are virtually untested historically, and because of the high levels of pyrite associated with the gold they are easy to detect through surveys. I wouldn’t be surprised to see more success from Canaco as they expand the envelope that they explore. So I will continue to hold my position on that speculation.

Feb 5

Letter 31: Bank earnings and more bank earnings, lightening up on gold stocks (again) and a soon to come Canaco Magambazi resource

Portfolio Performance:

Portfolio Composition:

Waiting on Magambazi…

I have been working most of the week on an evaluation of Canaco’s Magambazi deposit in Tanzania. I was hoping to be finished the work by today but its carrying on and I don’t have a lot of time to finish it today (what with the superbowl and all) so this will be a rather short update, but with a longer, hopefully rigorous analysis of the Magambazi deposit will follow shortly tomorrow or the next day.

Outperformance of the US

Now that is something that I haven’t said in a few years.

While it was another good week for the S&P and a decent week for my portfolio it was not a great week for the TSX. Again. This is becoming a pattern. Its striking how badly the TSX is underperforming so far this year. The S&P is up almost 6%, the TSX is up hardly at all.

I have tried to increase my positions in the US-sensitive stocks I own to take advantage of this American out-performance with a particular emphasis on leverage to the mortgage industry. Most recently, in the last week I added to my positions in Community Bankers Trust, PHH Corporation and I introduced a new position in Rurban Financial Corp.

Rurban Financial Corp

Rurban was recommended in a comment (by Robert) to my post last week. I did a quick look at the company, which released 4th quarter earnings on Monday, and they do indeed look cheap. And while I haven’t had a chance to take a close look at their prospects, I’d liked what I saw on the surface, so I bought a small starter position.

The company produced earnings ex a one time merger charge and ex OREO losses of 23 cents per share in the 4th quarter.

Now I admit I have not dug into Rurban to the point that I need to (this Canaco resource estimate has been all consuming of my spare time). I plan to do that in the next week. I’d like to put together a comparison of Rurban and Community Bankers Trust and perhaps Bank of Commerce Holdings (both of which I will touch on below) side by side to better evaluate Robert’s legitimate skepticism in BTC.

Community Bankers Trust 4th Quarter Earnings

And speak of the devil, they released 4th quarter earnings on Tuesday. I thought the numbers looked pretty good. The quarter was summed up by the following statement from CEO Rex L. Smith III:

“Our goals for 2011 were to make major improvements in our problem assets and to rebuild the fundamentals of the core bank, and I am pleased to report that we accomplished our goals. Both nonaccrual loans and net charge-offs saw continual and substantial declines throughout the year. At year-end our ratio of nonperforming assets to loans and other real estate was at its lowest level since the first quarter of 2010. Additionally, the fourth quarter showed a strong increase in new loan production in our targeted growth areas. All of this occurred while we lowered noninterest expense for the year by 21%.

Let’s step through some of the key metrics and update the graphs I showed last week with the 4th quarter numbers.

Pro-forma earnings (that is earnings before the FDIC amortization and before any one time hits to investments and real estate owned) were strong in the fourth quarter, coming in at 14 cents per share. Again I think the bank has a lot of earnings power going forward once (if) it is able to bury its past misdeeds.

Equally important, nonperforming loans were down again in Q4.

The only negative I saw for the quarter was something I have seen a lot of with the banks reporting fourth quarter results thus far. Net interest margin is on its way down.

Banks are struggling with the headwind of low interest rates. Basically, purchasing non-risky securities (ie. Treasuries and government backed MBS) means accepting extremely low returns. As older securities mature and roll off the books they are being replaced by low yielding new securities. Of course this is exactly what Bernanke is looking for to try to get the banks lending again. That seems to be working in the case of BTC, as loans originated was up in Q4.

Bank of Commerce Holdings 4th Quarter Earnings

I wrote a short piece ofter my purchase of Bank of Commerce Holdings about two months ago. Since that time the stock has risen about 15%, so its been an okay purchase but nothing exceptional.

I have yet to really evaluate the stock in the kind of depth I need to. I hope to get to that in the next week. In the mean time I have been compiling the basic statistics to do that evaluation. The company came out with another data point on Tuesday when they released their 4th quarter earnings. I would call it a mixed bag. On the bright side the company showed another strong earnings per share number when you ex-out the one time hits, and ROE and ROA also showed strength on a proforma basis.

Note that my estimates of ROE and ROA exclude provisions from loan losses, losses on real estate owned and one time investment gains so they are somewhat higher than the posted numbers in the news release.

On the negative side the company struggled in much the same way as Community Bankers, posting a lower Net Interest Margin quarter over quarter.

Perhaps more worrying is that nonperforming loans are rising.

I’m not sure about Bank of Commerce Holdings. I don’t have a large position in the stock. I don’t love where the bank is based (around Sacramento California) and I don’t like how non-performing loans are rising at all. As CalculatedRisk pointed out recently, there aren’t any signs of things improving in Sacramento yet.

The percent of distressed sales in Sacramento was unchanged in November compared to October. In November 2011, 64.1% of all resales (single family homes and condos) were distressed sales. This was down slightly from 66.1% in November 2010.

I’m going to evaluate it closely and turf it if I don’t see a strong story being written that will lead the company back to the $6+ level.

I need to understand gold better

Early in the week the gold stocks and the bullion looked to be breaking out together and there was a hope (at least in my mind) that it was for real. Then the Friday employment number came out and presumably frightened everyone about the prospects of inflation and the gold price dropped 1.8%. Some of the gold stocks got hit much harder. I’m not willing to find out if this is a blip or another true correction; I reduced my trading positions in Aurizon, Canaco, and OceanaGold (though as you will note at the end of the post with respect to my weekly practice account trades, I mistakenly bought rather than sold OGC. This is something I will have to rectify on Monday).

What I need to do to gain some lasting confidence in my gold stock position is gain a better understanding of the supply/demand dynamic right now. I’m flailing a bit here and I’m fully aware of it. But there are a number of headwinds happening here that I don’t want to ignore:

The lack of Indian demand brought on by the strong rupee
An improving US economy will mean higher interest rates eventually
The ETF has become such a big part of demand and I wonder how much of those holders are “weak hands”

The problem is that while I believe in gold in the long term, I also know that a lot can happen in the interim. Rick Rule was pointing out a few months ago how in the 70’s and early 80’s, when gold rallied from $35 to over $800, it also had a number of corrections, including one of over 50%.

My lack of clarity in understanding just what is driving gold at the moment (and whether in the short term, particularly given that the seasonality effect is about to turn against the metal, it remains sustainable or not) is leading me to these short term in’s and out’s with OceanaGold and to a lessor extent Aurizon. Gaining back some clarity, and with it hopefully some more certainty in my decisions, is another endeavour I hope to accomplish in the next week.

Speaking more company specifically, Atna remains the strangest bird of the bunch in the gold stock sphere. It consistently outperforms (even goes up) on days when other gold stocks are going down and then does nothing (or goes down) when all the other gold stocks are up. I don’t understand the stock for a second, though I am happy that the trend in the stock is, to borrow the phrase from Dennis Gartman, from the lower left to the upper right.

My soon to be complete Canaco Magambazi Estimate

In a next day or so I will be posting my interpretation of the resource estimate at Mogambazi. I basically have went through the deposit, cross-section by cross-section, and evaluated the resource using a rough block model. I thought it would be a fun project, and it has been, but its also been a lot of work. My tools consistent of Visio, Excel and the screen capture tool snip-it, and my main resource to educate myself has been google, so its been a bit of a process. Still, I’ve learned a lot and have become developed a better understanding of what Magambazi is (both the good and the bad) which I think will allow me to act prudently on it in the future.

So stay tuned for that.

Weekly Trades

Feb 3

1 Comment

The Canadian House Price Plateau (or cliff?)

I live in Calgary, Alberta. The house prices here are high by most global standards. The average sales price of a single family home in Calgary was $453,000 in December.

In Canada, Calgary is nothing special. House prices in Canada are high. I stumbled upon the following interesting research by the Demographia International Housing (DIH) that compared house prices across the globe. Here is what they determined as being the unaffordable locales in Canada.

For those of you unfamiliar with Canada, Fredricton, Thunder Bay and Yellowknife do not represent a “hub” of Canadian population. Vancouver, Victoria, Toronto and Montreal do.

The above was taken from the DIH’s Affordability Survey (2012). The methodology they use is to rank cities based on affordability is to use a ratio of the median home price in the city divided by the household disposable income. The number gives a ratio, and a ratio of greater than 3 has traditionally been seen as creeping into the unaffordable category.

Whne I read through the report, my first question was, what exactly is household disposable income (HDI)? From wikivest:

The amount of money that households have available for spending and saving after income taxes have been accounted for. Disposable personal income is often monitored as one of the many key economic indicators used to gauge the overall state of the economy.

In Canada, HDI is somewhere around $55-$65K depending on the source you use to calculate it:

While the DIH provided some interesting city by city numbers, I was able to dig up a Canada-wide number from a recent speech given by Mark Carney. You have probably read sound bites from this speech before. In particular the following shocking, over the top, end of the world type pronouncement about the Canadian housing market has been quoted widely:

Some excesses may exist in certain areas and market segments.

These central bankers are fear mongerers!

But not to worry, Carney also pointed out that overall the Canadian housing market is healthy:

Canada’s housing supply is relatively flexible, compared with other countries, and it appears to have grown at rates broadly consistent with underlying demand forces, the most important of which is the rate of household formation.

Of course, in the United States, in the time leading up to their housing collapse, Alan Greenspan and then Ben Bernanke said much the same thing. One thing I have learned from reading all these books about the 2008 housing debacle in the US is that what a central banker says has more to do with the central bankers ideology is than the on the ground reality.

If you look at the data, you get a somewhat more worrying picture. Below is canadian house prices to disposable income:

Overall the country is quickly approaching 4.5. Using the DIH methodology, this would put the country as a whole in the “seriously unaffordable” category.

As for Calgary, with a ratio of 3.9, it is only “moderately unaffordable” (phew), though we are on the cusp of being “seriously unaffordable” (uh-oh). There is a really excellent analysis of how both house prices and household income have grown on the economic analyst website. They posted the following comparison for Calgary in particular:

One more point about Calgary. If you look at the median house price that is being used for Calgary by the DIH and others, you would be struck by the fact that it is $353,700 and not $393,000, which is median price reported by the CREB. The reason for the discrepancy is that the $353,700 number includes the “surrounding district” which means it includes Cochrane, Airdrie and some of the farming communities surrounding the city (Acme?). If you include the metro Calgary area only, which is what the local real estate board does when they are reporting statistics (because they like to print higher numbers), it would put Calgary into the “seriously unaffordable” category. I cannot find data on the area used to calculate the average household disposable income of the city, but I imagine it would be based on tax receipts and thus be restricted to the metro area.

Back to Canada as a whole, price to rents tells the same basic story.

Its either a heck of a bull market or a bubble.

As an aside I was amazed to learn that the price to disposable income in Vancouver is a rather bizarre 10.6. And that is using a $678,000 median. If you start using the average home price in Vancouver, the ratio is closer to 15.

Of course none of this has to end until interest rates show some sign of rising. Right now our househols pays prime -0.9% on our mortgage. That works out to about a 2% interest rate. Its rather insane. Even if we had a $500K mortgage (we don’t) it still be affordable. Of course if that rate went to 6%, it would be a different story. Some day that might happen.

Opportunities?

So why am I writing about this? Well for one, I think its an interesting study. The Canadian housing market has defied all other housing markets that have crashed and burned in the last few years. It has also defied most all metrics of affordability. For all the bears out there that say that the US housing collapse was inevitable it seems a reasonable question to ask: “then why not Canada too?”

I am of the mind that these forever rising prices, particularly Vancouver and Victoria and the inner city area of Toronto, are going to end badly some day. Everywhere else in the world the 3:1 ratio holds but Canada is different? The different argument is a big circular one. Because the different argument inevitably comes down to the fact that Canadians are inherently prudent and would not expose themselves to large risks. Which apparently means that this attitude allows Canadians to take on large risks. Anyways…

I also bring the topic up as a potential area for short candidates. Who would be hurt by a price fall? Particularly Vancouver.

Well first and most obvious is the Canadian banks. Mortgage debt makes up around 42% of the loans on the balance sheets of Canadian banks. This number has increased from 31% in 2002.

Another name that comes to mind is Home Capital Group. The company is always being praised on BNN by some expert making a top pick. The stock appears to trade relatively cheaply, at less than 10x earnings. But the business of the company is to make loans to people that can’t qualify for CMHC loans. I don’t know if the loans they make are “subprime loans” persay, they probably aren’t, but the company fills the exact same niche that the subprime borrowers in the US did.

I don’t know enough about the company to make any more observations than that right now. But it intrigues me. The company is worth a closer inspection.

And I’m open to ideas. What other companies could potentially be left with their pants down in the event of a material decline in Canadian house prices? I think there is plenty of time to gather more information about this trade. There probably is not much to worry about until interest rates begin to rise. And that might not happen for another couple of years. Please contact me with any suggestions, either by email or in the comments.

Moneyball without the ball