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Posts from the ‘Aurizon Mines (ARZ)’ Category

Yesterday’s David Tepper Moment

David Tepper is a very successful hedge fund manager who, in the fall of 2010, went on CNBC and explained, with a simplicity that the market loves, why you had to own stocks.

“Either the economy is going to get better by itself in the next three months…What assets are going to do well? Stocks are going to do well, bonds won’t do so well, gold won’t do as well,” he said. “Or the economy is not going to pick up in the next three months and the Fed is going to come in with QE.

“Then what’s going to do well? Everything, in the near term (though) not bonds…So let’s see what I got—I got two different situations: One, the economy gets better by itself, stocks are better, bonds are worse, gold is probably worse. The other situation is the fed comes in with money.”

I am coining the phrase “David Tepper moment” to refer to a time when what appears to be the obvious thing to do is the right thing to do.  A moment when the correct action is “just that simple”.

I believe that yesterday was a David Tepper moment for gold stocks.

Read more


Week 43: Up and down

Portfolio Performance

Portfolio Composition

Week 42-43 Trades

Biweekly Portfolio Updates

Those who read this blog regularly may have noticed that I have begun to post my portfolio updates on a bi-weekly basis.  Every week was just too much.  First, not enough happens to my portfolio every week to devote an entire post to it.  Second, its a pain to copy and paste the pictures and update the chart every week.  That is time that would be better spent doing research.  Third, an perhaps most importantly, I have found that with weekly updates I was becoming a little too focused on my short term performance, and I think this was conflicting with my investment style.

When I think of how I have made money in the past, it has rarely been from making quick trades in and out of stocks.  I generally make my money by sitting.   Somewhat paradoxically my best investments have tended to go through a significant period of pain before eventually moving in the direction that I had originally expected them to.

I have to accept, and to some extent expect, that my portfolio is going to go through significant drawdowns at times.  Those drawdowns are challenging.  These drawdowns cause me to reevaluate, and either to strengthen my conviction in a particular position or to realize the folly.  A lot of the time I waffle back and forth on a stock, buying and selling it at the margins, before finally coming to a conclusion on whether to keep it or not.

In the course of the last year I have found that there is extra stress associated with keeping a public portfolio, where the performance is there for all to see, even though most of the people that read this blog are strangers.  I don’t want to make bad decisions.  I feel like showing my portfolio every week may be affecting my decision making ability, at least a bit.  So I am going to try showing my portfolio every two weeks from now on, as this will make the portfolio less of a focus of the blog, and will allow me to focus on the research topics that I really enjoy writing.

With that said…

Out of Aurizon Mines

Without of a doubt my most significant move over the last two weeks was to get out of Aurizon Mines.  On the downside, I got out of Aurizon before it jumped this week and became one of the TSX best performers for the week.  I’m not terribly upset with that because I bought Atna Resources, Keegan Resources, and Gold Standard Ventures with the proceeds.

The reason for swapping a producer for 2 development companies and an explorer was simply valuation.  The explorers and developers have been hit extremely hard.  I honestly never thought Atna would get back below $1.  I mentioned Keegan Resources in a previous post, pointing out that I learned of the company from this Mineweb article, where they were listed in the table below as having one of the highest cash to market capitalization ratios of any of the juniors.

Its worth noting that Canaco Resources is also on the list with a 0.65 ratio.  I bought Canaco back a few weeks ago at 85 cents and it has done reasonably well since then, trading back up to 95 cents.  I would say that companies like Keegan Resources and Canaco Resources represent fairly low risk opportunities to take advantage of the current gold price environment.  Both companies have 4x to5x more cash than their current yearly burn rate.  Both companies have large deposits and they are actively exploring so there is the possibility of these deposits getting bigger.

The downside to both is that the deposits are so-so, and they are in Africa. Those are my only hesitation with these two stocks. But I am optimistic that the takeover of Trelawney may portend to a bottom in the deposit holding juniors.  I was surprised that IAMGold chose Trelawney as a target.  It was my impression  that the deposit had disappointed and that it was going to be tougher to open pit than was at first suspected.  It goes to show there is a price for everything.  The price for Keegan Resources right now is hardly the cash in its bank accounts.  Canaco is only a little better.  I have to think that the mining intermediates must be looking at these possibilities with interest.

A future move that I could see myself doing in the next couple weeks would be to lighten up on these two companies a touch so that I can reinitiate a position in Lydian International.  I sold out of Lydian when it looked like the gold sector was about to go into tank mode.  I figured Lydian would go down (it did) but I also don’t believe that has anything to do with the validity of their project.  The work I did on Lydian 9 months ago remains true today.  The company could easily be a $7 stock if gold deposits began to be valued at $1500 gold.  It has a much better deposit than either Keegan or Canaco.

I also added to my position in Gold Standard Ventures when they announced news of a second drill hit on their Railroad property.  I listened to the conference call that was held that morning.  It is still too early to know what Gold Standard has hit upon.  What they know is that they have two large, long intervals about 300m apart, and they know from analogy that the mineralization and formation they are drilling into is consistent with some of the large Carlin gold deposits.  The stock has a market capitalization of $200M now, so its no longer a cheap speculation; there is a lot of resource built into the share price.  Still, I find it hard to lighten up at this point, when the evidence right now is pointing towards one of those large 5-10Moz Carlin deposits that would make a $1B market capitalization not out of the question.

Banks doing well… for now

The regional bank stocks that I have bought continue to perform well.  I am going to write a more lengthy post reviewing the earnings of the 4 stocks that reported this week (RBNF, BOCH, BTC, and SHBI) so I won’t go into that detail here.

What worries me about the regional banks is that there is some evidence that the US economy is softening.  In particular, the ECRI WLI, which I have been following for years, appears to have stalled out, and it fell for the 4th consecutive week this week.  This softening makes me feel much better about the gold stocks I hold, but it gives me pause on the regional bank stocks.


Also making me feel much better about gold stocks are my worries about Spain.  I now follow the Spanish 10 year and 5 year bond on a daily basis.  Both are getting ominously close to crisis levels.  It appears that my analysis from earlier this year (What is the LTRO going to do for Europe? And how does it affect my stocks?) is turning out to be correct.  In it I wrote:

Like the Fed operations in 2008, the liquidity injections led to short term spikes but no lasting impact on the market. I am willing to speculate that the LTRO response with follow suit.

The ECB needs to provide further liquidity injections as the markets in Europe are rolling over.  This time they are rolling over in response to Spain, which is somewhat more disconcerting than how they rolled over for Greece last year.  I have been hunting the net for some recent Kyle Bass commentary on the situation, but I have not been able to find any.

Losing dollars because of the dollar

I am taking a haircut on the strength of the Canadian dollar.  If you look at the difference between the Canadian and US dollar values of the account, you will notice that the Canadian dollar value is now a full 2% lower then the US dollar value.

More importantly, more than 50% of my investments are in US dollar stocks.  The regional banks and mortgage servicers that I own suffer every time the Canadian dollar goes up.  A move of the Canadian dollar to 1.10, which has been predicted by some, would hit the US stock portion of my portfolio to the tune of 10%, and my overall portfolio, in its current construction, by 5%.

I’m not ready to do anything about this at the moment.  With the problems in Spain creeping up, I can imagine a scenario where the Canadian dollar corrects rather severely, and my US dollar assets act as somewhat of a hedge.  But it is certainly something to keep an eye on.  I would hate to see myself turn out right on my US stock holdings only to see the gains wiped out by currency movements.

Aurizon Mines: Maybe growth is finally on the horizon of Aurizon

Sorry about the title.  That was a terrible rhyme.

I didn’t set off with the intent of writing a long post on Aurizon Mines this morning.  I have other research projects to spend my time on that hold more near term potential.  In particular, I have regional banks to evaluate, mortgage lenders to learn about, and mortgage lending podcasts to listen to and transcribe.

Nevertheless I must have a masochistic side because I am always more fascinated by the times I am wrong and the things that I don’t understand than with what is working and making sense.  And nothing has been wrong or made as little sense to me as the downward spiral of Aurizon Mines.

Over the past 6 months I have (somewhat unintentionally) been swing trading Aurizon Mines.  I hold a core position but around that position I buy more at or just under $5 and I sell what I buy at around $5.75 or $6.  It worked well a couple of times last year, however this year not so much.   The stock stalled out a few weeks ago at $5.50, it didn’t stay there long, and I ended up jumping out of some of my non-core position in the $5.30 range.  After that I sat as a bagholder with the rest, watching the stock tumble below $5.

In the last couple weeks I have been in and out some more, buying at $4.80, getting out at $4.9 before buying back on Thursday at $4.50.  The frequency of my indecision is telling. I clearly don’t know what to think about the stock.

To be honest, I didn’t think Aurizon would get this low.  The company holds $1.31 in cash and would be considered to be one of the lower cost gold producers. It has consistently met targets.  Its not a management disaster like so many gold miners.  These are solid operators.

The Alamos Gold Comparison

I did a comparison a few months ago between Alamos Gold and Aurizon Mines to demonstrate the disconnect.  I think it is instructive to dig up and refresh that analysis now that the Q4 numbers are out:

Instead of focusing on the valuation discrepancy and how the market has it wrong, I want to focus instead on why the market is willing to value Alamos at 2x to 3x the value they are willing to assign to Aurizon.

I think its all about growth and costs.

In the Alamos Q4 report, the company forecast that they would increase production from 153,000 ounces to over 200,000 ounces in 2012.  They also predicted that costs would come in about the same as they did in 2011.

In 2012, the Mulatos Mine is forecast to produce its one millionth ounce of gold. Ongoing exploration success has resulted in a track record of mined reserves being replaced. In 2012, the Company expects production to increase to between 200,000 and 220,000 ounces at a cash operating cost of $365 to $390 per ounce of gold sold ($450 to $475 per ounce of gold sold inclusive of the 5% royalty, assuming a $1,700 gold price). The Company expects that gold produced from the gravity mill, which will process high-grade ore from Escondida, will add a minimum of 67,000 ounces of production in 2012 at a grade of 13.4 g/t Au. Based on bulk sample testing conducted in 2007, the Company believes that there is the potential for higher production from the gravity mill as a result of realizing positive grade reconciliation to the reserve grade.

The high-grade gravity mill has been constructed and is currently undergoing commissioning and is expected to be operational with high-grade production by the end of the first quarter of 2012. The current life of the Escondida zone is approximately three years and exploration efforts in Mexico in 2012 will continue to focus on sourcing additional high-grade mill feed. Metallurgical testing completed in 2011 on higher grade ore from San Carlos demonstrated that it is amenable to gravity processing, potentially doubling the amount of available mill feed. Further optimization and metallurgical studies are underway in order to increase the amount of high grade ore that can be processed through the gravity plant.

On the other hand a look at Aurizon’s Q4 report shows the following outlook:

It is estimated that Casa Berardi will produce approximately 155,000 – 160,000 ounces of gold in 2012 at an average grade of 7.5 grams of gold per tonne. Average daily ore throughput is estimated at 2,000 tonnes per day, similar to 2011. Mine sequencing in 2012 will result in ore grades that are expected to be approximately 6% lower than those achieved in 2011. Approximately 42% of production will come from Zone 113, 41% from the Lower Inter Zone, and the residual 17% from smaller zones and development material.

Assuming a Canadian/U.S. dollar exchange rate at parity, total cash costs per ounce for the year are anticipated to approximate US$600 per ounce in 2012. Onsite mining, milling and administration costs are expected to average $134 per tonne, up approximately 6% from 2011 costs as a result of higher stope preparation costs and smaller stopes.

Flat production.  Higher costs.

$600 costs are not high by most gold mining standards.  With those sort of costs Aurizon would still sit in the top quartile of low cost producers.  I think that in this case Aurizon is guilty by association.  There have been SO MANY gold miners that have began to predict higher costs only to see those costs spiral much higher than was originally anticipated. The market is on guard.

The Sinking Growth Ship

As for the growth, the problem is that the company’s flagship growth project is not inspiring confidence.   I stepped through the news timeline at Joanna in a previous post.  Since Aurizon has made it a habit of updating the street with quarterly reminders of just how shitty the Joanna PEA is going to be, let’s do the same thing here.  Below is the time line of events:

May 12th 2008

Aurizon first commissioned a pre-feasibility study on Joanna.

November 11, 2009

Aurizon finally received that pre-feasibility study and proceed to a full feasibility study.

September 14th 2010

Aurizon notifies shareholders that the original recovery process assumed (called the Albion process) would show lower recoveries and higher costs than first anticipated. Additional metallurgical test work would be done and the study delayed until mid 2011.

August 11, 2011

Aurizon delays the feasibility study for Joanna again, saying: “the projected capital and operating costs appear to be significantly higher than previously anticipated. The increased scope of the project, as a result of the expanded mineral resource base, has increased capital costs, including those associated with an autoclave process. The costs of ore and waste stockpiles, tailings and of materials and equipment have also all been trending higher, along with the gold price.”

January 11, 2012

Another update giving an ETA: Feasibility study work on the Hosco deposit will continue in 2012 with completion of the study anticipated by mid-year. The feasibility study will incorporate a reserve update based on the increased mineral resource estimate announced on June 13, 2011, together with results of metallurgical pilot tests, a geotechnical study, updated capital and operating cost estimates, and other relevant studies.

As I wrote at the time:

Its been almost 4 years since the original pre-feasibility study on Joanna was complete! At this rate they should be mining by 2100.

The time line can now be updated with the latest installment from the Q4 report and the following comment:

While some studies are still in progress, based on its review of information currently available the Company believes that the feasibility study is sufficiently advanced to conclude that the projected capital and unit operating costs will be significantly higher than estimated in the December 2009 Pre-Feasibility Study, due in part to the change in the scope of the project, the expanded mineral resource base, the selection of an autoclave process and a decision to process the ore on site.

I think this is about the 3rd time the company has warned investors not to get their hopes up about Joanna.  Keep in mind that the original numbers for Joanna weren’t exactly thrifty (if I rememver right they were $200M + capital and $700 costs).

If I was going to translate this news-release-speak into plain english it would sound something like this:

It is surprising even us with how shitty this project is turning out to be

But that’s just my interpretation.  I could be wrong.

Takeover talk!

I have found 3 articles (here, here, and here) discussing a post-earnings release interview (or maybe it was on the conference call, I haven’t had a chance to listen yet) done by George Paspalas, the company’s CEO, where he said that the company has been approached by potential suitors and that the company is also looking for companyies they could takeover.

With respect to the potential for an acquisition, Paspalas said the following:

To receive the company’s interest, a target would have to be producing around 120 000 oz/y, and at similar profit margins to Aurizon’s flagship Casa Berardi mine in Quebec.  “We’ve looked hard, I can tell you that,” Paspalas said, speaking in a telephone interview from the firm’s Vancouver headquarters.   “There are a lot of companies out there…that are at a point where they have a pretty good project, but they don’t have any cash – and the shareholders are saying ‘enough’s enough’ in terms of dilution,” commented Paspalas.  “We have five or six opportunities in our grade one category,” he said, adding that one of these could close in the near-term if there weren’t any pitfalls in the technical due diligence or price negotiations process.

He went on to say that they are shifting their focus from looking at acquiring a producing mine to instead acquiring a near-term project.

The one report also said that Aurizon “has itself received informal approaches regarding potential mergers.”

Cautiously Optimistic

I think this is quite good news.  The problem with Aurizon, as I have tried to lay out above, is that the market wants growth and the market isn’t buying Joanna as the vehicle for that growth.  It’s too bad they will have to pay up a good chunk of their cash hoard to acquire a project but the argument could easily be made that the cash is being ignored by the market right now anyways.  If you remember Argonaut Gold, their adventure to double digit share prices began when the company took over Pediment Gold and with that acquisition bought themselves a stable of near term production projects.  A similar acquisition by Aurizon would be a positive.  It would allow the brokerages to start prjecting realistic growth  into the future, and from those higher production numbers they can begin to tag a higher multiple onto the stock.  Then everyone gets excited about the prospects and we all jump on the bandwagon and a couple of fund managers get on BNN and hype the stock and pretty soon you have Argonaut Gold all over again, going from $3 to $10 in a little over a year.

Its a plausible scenario.   If the takeover happens and it looks like its the right takeeover, I will no longer swing trade the stock and instead will begin to hold it for the longer term.  But without the takeover I am just not willing to put too many of my eggs in the Joanna feasibility basket, which is sounding more and more to me like it has a big hole in it.

Buying when you don’t want to

The hardest posts for me to write are the one’s where I have to write that I bought a bunch of stocks on a day where the market was down a lot.  Its tough because I am worried I will be proven wrong.  Its extra tough because I am notoriously early and so I have been wrong many times before.

The market really tanked today and nothing tanked harder than the junior gold and oil stocks.  I had lightened up significantly on the gold stocks last week; I exited Canaco Resource, OceanaGold and a significant portion of Aurizon Mine. Unfortunately I used some of the proceeds to buy Pan Orient Energy, which took it on the chin today.

Nevertheless there is some truth to the old adage that the best time to buy stocks is often when you don’t want to.  Today I didn’t want to buy anything.  I even had half a mind to sell it all and stand away.

But having thought it through, I am having trouble making sense of the idea that this is the start of something big.  I have become a convert to the idea that the LTRO has taken out much of the systemic risk potential. The prices of periphery bonds suggest as much; even after today’s shellacking Italian and Spanish bonds sit near their lows.  The TED spread and Swap spread hardly moved at all and currently sits at 40 and 27 respectively, well of their highs of 60 and 55.  The bank stocks, while hit hard, did not lead the way down in the way they did in August.

It just doesn’t feel to me like it did in August, or in November for that matter, when the fear was palpable.  Yes, we are worried about Greece and what is going to happen.  But the evidence does not suggest that the big players are that worried.  If they were we would see more signals of the stress in the bond market.

Which makes sense.  By this point everyone knows about Greece.  Everyone who had money at risk with Greece should have been able to figure out how to take it off the table.  That yields aren’t rising in the periphery suggests that the real problem, that a Greece default would cause a domino effect, is not in the cards.

What I bought

I’ve had good luck buying Aurizon under $5 in the past and so I did so again today, restoring my full position in the stock.  I also bought more Golden Minerals.  Golden Minerals is a stock I had been tempted to sell when it got to $10, but I got a little greedy and decided against it, only to watch the stock fall back to $6.80 today, which is not too far away from my original purchase price.  The stock is reasonable at these levels; the company has $2 cash on hand per share and a 6Moz gold equivalent resource.

Interestingly, Rick Rule was on BNN yesterday and he had some positive comments on Golden Minerals in this clip (I’m not really sure how to embed video from BNN).

Since last Wednesday its been a swift fall for many gold stocks.  My bet here is that the latecomers have been fleshed out and that with stocks like Aurizon and Golden Minerals approaching their 52 week lows once again, we are close if not at the bottom.

I also added to Pan Orient.  This will be the last time that I add until I see the stock begin to rise again.  For the time being I will sit tight with what I own.

Week 35: Continuing to Move away from Gold: Out of OceanaGold, Canaco Resources, into Pan Orient Energy, Newcastle Investments

Portfolio Performance

Portfolio Composition:


Sold the Gold Sell-off

This was the week where I got fed-up with gold stocks doing nothing and began to sell them en masse.  I completely eliminated my position in OceanaGold, and in Canaco Resources.  I dramatically reduced my position in Aurizon Mines, and somewhat reduced my position in Lydian International.

I do have to wonder whether the $90 drop in the price of gold was orchestrated.   Interestingly, mention of such a possibility came from a rather unlikely place on Thursday, as I was sent the following excerpt from Dennis Gartman, who was quoting from a friend “near the centre of the events”:

Whether or not the plunge was orchestrated, I had to start removing dead weight from my portfolio and this provided a good excuse.  As the price of gold fell and OceanaGold and Canaco Resources began to crack, I asked myself what am I still doing in these stocks?  I couldn’t come up with a good answer so I sold.

In the case of OceanaGold and to a lessor extent in the case of Aurizon Mines, the catalyst that could move the share price higher remains somewhat in the distance.  I am not seeing anything like the takeover frenzy that has been predicted by some, and so these stocks become waiting games; lined with the hope that either the market catches onto the name and bids it up, or that some sort of (lucky) catalyst emerges.  I have not had very much luck investing on such hopes in the past.

In the case of Canaco Resources, I re-read my analysis of Magambazi.  That analysis got a lot of attention during the early part of the week as it was posted on Stockhouse (by some guy who seems to be taking credit for doing the work – sigh).  While I still question whether there is an error in my analysis, I do think I raised enough questions about the deposit, and enough uncertainty about the eventual resource estimate to be somewhat wary of the NI 43-101 that will be out shortly.  I decided to step aside until that resource comes out, or the share price falls back to the point where I feel like the downside is priced in.

Adding to Newcastle, Pan Orient, Leader Energy Services

The other part of my reasoning for selling some of the gold names is I see better alternatives elsewhere.  With oil at $100 per bbl I would rather be involved in oil companies with near term catalysts (Pan Orient) and service companies poised to take advantage of the move to drilling for more oil (Leader).

In the case of Newcastle, I listened to the fourth quarter conference call and reviewed the companies slides on mortgage servicing rights.  This appears to be an opportunity that has been overlooked by the market.  Newcastle is investing money into MSR’s with potential rates of return exceding 20%.  If they inded capture these sort of returns, I expect a significant dividend increase and a move in the share price to around $10.  I will write-up some of my findings with Newcastle later this week.

Week 30: Cognitive Dissonance, Canaco updates, Canadian house prices and the story of Community Bankers Trust

Portfolio Performance

Portfolio Composition

Trying to not be dogmatic

A few years ago I read a book called Mistakes were Made.  The book described our ability as human beings to remain convinced that we are right to the point where we ignore all evidence to the contrary.

Our predisposition to fabricate reasons why we are right and ignore reasons why we are wrong is based on a concept called cognitive dissonance.  As the book defines it:

Cognitive dissonance is a state of tension that occurs whenever a person holds two cognitions (ideas, attitudes, beliefs, opinions) that are psychologically inconsistent… Dissonance produces mental discomfort ranging from minor pangs to deep anguish; people don’t rest easy until they find ways to reduce it.

All symptoms I am all too well acquainted with.

Along the same lines, I came across an interesting piece on FT this week.  The following quote can be attributed to SocGen’s Dylan Grice:

But all is not lost. The bias towards thinking we’re more correct than we are isn’t driven by an inability to fully assimilate undesirable information but an unwillingness to do so. Therefore, the first step in removing the bias is to adopt procedures that foster a more honest acceptance of logical conclusions. Logic has no emotional content per se. There is no such thing as good or bad information; information is only true or false.

But because of our hardwiring, we only want certain information to be true. In particular, we want the information that confirms our prior beliefs and validates our belief systems to be true — about ourselves, about others, about the world. Thus, debiasing ourselves must involve an honest assessment of what we want: do we want to be right about everything, or do we want to know what’s true?

Let’s bring this back to what this blog is about: investing.  In my piece last week I stepped through the basic premises on which I am currently invested.  The tenants I stated were the conclusion of a somewhat anguished and certainly restless mental reevaluation that I had been running through over the prior few weeks.

As the market moved against me I  started to look at why I might be wrong.  In my spare time I tried to “assimilate the undesirable information” and paint the most contrary picture I could.

I especially went through the exercise with gold and with my rather significant precious metal stock positions (Aurizon Mines, Atna Resources, OceanaGold, Canaco Resources, Geologix, Esperenza Resources, Lydian International and Golden Minerals).  Gold is always easy to question (what does gold really do anyways?).  I attempted to soberly evaluate both the prospects of the metal  and the companys.  I looked for reasons to basically cut them loose.

I hemmed and hawed a lot, and at times began to convince myself that I was indeed wrong.   But in the end I was led back to the basic points of valuation and underlying conditions, which seemed to me to remain firmly in gold’s favor.

This is how I make decisions.  At times it undoubtably appears that I am flip-flopping.  I am sure that my weekly writings must have an aire of contradiction when read one after another.  A reader might wonder how it is that my point of view can go from one extreme to another in the matter of weeks (see Argonaut Gold).  Or at times even flip 180 degrees only to flip back a few weeks later (see Argonaut Gold).

In truth, this is the only process I know of that allows me to really question whether I am right.  If I can push myself to the edge, almost convince myself of the diametrically opposed point of view, and still in the end come back to my original conclusions, then well, that’s really getting somewhere.   At times I push myself so far that I actually begin to believe it myself (ah yes, see Argonaut Gold), but that is just a occasionally necessary casualty.  Far more often I leave the exercise with more clarity, and with that clarity comes the likelihood that I will act properly when the situation arises.

In the end I came away from my “anguished” analysis of gold more confident in my positions than I was when I started.  And this week, on Wednesday, when the Fed news hit the wire that interest rates would be low for time eternity, that gave me the clarity to act.

The moment I read the news I bought a position in Barrick Gold, and I added to my positions in Esperanza Resources and Golden Minerals (though I neglected to make the AUM trade in my practice account).  The next day I added to OceanaGold, and thta was followed by additions to Atna and Canaco the day after that.

In my practice account:

And in my actual account:

You do the work so that you have the confidence to act.  You put in the time learning and working through why so that when an opportunity makes its brief appearance, when Bernanke comes out and says “yeah we aren’t going to raise rates for a long time” you can recognize it for what it is and say “all right, I’m in” and you know what you have to do.

Had I not been stepping through the thesis of why gold and gold stocks remain a solid investment, I likely would not have had the conviction to buy into the rally.  At worst, I would have sold into the rally, because if you really don’t know why you are investing in something you tend to take the first blip after a long period of blah as a “finally I can get out” moment.  As it is, with the Fed putting interest rates on hold for another couple years, and with their actions maybe even foreshadowing a true QE event in Europe, I feel quite confident that I am positioned well for that fall out.

Speaking of Canaco Resources…

I bought Canaco Resources at the end of the year at about $1.10 as part of my “tax loss buying binge”.  A couple of things happened with Canaco this week.

First, the stock went up.

Second, the company updated us on its activities in Tanzania:

  • Expect a resource estimate by the end of March
  • Expect a preliminary economic assessment by the end of the third quarter
  • Expect further metallurgical testing results at some point

Third, Canaccord Capital came up with an updated price target, and more importantly helped give us a glimpse at what to expect from the upcoming resource estimate (hat tip to howestreetbull who posted this on Investors Hub).

  • Canaco has approved a US$35-40 million 2012 exploration budget, and is currently drilling 10,000 metres per month at Handeni with nine diamond drill rigs and one RC rig.
  •  Six of the drill rigs are focused on delineating the Magambazi resource in preparation for the initial resources estimate. Two diamond drill rigs are focused on the Kuta and the Magambazi North Extension targets. The remaining diamond drill rig is operating on the Majiri target, where previous surface sampling and RC drilling indicate a gold anomaly. The RC drill rig iscurrently operating on the Bahati target to test preliminary regional targets.
  • We are expecting an initial resource and metallurgical test results in Q1/12, and a PEA in Q3/12. We are expecting an initial resource of 2.3 million ounces of gold at a grade of 3+ g/t gold. Previous metallurgical testing indicates recoveries of 90+% using a conventional CIL process.

Valuation: with US$110 million in cash, we believe the company is in a strong position to continue to derisk and advance the Handeni project. Our peak gold price estimate of NAVPS (10%, US$1,750/oz) remains unchanged at $7.50. We continue to value Canaco based on a 0.65x multiple to our peakgold price estimate of NAVPS.

At the current price of $1.50 Canaco trades at a market capitalization of $300M.  Subtracting the current cash balance of $115M, the enterprise value of the company is a little less than $200M.  If the deposit does indeed contain 2.3M oz of gold, the valuation being given for those ounces is about $80 per.

This is a 3 g/t open pittable deposit that looks to be 90% recoverable with a straightforward metallurgical process sheet.  In my opinion (and apparently Canaccord’s as well) those ounces should be worth more than $60/oz.

To throw out a comparison point from a recent PEA, Prodigy Gold had a PEA done for its Magino gold property last March.  The PEA assumed a CIL recovery process, a 9 year mine life, producing gold from an open pit at a grade of 1.2g/t for 9 years to give a total mine of life production of 1,585,000 oz of gold.  The after tax NPV5 of the project was estimated at $259M at $1000/oz gold.   That works out to a value of $160/oz.

Albeit there may be better comparisons out there, but this one surely suggests that Canaco is undervalued.  Canaco’s Magambazi project is much higher grade than Prodigy’s (3g/t versus 1g/t).  The location is Africa, versus Canada for Prodigy, which probably suggests a bit of a discount against Canaco but not enough to make me change my opinion.  And while the Magambazi strip is as yest unknown,  the Magambazi deposit appears to be around a hill top, which should lead to a reasonable number (the strip for Prodigy’s Magino is 3.3).

Finally, the last bit of news was that Brent Cook came out with the following plug about Canaco:

“The funds were just jumping in on this thing – and they all bailed out as well – the stock got down to $1.20. During this time period they’ve been drilling and drilling and drilling, and the results continue to show me that they’ve got what I think is going to be a legitimate, decent size, decent grade, open-pittable deposit in Tanzania,” Cook says. “So we’re buying this stock at $1.30 with $115 million in the bank, and a $41-million exploration program. That, to me, seems like a good buy.”


When the gold price broke out on Wednesday, Canaco was the first stock I added to.

and speaking of gold…

I came across this interesting piece of information regarding the appetite of the Chinese for gold.   This may be old news to some but I think it is still worth reporting.

The People’s Bank of China  research director Zhang Jianhua was cited as saying Monday in the central bank publication Financial News that gold purchases should be ramped up when prices drop, although he gave no indication of what proportion of the nation’s $3.2 trillion forex reserve should be allocated to investments in gold.

Apparently, Jianhua called gold the only safe haven left and said that:

“the Chinese government needs to further optimize China’s foreign exchange asset portfolio and seek relatively low entry points to buy gold assets…no asset is safe now.  The only choice to hedge risks is to hold hard currency – gold”.

High House Prices

I’ve been doing some research on house prices in Canada and in particular in my city, Calgary.  I plan to do a separate post on my findings shortly, but for the moment I just want to throw up a couple teaser graphs that gave me pause for thought.

The chart is taken from a speech given by Mark Carney to a Vancouver audience last June.  The methodology used is the ratio of the nationwide median home price to the median household disposable income. A ratio of greater than 3 has traditionally been seen as unaffordable.

It makes you think.

One other chart from the same report.  Below is the average house price in Vancouver:

Its either a heck of a bull market or a bubble.  To say it another way, I don’t know about house prices, but when a stock goes parabolic you typically know how it is going to end.

Anyways, more on this later.

Community Bankers Trust

It was a good week for Community Bankers Trust (BTC).

Earnings will come out for the company on Tuesday.  Hopefully the company will put together another profitable quarter.

The BTC story

I bought BTC as a turnaround story.  Community Bankers Trust is a bank that has been trying to reincarnate itself after the first incarnation came close to an early death. My observation is that they have been successfully navigating this resurrection, and with the recent turn in profitability (and a helpful turn in the economy) the bank is on its way to realizing its earnings potential.

The bank was hit hard by the recession in 2009.  The company saw nonperforming loans skyrocket from 2% of total loans in the first quarter of 2009 to 10% of total loans in the second quarter of 2011.  Yet there have been signs that the efforts the company has been making to turn itself around are working, culminating with a profitable quarter in Q3.

Let’s hope they can keep that momentum.

How did they get to here?

The original strategy of the bank was, as far as I can tell at least, to simply buy other banks and get bigger.  Witness, the name of the original company was called Community Bankers Acquisition Corporation  (CBAC), so they weren’t exactly being subtle.  Along with the acquisition strategy, the bank seemed to have a “worry about the profitability later” strategy, which may have worked ok when the economy was growing but that fell flat when the economy didn’t in 2008.

As best as I can discern the acquisition effort was spearheaded by Gary Simanson. He headed up the original company CBAC, and then moved into a position of Strategic Vice President, a position I don’t think I’ve ever heard of with any other company. According to this article, Simanson was responsible for subsequent acquisitions.

In truth, the timing was what killed the acquisition strategy.  To quickly step through the timeline, in May 2008 the company began its journey by acquiring two local Virginia banks, TransCommunity Financial Corporation, , and BOE Financial Services of Virginia, Inc.  In November the bank moved ahead and acquired The Community Bank, which was a little bank in Georgia.  Finally in January 2009 they acquired Suburban Federal Savings Bank, Crofton, Maryland.

So you had 4 bank acquisitions in less than a year happening at the time of a 100 year financial tsunami.  How do you think things turned out?

Change in Direction

By 2010 Simanson had left the company and the direction of the company was changed to the more pragmatic “we need to get profitable before we go belly up” strategy.

This was described pretty bluntly in the 2010 second quarter report. CEO Gary Longest said at the time:

Our strategy has shifted from that of an aggressive acquisition platform, to one that meets the banking needs of the communities we serve, while providing sustainable returns to our stockholders. To this end, we are taking the necessary steps to return immediately to profitability. We are actively analyzing our market base to assess the contributions of all branches to our franchise value and will take the appropriate actions in the third quarter of this year. Additionally, we will make aggressive expense reductions, and will look to restructure and strengthen the balance sheet. We are confident that the analysis of these potential critical paths and the resulting execution of these initiatives will lead us back to profitability quickly.” “Our goal is an immediate return to consistent quarterly profits. To accomplish this, we have no alternative as a Company but to make clear and intelligent decisions in the next 60 days, no matter how difficult, to accomplish that goal as soon as possible. That is our full focus.”

 In a somewhat odd twist to which I’m sure there is a good story, Longest himself was gone only a couple months later. Nevertheless the interim CEO and soon to be permanent CEO Rex L. Smith took up the reins and has carried out the strategy quite well given the circumstances.

 Where are they now?

I already mentioned that the company had its first profitable quarter in a long time last quarter.  I don’t believe this was a one time fluke.  It looks to me like its the culmination of a number of initiatives put forward by the bank that have been geared towards making the bank more profitable.

The company has made an effort to lower the cost of its deposit base.  Time deposits, which are expensive high interest bearing deposits, have decreased from 73% to 67% of total deposits since the end of 2009.  As well, the cost of the time deposits has come down from 2.9% in 2009 to 1.6% in the third quarter.

The effect has been a steadily rising net interest margin (NIM) since the strategic direction change in 2010.

(note that this graph is a simplified version of NIM calculated as a percentage of all assets rather than the more common formulation of interest bearing assets)

The company also undertook efforts to reduce expenses.  The most common way of illustrating the day to day expenses of a bank is through something called the Efficiency ratio.  The Efficiency ratio is simply the ratio of the total non-interest expenses at the bank (so the salaries, building costs, lawyer fees, pretty much everything except the actual cost of borrowing money) to the  net interest margin (so the amount of interest made minus the amount of interest paid).  The reason that you look at the Efficiency ratio is because it ex’s out growth, since growth should occur for both NIM and expenses in concert with one another.

The Effiency ratio of BTC has been falling consistently.

What’s it worth?

To get an idea of what the bank might be worth if it continues to pull itself together, I put together a proforma earnings estimate.  I stripped out all the provision for loan losses, the FDIC intangibles (from their earlier acquisitions) that the bank is required to amortize, as well as losses on real estate and gains of the sale of securities.  So basically I looked at the banking skeleton that is BTC.  Here is what I found:

What this clearly demonstrates is that if get rid of all the scabs, there is quite a profitable little enterprise here.

Meanwhile, the bank sports a tangible book value that is much greater than the current share price ($1.40 after last weeks run up):

What is left to be done?

The story that still needs to play itself out is the healing process.  The really big negative for the bank is that it still has an extremely elevated portfolio of non-performing loans.  There are signs that this is abating, and in truth part of the bet here is the same one that you make on any regional bank: the US economy is turning the corner, the Fed is not going to allow it to fall into another recession, and so the worst of the loan defaults are behind us.

But just to get an idea of the risk here, typically you wouldn’t want a bank to have non-performing loans in excess of a couple of percent.  Many of the best banks I’ve looked at have nonperforming loans of well less than 1%.  BTC, onthe other hand…

There are tentative signs that the peak has passed, but it will take a few quarters before we know for sure that further write-downs are not coming.

Earnings on Tuesday will give us a lot of insight into the direction of the trends.  I’ll be looking closely at nonperforming assets and the 30-89 day deliquents (which are an early warning of the soon-to-be not performing.  I also will be hoping to see some decent earnings.

Letter 26: A Move in ACFC, the end of tax loss selling for gold stocks, Mispricing of Aurizon Mines, and All the Devils are Here

All the Devils are Here (though most have probably moved to Europe)

Over the winter break I read the book All the Devils are Here, by Bethany Mclean and Joe Nocera. The book essentially traces out all the strands that culminated in the panic of September 2008. The book identified the following factors:

  1. A reliance on ideology instead of analysis. In particular this applies to the Federal Reserve and Alan Greenspan, whose ideological “market is always right” view permeated the decisions of the Fed and to some extent those of the other regulatory bodies. But more generally, ideology, specifically free market ideology, seemed to permeate through all the political and financial institutions to the point that it replaced a sober look at reality. Similarly, for many traders and investment bankers, an ideological reliance on “the model” often led to an ignorance of the potential risks of an outlier scenario
  2. The absence of regulation. For a variety of reasons (the power of the lobby groups, the political infighting between the regulatory bodies, the ideological free market view of the participants and the myopic focus on regulators on Fannie and Freddie) an attempt to regulate the subprime industry was hardly even contemplated until it was too late.
  3. The development of securitization. The most important consequence of the innovations to pool mortgages, to tranche pools, and then to create pools of pools (CDO’s) was that the lender and the borrower became further and further divorced by more degrees of separation. The securitization process created so many layers of intermediaries between the party who actually ended up with the loan on their books and the party that took the money that risks were easily lost in the translation.
  4. The rubber stamped AAA status provided by the ratings agencies. Some books focus on how the rating agencies didn’t understand what they were rating. Mclean and Nocera point out that the revenue structure of the agencies was doomed to be corrupted. A system where the raters are paid by the producers of the securities they rate might be considered to be an insane one. The result was that the agencies were played off against one another by the investment banks; market share went to the most relaxed rating. Add to this the fact that the agencies, particularly Moody’s, became focused on profits at the expense of their inherent conflict of interest, and you had a situation ripe for abuse.
  5. Greed. Politicians more concerned with their own campaign donations than with promoting sustainable public policy. Company executives intent strictly on their own promotion and profit. Mortgage originators with essentially no moral compass at all. The system was (and is) corrupt.
  6. A lack of understanding. The same characters at play as with greed. So few people saw the disaster coming. Sure some did, there were a few regulators and a few hedge funds that saw how unsustainable the leverage being piled on in the mortgage sector was. But the vast majority didn’t have a clue. Even the supposed smart money didn’t really get smart until 2006-2007.

It is this last point, the lack of understanding, that I think is most relevant to what we face today. It really surprised me how little the people in influential and powerful positions understood the concepts that they were making decisions with regard to. Even Hank Paulson, who is actually portrayed in quite a positive light, was completely blind to the corruption and leverage being amassed in the mortgage market.

This naturally begs the question of Europe: how many of the politicians and bureaucrats in the EU really understand the situation they are trying to navigate? Do they really know the risks inherent in the decisions that they are making? Do they even really understand the banking sector they are trying to protect?

The last 6 months for me has been an education in how the modern banking system works. I have been trying to read all that I can, all the boring, technical aspects. And I don’t think for a minute think that I’ve wrapped my head around it. There are so many moving and interdependent parts. It’s also not a very tangible subject. It simply isn’t something that is easily understood.

Thus I think it’s a legitimate question as to whether the bureaucrats of Europe have the understanding required to navigate the minefield of sovereign defaults and banking bankruptcies. As Lehman showed, it only takes one mistake to create a loss of confidence that spirals uncontrollably.

How can you take on risk with this in mind?

The end of (tax loss) selling?

The week after tax-loss selling is always an interesting one.  It provides the first glimpse into whether a security has been facing unrelenting selling because of investors simply wishing to take their losses (and their tax breaks) and move on, or whether something more nefarious is at play.  Along the lines of the former, this week provided a rather marked jump in a number of the regional bank stocks that I have initiated a position in.  Most conspicuous of these moves was that of Atlantic Coast Financial.

A Take-over Imminent for ACFC?

ACFC had a rather astounding 50%+ move this week.  I really have no idea what precipitated the move.  To take it with a grain of salt, the volume for the stock this week was less than spectacular, though the same could be said for almost the entire move down.

As I pointed out last week the stock is a bit of a flyer; the bank is a mortgage lender in one of the most crippled mortgage markets (Florida), they have bad loans coming out their wazoo, and a stock that has fallen from $10 to $1 in less than a year generally does not do so on speculative panic alone.  Nevertheless, part of the story is the book value, which even with 3 years of bad loan write-downs lies at a rather surreal $19 per share (versus a share price of $1.70 when I bought it).

The other part of the story is simply the realization that what is going on with this bank (and many of these little community banks that got caught up in making bad loans at the wrong time) is a race between the write-downs of their past transgressions and the earnings of their current performing loan book.   With ACFC it is not at all clear to me that the bad loans will win out; in fact I tried to make the case last week that with a little luck (and an improving economy) the performing book may very soon be able to out-earn the losses on a consistent basis.  If this happens, the shares are clearly worth more than 10% of book value.  Even if it just becomes a possibility, a shrewd competitor may be tempted to take a plunge.  I constructed the chart below to try to see where ACFC is in that process.  The chart compares earnings before provisions (black) to the quarter over quarter change in non-performing loans (red).  Its basically a look at whether the company is out-earning the loans going bad each quarter.  The 3rd quarter was the first in four that the black won out.

Community Bankers Trust: Another Regional Bank with a Move of its Own

While ACFC was the best of the lot of regionals, there were others that showed signs of life.  Community Bankers Trust surged on Friday.  The stock remains at about 1/3 of book value.  If it were not for Europe and the ever-impending doom there, I would add more.  As well, Oneida Financial continues to push higher.  Unlike ACFC, BOCH and BTC, Oneida is a terribly boring bank trading at about book that is probably going to do nothing but increase in price by 10% a year and pay a 5% dividend until one day it gets bought out.  At some point I might get bored with with relatively low return, but in this environment, I am happy to take a reward with so little risk.

Will Gold Stocks Rise now that Tax-loss Selling is over?

As for the golds, Esperanza, Canaco and Geologix all are showing classic signs of a let-up in tax loss selling.  All are well above where I bought them.  Aurizon, on the other hand, continues to be sold rather indiscriminately.  Yes, I realize that the price of gold is getting clobbered on a regular basis.  I can appreciate that investors may be questioning the wisdom of holding gold as a hedge to anything given the fact that it seems to dramatically underperform on risk-off days.

Still, I scratch my head at Aurizon.  Here is a low cost gold producer that is comparatively less correlated to the price of gold than most of its competitors.   For one, if you are low cost you are by definition high margin.  Thus, a $30 move in the price of gold is of much less impact to a producer with $1000/oz margin (like Aurizon), than say a producer with a $500/oz margin.  Yet Aurizon regularly trades down MORE than your average gold producer on the down days.

Going Short Argonaut Gold and long Aurizon Mines

So confounded have I been that in order to hedge my risk with Aurizon I have decided to take a short position in a fellow gold producer, Argonaut Gold.  To be sure, there is nothing wrong with Argonaut Gold.  I wrote the company up rather glowingly a couple months ago.  However that was at $5, and now AR trades at $7, while in the same time Aurizon has fallen to less than $5. Below is a comparison of the key metrics of both companies.

So to briefly summarize the above, Aurizon produces more than twice as much gold, it produces over double the cash flow, and to top it off, Aurizon’s 3rd quarter was stronger than Argonaut’s.  Argonaut potentially has a better pipeline of projects, but this is more than nullified by the fact that Aurizon trades at almost half the price on a per producing ounce basis, produces those ounces at $50-$100 cheaper, and has over $1 in cash on its balance sheet while Argonaut has a mere 30 cents. It simply doesn’t make sense.

While I remain bullish the price of gold, I also remain wary that I am not very right in this bullishness at the moment, and so it seems like the prudent thing to do to short what seems relatively over valued and buy what seems relatively undervalued.  Anyways, that is what I did.

I also bought back OceanaGold for another run.  Its getting to be repetitive, but it has been a consistant source of profits.  Buy OceanaGold below $2.20 and sell it above $2.70.   I must have done this 3 times already in the last 9 months.