Posts from the ‘Aurizon Mines (ARZ)’ Category

Mar 4

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

Portfolio Performance

Portfolio Composition:

Trades:

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.

Jan 29

4 Comments

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.”

Yup.

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.

Jan 2

4 Comments

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:

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
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.
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.
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.
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.
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 3^rd 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.

Portfolio

Dec 18

Letter 24: Risk and Reward, Atna Analysis, More Community Banks

Last week I wrote that I did not understand why the market was reacting as favourably as it was to the European proposals that came out of the Dec 9th summit.

A tweak here, a tweak there and pretty soon you have… well not a whole lot to be honest.

In a way I felt vindicated by the market collapse that occurred in the early part of this week. In another way I felt sick to my stomach, because though I have been creating an evermore conservative weighting to my portfolio, when the shit hits you still feel it.

Kyle Bass was on CNBC this week giving some more detail on his doomsday-like expectations:

The observation that deposits are leaving Greek banks at an annualized rate of almost 50% is somewhat frightening. Clearly this crisis is going to come to a head soon.

John Mauldin publishes a great conversation between Charles Gave and Anatole Kaletsky. It is quite provoking, and its hard to walk away after reading it without feeling the impending doom that awaits the Eurozone. Kaletsky and Gave both make the quite reasonable point that perhaps Germany would prefer a break-up of the Eurozone. If you watch what Germany is doing, and ignore the platitudes they are saying, you might question their motives. Kaletsky points out that of the necessary measures to fix the Eurozone, Germany seems to be steadfastly opposed to both Eurobonds and to ECB intervention. Absent those measures, what hope does the Eurozone have? Perhaps that is the plan all along.

Gold Stocks – I should went all out

Gold stocks got CREAMED this week. I had been lightening up on my gold stocks the week before in anticipation that something might be about to hit. I didn’t like the way gold was going, I didn’t like the fact that the WSJ was penning articles describing a dearth of Indian demand, and I didn’t like that Draghi talked tough during the EU summit, suggesting that money printing was still some time off.

Nevertheless being that I was not fully out of gold stocks, I got smacked about pretty good over the course of the week. Atna, Aurizon, and with Lydian all performed quite miserably.

What’s Wrong with Aurizon?

Aurizon is a surprise to me. I expected the stock to hold up better than it has been. I might have expected its performance to be closer to that of Alamos. Both are low cost producers. Both are single mine operations. Yet the valuation difference between the two is somewhat staggering.

I can only guess that there is a strong seller of Aurizon out there that wants to be out of the stock by year end. I can only hope that the new year will bring some sanity to the stock.

While reviewing Aurizon, I began to wonder how much having a AMEX listing hurts the stock. Anecdotally it appeared to me that the Canadian stocks with AMEX listings are much more volatile then those without. I decided to take a closer look.

I grabbed price data since August 1st for 9 stocks, 5 with AMEX listings and 4 without. From the web I grabbed a visual basic function that calculates volatility based on the following Black-Scholes formula.

For purposes of Black-Scholes calculations, volatility is the standard deviation of the periodic percent change in prices, divided by the square root of time. Volatility is emphatically NOT the same as “beta”, which measures the correlation of a security’s price movements with those of the overall market. Neither is volatility simply a measure of the standard deviation of a security’s closing prices over time.

Here is the volatility of each security:

Is there a correlation? Perhaps, though its not as clear a one as I had suspected. The distinction is most clear between Aurizon, Alamos and Argonaut Gold. There is no reason, in my opinion, that Aurizon is so much volatile than these other two stocks. But apart from that, volatility seems similar between stocks on the two indexes.

I bought back some of the shares of Aurizon at $5.07 that I had sold at over $6 a few weeks ago.

The NPV of Atna

Another stock to get clobbered this week was Atna Resources. I mentioned a couple weeks ago that I had finished an analyses of the company and would post shortly. I never did that post, until now.

Below is the after tax NPV10 that I calculated for Atna at various gold prices.

I based my model on the following assumptions:

Briggs:

A 11year mine life, at 40,000 t/d
Total produced ounces of 476,000 oz over LOM
0.017 oz/t resource over the mine life, strip ratio of 4 and with 80% recoveries
Resulting in gold production of 39,700 oz per year
Mining costs of $1.30/t mined, milling costs of $4/t milled and G&A costs of $1.7/t mined
Cash costs of $898/oz over LOM

Pinson:

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

Reward:

A 8 year mine life, at 24,000 t/d
Total produced ounces of 292,000 oz over LOM
0.026 oz/t resource over the mine life, strip ratio of 4 and with 80% recoveries
Resulting in gold production of 36,400 oz per year
Mining costs of $1.30/t mined, milling costs of $4/t milled and G&A costs of $1.14/t mined
Cash costs of $560/oz over LOM

Columbia and Cecil:

To the current resource of each I assigned a simple asset value per ounce of $40/oz measured and indicated and $20/oz inferred on the total resource of both properties

Atna is, in my opinion, is one of the best gold stock investments out there. As demonstrated above, the stock is trading at about 1/3 of its NPV 10 at $1500 gold. If I wanted to get more aggressive in my evaluation, I would note that many companies are moving to value feasibility on NPV5. On an NPV 5 basis Atna is worth $3.86 per share at $1500/oz gold. That number jumps to almost $8 per share at $2100/oz gold. Clearly there is upside once the momentum begins to build.

I added to my position in Atna on Friday at 78 cents.

Taking Advantage of the Collapse

In addition to Atna and Aurizon, I also added new positions in a few juniors. Call it the beginnings of a basket; I added a couple of non-producing juniors with deposits to my portfolio this week:

Geologix was recommended by Rick Rule as a takeover candidate on BNN about a year ago. Since that time the stock has fallen significantly. The company has a very low grade copper-gold deposit called Tepal in Mexico. The PEA that was published on Tepal a few months ago put the NPV5 of the project at $412M based on $1000/oz gold and 2.75/lb copper. Geologix has $14M of cash on hand. With 145M shares outstanding, the market capitalization of the company was $28M at my entry price of 20 cents. That puts half the market cap in cash and the other half in a project with an NPV that is nearly 10x the value of the company. Something has to give here.

Esperanza Resources is another old Rick Rule recommendation. Rule doesn’t talk much about specific stocks anymore, but there is some evidence that he is still interested in the company. http://www.investmentu.com/2011/September/why-gold-mining-stocks-will-skyrocket.html . The company certainly fits the bill of the sort of stock Rule likes. Esperanza has 1Moz of gold in Mexico. It’s a heap leach project so it should be able to be brought on production without a massive capital requirement (about $100M). Like Geologix, the company has almost half its market cap ($100M) in cash on hand ($50M).

I plan to add more to both of these stocks in the coming weeks.

Regional Banks: A Position in Community Bankers Trust

Community Bankers Trust (BTC) hit my bid when it sold off back down to a dollar this week. BTC is trading at 27% of tangible book value. This is, of course, partially because of the large number of non-performing loans on their books. Non-performing loans make up 8.9% of total loans in the Q3 quarter. This was down from 10.1% in Q2. In fact, there are some encouraging signs that the worst of the loan losses are behind us. The company has shown 3 quarters of lower loan amounts 30-89 days past due. This trend is beginning to show up in the total non-performing loans, which decreased for the first time in a year in Q3.

Moreover, as I have pointed out previously, insiders continue to buy the stock. Third quarter purchases by insiders were a little less than $50,000.

And Another Regional Bank Position in Atlantic Coast Financial

To be perfectly honest, I might have made a mistake here. I’ve only put a very tiny amount of capital at risk, but even that may have been too much. Atlantic Coast Financial (ACFC) is a lottery ticket. I bought the stock at $1.70 on Friday. There is just as much chance that it will go to zero as there is that it will double.

ACFC is a former Mutual Holding company that did their second step bank in February. The second step added cash to the balance sheet and resulted in a bank trading well below book value. ACFC trades at a rather crazy 10% of tangible book. Clearly there is more to the story.

The more to the story is that the bank is centered in Jacksonville Florida. They primarily make residential real estate loans. Real estate in Jacksonville has not done particularly well over the last few years (though it appears to be bottoming).

The falling real estate prices have led to skyrocketing non-performing loans. Those non-performing loans have not shown any sign of peaking yet (thus the possible mistake on my part).

The questions are, how many of these nonperforming loans will eventually be written down, and will there be value left in the equity once the non-performing loans are written down.

What drove me to take a small position in the stock was in part that an improving economy, and stabilizing home prices in Jacksonville, may mitigate further deterioration of the bank assets. As well, the bank is generating decent earnings before provisions. Ignoring provisions in Q3, the bank earned $1.16 per share. In Q2 that number was $0.55.

What is going on at ACFC is something akin to a tug-of-war, whereby on the one hand loan losses strip away value every quarter, while on the other earnings power of the performing loans adds value back. The share price is so low that it doesn’t take much a a shift in the dynamic between these two forces to change the value equation substantially. Its easy to see how a stabilization in non-performing loans could quickly allow the earnings power to win the race and shareholder value to go up substantially.

The other factor in my decision to buy was the recent announcement that the company was looking into strategic alternatives.

On November 28, 2011, Atlantic Coast Financial Corporation issued a press release announcing that its Board of Directors has engaged Stifel, Nicolaus & Company, Incorporated to assist the Company in exploring strategic alternatives to enhance stockholder value

Part of the reason that the company is looking for options is that they are not in compliacne with the Individual Minimum Capital Requirement (IMCR) agreed to by the Bank with the Office of Thrift Supervision on May 13, 2011. Under the IMCR, ACFC agreed to achieve Tier 1 leverage ratio of 7.0% as of September 30, 2011. Tier I capital at the bank is 6.22% right now.

It is a far from perfect scene. Nevertheless, an improving US economy and stabilizing housing prices could give me a decent return on the stock. The book value of $19 is unrealistic, a return to $3 is not.

Portfolio Composition