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Posts from the ‘Canaco Resources (CAN)’ Category

My Canaco Debacle

My post on Canaco’s Magambazi deposit has received more attention than perhaps any other post I have made.  What is sadly ironic is that while I put a lot of work into my evaluation of Magambazi, the net return of all of that work has been less than zero.  I want to take a few paragraphs here to do a post-mortem on the subject and to come up with a few lessons learned.

Lesson #1 Analysts can be lazy and you shouldn’t believe they know more than you

I began my relationship with Canaco at the end of last year in an attempt to take advantage of tax loss selling.  I bought the stock at $1.10 having done very little research into the company besides having read through the corporate presentation, acknowledged they had a significant amount of cash on the balance sheet, and read through a couple of Canaccord reports that I got my hands on, suggesting that Magambazi had somewhere between 2-3 Moz of gold.

Soon after the stock ran up along with all the other gold stocks and I felt like I better get a more clear idea of what I owned and whether I should continue to own it at that elevated price.  Thus came about my analysis of the Magambazi desposit. I did my analysis of  Magambazi when the stock was $1.70.  The analysis suggested that the Magambazi deposit was unlikely to contain 2-3 Moz and was far more likely to  contain 1-2 Moz, with the greater potential being on the low end of that range.

As I wrote at the time, while my analysis raised a lot of questions, I was reluctant to believe it over the parade of analysts with estimates of 2 million ounces plus grading 3 g/t or more:

All 3 of these estimates are lower than I would have expected.  To be honest, I’m not sure what to make of that.  I don’t know how much I trust my own work given the uncertainty with specific gravity and obviously the low-tech tools I am using.

In the end I concluded that I could quite possibly be wrong, and that even if I was right, the stock was probably trading not too far away from where it should given the cash on the balance sheet.   I concluded that while I wouldn’t add more, I wouldn’t sell my holding right away either.

Fortunately my conviction tends to be heavily influenced by price level, and as the stock began to fall, I changed my tune.  Soon after my write-up gold stocks began to fall (in particular junior explorers began to be decimated). I wrote the following:

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.

I sold my position at $1.47 per share.

It is at this point that it all could have ended well.  I could have ridden off into the sunset with a tidy profit and a big “I told you so” in the mail when the 43-101 on Magambazi came out.

But it didn’t end well.  Because I got cute.

Lesson #2 Don’t get cute

In retrospect my reasoning on the matter was fairly sound.  The logic based on the knowledge available was acceptable.  The problem, I believe, lay in optimism of my original assessment, which was perhaps unconsciously skewed by an attempt to match analyst estimates that were far more robust than what I was seeing.

Anyways, here is how it went down.

Canaco was trading at 85 cents.  They had 50 cents of cash in the bank give or take.  I looked at Magambazi and thought, look, they are going to report at worst 1 Moz at 3 g/t, how much lower can the share price go?  Its priced in right?

I bought Canaco at 87 cents.

It didn’t seem like a bad bet at the time.  And fortunately I didn’t buy a very large position (actually looking at the relative size of the position in my practice portfolio it appears I over-bought there.  My actual position in Canaco was about 1% of my overall portfolio, but it looks like I bought around 3% in the practice portfolio.  I’ve noticed this is a continuing problem for me because I’m not doing the ratios with each trade and so my practice portfolio has gotten somewhat out of sync with my actual portfolio.  But enough of that).

Nevertheless, unfortunately it would turn out to be large enough to take away all the profits I had made and then some.

When I look back on this fateful purchase I notice two catalysts to the downside that I really underestimated at the time:

  1. The junior market was about to go into a deep bear market where even cash is not valued at cash anymore
  2. The reported 43-101 grade of Magambazi would be based on an open-pit model

Number 1 is what it is and what can you say.  Its a shitty market. It was #2 that really killed the stock.  When the deposit came in at 1.5 g/t  that was final nail in the coffin.  Even my estimates calculated that the average grade would be 3 g/t.

So what happened to the grade?

Canaco hasn’t released the actual Ni 43-101 report so I can’t really talk too specifically about the assumptions made.  But they did say in the news release that the resource was based on a pit model:

Measures were taken to validate that the mineral resource meets the condition of “reasonable prospects of economic extraction” as suggested under National Instrument 43-101. To this end, a pit shell was generated using a gold price of US$1,250 per ounce and an overall pit slope of 40° for the purpose of resource tabulation. Only blocks within the pit volume were included in this resource estimate and Table 2 presents a summary of the estimated mineral resource for a range of cut-off grades. The cut-off grade of 0.5 grams per tonne was selected as the resource base case considering extraction by conventional surface mining and mineral processing methods.

When I did my estimate I made a very tight block model around the high grade intercepts.  I drew my lines to fit exactly around each intercept, with no give or take around it.  Take a look at the cross-section below for example:

I suspect that what happened is that when the open-pit model was done, it was determined that realistically, you were not going to be able to separate the high grade ore from the low grade shell so easily.  You would inevitably end up with a diluted grade going through the mill and so the mined deposit grade would be a lot lower than what you would get if you could just surgically extract the high grade material.

I totally missed this.  Its obvious in retrospect.  Canaco management even said they were looking at Magambazi as an open pittable project.  But I didn’t put two and two together.

Cést la vie.

I remember when I read the news release when it came out in the morning the first thing I thought was, wow, that’s really bad.  As I tweeted that morning, that’s why you call it speculation, not investment.  I put in a sell at the market order, I figured that with 50 cents of cash I’d still get out at over 50 cents and be done with it.  Alas, before the market opened it became clear that the stock wasn’t going to trade at anywhere near 50 cents.  It is unfortunate in cases such as this that because I have a job and cannot watch the market during the day, I often have to make decisions to buy or sell at the open in premarket and deal with the consequences later.  Weighing the alternatives I took the order off and decided to see where the stock ended up.

Lesson #3 When something is bad, its rarely worth buying

The basic premise here could be applied to many things; bad managements, bad businesses, and bad markets.  It certainly could be applied to bad deposits.  If its bad, don’t try to put a value on it.  Just walk away.

When I bought back Canaco at 87 cents, it was because I figured the market was overestimating the “badness” of Magambazi and underestimating the cash on hand.  Between that purchase, and my sale of Canaco at $1.47, I had implicitly put my own valuation on that badness – somewhere between a dollar and a dollar fifty a share less the cash on the balance sheet.

The problem with doing this is that badness tends to have an extremely relative value.  Something good tends to hold its value regardless of the market, but something bad tends to fluctuate wildly as participants go between optimistic and pessimisstic evaluations of just how bad it is.  To make a case and point, look at Lydian International.  I sold out of Lydian a couple of months ago when I was liquidating all things gold but dine that time the stock has held up remarkably well.   That is because, as I pointed out in my initial analysis, the Amsular deposit is basically a good, solid deposit.  There are always bidders that step in when the stock begins to sway.

Canaco is the opposite.  Magambazi is a questionable deposit.  It still might work.  It might not.  Me trying to put a value on that was stupid.   When something isn’t good, you  need to just walk away.

Where to go from here?

I talk a good game but sometimes I don’t do what I say.  Perhaps I will look back on this with another lesson learned and say that yes, I should have just walked away at 30 odd cents.  But I haven’t.  At least no yet.  In the case of Canaco, even though Magambazi had proven to be bad, I was just too tempted by the fact that the company was trading at about 2/3 of its cash on hand.  Cash is neither bad or good.  It is cash.  When cash is valued as though it wasn’t cash, I am always tempted by the opportunity to prosper from its revaluation back to cash.

I bought a few more shares at 32 cents.

It just seems rather insane to me that we are in an environment where the cash you have on your balance sheet isn’t valued as such.  And yes I know this is an exploration company, and they could eat up that cash in a number of stupid ways.  But still… a little less than 50 cents of cash trading at a little more than 30 cents?

Another point that Canaco has in its favor is that the actual amount of cash is quite significant compared to drilling and corporate expenditures.  If Canaco was a $5M market cap company with $7M in cash, I would be far more skeptical that they would eat through that cash quickly and therefore that it shouldn’t be valued on their balance sheet at whole value.  But Canaco is a $60M market cap company with $95M in cash in the bank.  The company has apparently stopped drilling on Magambazi at the moment.  Cash corporate expenses look like they are about $1.3M per quarter.  Its going to take a while and a good number of bad decisions for that cash to disappear.

The other point is that Magambazi, while being a relative disaster, is not a complete disaster.  The market, with its unrealistic expectations having been set by the analyst community, certainly viewed it as such.  Yet there are 1 Moz there, and there is the potential for more.  The cash provides the opportuntiy for good things to happen.  Heck, even a general market recovery (something that albeit may be fantasy and that I am not myself leaning towards) could be enough to move the stock significantly towards its cash value.

Anyways, those are the reasons.   I make no promises about how long I will continue to hold any of these shares.  I may decide that the opportunity cost of holding Canaco isn’t worth it and just dump the whole thing.  If the share price goes on a run, which given just how bad it has performed with essentially no bounce makes you think some sort of a pop may be possible, I would likely sell.  I would certainly sell at cash value; I might even sell at 40 cents.

Until that time, the debacle continues.

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.

Spain

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.

Buying: Back into Canaco Resources

I think things have gotten a little stupid with Canaco. It goes down and it goes down and it goes down.

I bought the stock on Thursday at 87 cents.

A quick look at the company’s March presentation shows that cash on hand is $110M.  The market capitalization of the company is down to $174M.  That puts a value on Magambazi of $64M.

As Steve T has pointed out in the comments, subtracting cash on hand from capitalization for a junior is not a best practice.  The cash will inevitably be eaten up by drilling.  But Canaco can do a lot of drilling for $110M and I don’t think its a terrible bet to think that they find some more gold before they go through the cash.

I still have concerns about the Magambazi deposit.  The fact that the resource is being delayed until May suggests that some of my original concerns are valid (I did a detailed analysis of the Magambazi deposit here).  The company stated it this way:

However challenges encountered with final assembly of the large volume of project data necessitates a revision to the completion date of the initial mineral resource, now anticipated by May 15, 2012.

If I were to read between the lines, final assembly would suggest to me that there has been some trouble outlining the resource, perhaps, as I noted in my original post, because it pinches out so abruptly in spots.

So things are not perfect.  But there is a price for everything.  The stock is down from $5 to less than $1.  Even when I was at my most conservative I figured they had at least 1.5Moz at Magambazi.  Its still a decent deposit and it has the opportunity to get bigger.  The market clearly overreacted to the upside in the stock last year.  In my opinion, it has now overreacted to the downside.

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.