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Posts from the ‘Jaguar Mining (JAG)’ Category

Week 324: Underlying Conditions

Portfolio Performance

Top 10 Holdings

See the end of the post for my full portfolio breakdown and the last four weeks of trades

Thoughts and Review

The late spring and early summer months were a trying time for my investments.

I haven’t written up my portfolio in a while.  Part of that was due to the summer, being away and not having the time to do my usual work.  But I also went through a 3 month period, from mid-May to mid-August, where I lost money and struggled with why. That dampened my spirits for putting pen to paper.

Losing money is hard enough, but it is harder when you have been generally right in your decisions.   I try, like the namesake of this blog, to analyze underlying conditions and let that determine my general bent on sectors and the market.  Where there is a bull market I like to be very long those stocks, and when there is a bear market I like to pull back significantly, retreat into cash, and go short where I can.

Throughout the spring and summer I found myself in a general bull market in US stocks, one that had made me a lot of money throughout the winter.  I was, quite rightly, very long US stocks.  The market kept going up, albeit in fits and starts.  But I began to lose money.  Now I didn’t lose money quickly.  In retrospect that may have been a better route as at least I would have been forced to discover my error.  But instead my losses slowly accumulated over the months of May and June.

What’s more, I did not see noticeably poor performance from any of the stocks I owned.  Sure my names weren’t breaking out to new highs, but my core positions at the time, the likes of Radcom, Silicom, Sientra, Combimatrix, Identiv and Vicor were not by any means breaking down (I leave out Radisys as it is a separate discussion).

It wasn’t until my portfolio was down about 6%, in the middle of June, that I woke up to the fact that something was wrong.  I scoured my list of stocks but found nothing worrisome with the names I held.  I knew that the Canadian dollar had been rising so that must have been having some effect but I had never really quantified my currency exposure.  I had always thought of currency as an afterthought, something that balances itself out in the end.

As I crunched through the numbers on my currency losses, I realized that while in the very long run my theory that currency balances itself out might be correct, in the short run a currency can make or break you.  The Canadian dollar was in the midst of unwinding 2 years of gains in two months.  Measuring my losses from the portfolio top in mid-May, I was 6% down, of which 5% came from currency.

It is here that I made my first big mistake. I was armed with the information I needed to act decisively.  I knew my problem: stocks were in a bull market, but clearly the US dollar was not, and I was, rather unwittingly, very long the US dollar.

So what did I do?  Something that, in retrospect, was absurd.  I made only a token effort towards the problem, taking only the excess US dollar cash in my portfolio and putting it into a Canadian currency ETF.  This effort, while directionally correct,  impacted about 15% of my US dollar holdings and thus did nothing to alleviate the problem.  I followed this up with an even more inexplicable move, even to me looking back on it now.  I put on index shorts to hedge my long positions.

Here I was with losses proving that I was wrong.  I had determined the source of those losses.  And what did I do?  I did something that was likely only to exacerbate them.

It really goes to show how wrong one’s logic can be when you are trying to cling to what you had. The reality, I think, is I didn’t want to do what was right.  What was right was to sell my US stocks.  Not because my US stocks were going down. They were not.  Not because the theses behind these positions was not sound.  They were.  But because I was losing money on those US stocks.

Unfortunately I could not wrap my head around this.  All I saw were good stocks with strong catalysts.  How could I sell my positions?  It’s a bull market!

I spent most of June compounding my problem with band-aid solutions that only dug me in deeper. I fell back on oil stocks as a Canadian dollar hedge.  This had saved me the last few times; in the past the Canadian dollar had risen because oil had risen, so I had gone long oil stocks and my losses on currency were more than compensated with my gains on E&Ps.  I was saved a lesson and left none the wiser to how impactful currency could be.

But this time around the currency was not rising because of oil.  My appraisal that I should be long oil stocks was based on the flawed logic that what works in the past must work again regardless of conditions.  That is rarely the case.  In June and July I bought and lost money on companies like Resolute Energy, US Silica and Select Sands, all the time continuing to hold onto US dollars and lose on them.

I also went long gold stocks on the similar thesis that if the US dollar is weak then one should be long gold.  In this case I was at least partially correct.  That is the right thing to do given conditions. But my conviction was misplaced. Rather than being long gold stocks because I thought gold stocks would go up, I was long gold stocks to hedge my US dollar positions.  You cannot think clearly about a position when you are in it for the wrong reasons even if a right reason to be in it exists.  Thus it was that in late July I actually sold a number of my gold stock positions. It was only a couple weeks later, finally being of a clear head (for reasons I will get to) that I bought them all back, for the right reasons this time, but unfortunately at somewhat higher prices.

As I say it was at the beginning of August that I finally was struck by what I must do.  I’m not sure what led me to the conclusion but I think an element of deep disgust played a part.  I had just seen my biggest position, Combimatrix, get taken over for a significant premium. My portfolio took a big jump, which took down my losses from my mid-May peak from -10% (over 8% due to currency!) to -7.5%.  But then in the ensuing days I saw those gains begin to disappear.  Part of this happened because Radisys laid an egg in their quarterly results, but part of it was just a continuation of more of the same.  Currency losses, losses on index short hedges, some losses on my remaining oil stocks, and the ups and downs of the rest of my portfolio.

I simply could not handle the thought of my portfolio going back to where it was before Combimatrix had been acquired. I was sick of losing money on currency.  And I was reminded by the notion that you never see conditions clearly when you are staked too far to one side.  So I sold.

When I say I sold, I really mean I sold.  I took my retirement account to 90% cash.  I took my investment account to 75% cash.  There were only a couple of positions I left untouched.  And I took the dollars I received back to Canadian dollars.

I continued to struggle through much of August, but those struggles took on a new bent.  I was no longer dealing with portfolio fluctuations of 1%.  The amounts were measured at a mere fraction of that.   This breathing room afforded me by not losing money began to allow me to look elsewhere for ideas.

I don’t know if there is an old saying that ‘you can’t start making money until you stop losing it’, but if there isn’t there should be. When you are losing money, the first thing you need to do is to stop losing it.  Only then can you take a step back and appraise the situation with some objectivity.  Only then can you recover the mental energy, which until that time you had been expending justifying losses and coping with frustration, and put it towards the productive endeavor of finding a new idea.

In August, as my portfolio fluctuated only to a small degree but still with a slight downward slant, I mentally recuperated. And slowly new ideas started to come to me.  It became clear that I was right about gold, and in particular about very cheap gold stocks like Grand Colombia and Jaguar Mining, so I went long these names and others.  I realized that being short the US market was a fools errand, and closed out each and every one of those positions.  I saw that maybe this is the start of another commodities bull run, and began to look for metals and mining stocks that I could take advantage of.  I found stocks like Aehr Test Systems and Lakeland Industries, and took the time to renew my conviction in existing names like Air Canada, Vicor, Empire Industries and CUI Global.

Since September it has started to come together.  I saw the China news on electric vehicles and piled into related names.  Not all have been winners; while I have won so far with Albemarle, Volvo, Bearing Lithium and Almonty Industries, I have been flat on Leading Edge Materials and lost on my (recently sold) Lithium X and Largo Resources positions.  Overall the basket has led to gains.  I’ve also been investigating some other ways of benefiting from the EV shift.  It looks like rare earth elements and graphite might be two of the best ways to play the idea, and I have added to my position in Leading Edge Materials (which has a hidden asset by way of a REE deposit at the level of feasibility study) to this end.  Likewise nickel, which is not often talked about with electric vehicles and has been pummeled by high stock piles, has much to gain from electric vehicles and could see a resurgence over the next couple of years.  I’m looking closely at Sherritt for nickel exposure and took a small position there so far.

I saw that oil fundamentals were improving and got back into a few oil names, albeit only tentatively at first.  Such is the case that once you are burned on a trade, as I was when I incorrectly got into oil stocks in June and July for the wrong reasons, you are hesitant to return even when the right reasons present themselves.  Thus it has taken me a while, but over the last couple of weeks I have added positions in Canadian service companies Cathedral Energy and Essential Energy, and E&Ps Gear Energy, InPlay Oil and even a small position in my old favorite Bellatrix.  A company called Yangarra Resources has had success in a new lower zone of the Cardium, and I see InPlay and Bellatrix as potential beneficiaries.  These newer names go along with Blue Ridge Mountain Resources, Silverbow, and Zargon, all of which I held through the first half slump in oil.

I even saw the Canadian dollar putting in the top, and converted back some currency to US dollars a couple of weeks ago.

Most importantly, got back to my bread and butter.  Finding under the radar fliers with big risk but even bigger reward.  I have always said it is the 5-bagger that makes my returns.  If I don’t get them, then I am an average investor at best.

I found Mission Ready Services, which hasn’t worked yet but I think is worth waiting for.  I found some other Canadian names that I think have real upside if things play out right (in addition to the above mentioned metals an oil names, I added a position in Imaflex). Most profitably, I was introduced to Helios and Matheson after reading an article from Mark Gomes.

I don’t completely understand the reason why, but good things do not come to you when you are mired in a mess of doing things that are wrong.  It is only when you stop doing what is wrong that other options, some of which may be right, will begin to present themselves.

I also don’t know which of what I am doing now will turn out to be right, and what will turn out to be wrong.  I will monitor all my positions closely and try to keep a tighter leash than I have been.  What I do know is that I will not continue to be wrong in the same way I was through the months of May to August.  And that is a big step in the right direction right there.

Portfolio Composition

Click here for the last eight (!!) weeks of trades.  Note that in the process of writing this update I realized I do not have a position in Gear Energy or Essential Energy in the practice portfolio.  I have owned Gear for over a month and Essential for a few weeks.  This happens from time to time.  I miss adding a stock I talk about and own in my real portfolio.  I added them Monday but they are not reflected below.

Note as well that I can’t convert currency in the practice account.  I know I could use FXC but in the past I haven’t, I have just let the currency effects have their way with the practice portfolio. Thus you won’t see the currency conversions that I talked about making in my actual portfolio.  I may change this strategy the next time the Canadian dollar looks bottomy but as I am inclined to be long US dollars at this point, I’m leaving my allocations where they are for now.


A Rick Rule Example: Aurizon Mines

“Top mining companies are finally generating dramatically higher profit margin. Free cash flow is now “gushing” and will double in the next year as huge capital investments by the majors pay off.

That quote comes from a recent interview with investor Rick Rule.

The observation that gold equities are undervalued has been coming from a number of fronts of late.  Donald Coxe, David Einhorn, heck even Cramer was touting gold stocks a few months ago before his favorite, Agnico Eage, ran into stability issues at Goldex and scared Cramer silly.  Rick Rule said the following recently about the attractiveness of gold equities:

“There have only been two times in the past ten years when, from our own calculations, gold and silver equities were attractively priced relative to the metal, that being 2001 and 2008.  We are back strongly in that territory.

I believe if current gold and silver prices hold up, and I believe they are actually going to increase, that we are going to see a rather dramatic jump higher in the prices of select gold and silver equities on a go-forward basis.

The point, made best by Rule but also by others, is that gold miners are finally in the business of making money, not just producing gold.  A case and point of Rule’s comments: Aurizon Mines.

Here is a company that gets no respect from the market.  The company can release an excellent quarter, as they did two weeks ago, and the market will yawn.  If the price of gold falls a few bucks on any given day, the stock will crater 3% or more.  You’d think the company was some sort of fly-by-night chop shop given the way the market treats their paper.  Yet nothing could be further from the truth.

Below is Aurizon’s free cash flow and cash on hand on a quarterly basis.  Free cash flow is cash flow from operations less capital expenditures. Keep in mind that at its current price of $5.80, Aurizon has a market capitalization of $940M and no debt.

The free cash is allowing the company to grow its cash on hand significantly every quarter.

As the above figure points out, about 20% of Aurizon’s market cap is in the form of cash on the balance sheet.  The enterprise value of the company is only $740M after subtracting this cash.  Annualizing the last four quarters, the company is trading at about 9x its free cash flow generated.  That would be using an average gold price of about $1500/oz.

If you annualize the third quarter, where the realized gold price for Aurizon was $1695/oz, the company is generating $104M in free cash a year.  This puts the companyvaluation at a little less than 7.5x free cash flow.

It is important to recognize that what I am talking about here is free cash flow.  This is different then the metric that is often touted by the mining analysts in their evaluations.  They focus on the operating cash flow, which ignores any capital expenditures a company has.  I’ve chosen to look at free cash because:

  1. As I pointed out last week in my comparison between Jaguar Mining and Aurizon, companies generating similar amounts of operating cash flow can have drastically different expenditures required to maintain that level of cash flow.
  2. Free cash is what ultimately goes to the bottom line and increases the cash position of the company.

If I was going to look at cash flow from operations for Aurizon, here is what I would find.  In the estimates below I have removed the exploration expense to get a true picture of cash flow from operations.  Exploration expense is a tricky beast, because a company can choose to expense or capitalize the cost, which can work to obscure comparisons.  I prefer to leave it out when talking about operating cash flow (though I left it in when we talk about free cash).

  • In the last four quarters Aurizon generated $111M of operating cash flow (6.6x)
  • Third quarter annualized operating cash flow was $136M (5.4x)

On either metric the equity is cheap.

So Aurizon is cheap on a basis of four quarter trailing gold prices (~$1500/oz) and certainly on the basis of current gold prices $1700/oz.  I am certain that if you did the same analysis for other gold companies you would draw similar conclusions.  Some would come out astoundingly cheap.  OceanaGold comes to mind as a gold producer priced particularly inefficiently.

The next step I want to focus on is how Aurizon looks on a NAV basis.  Cash flow is the metric to evaluate current profitability, but to fully appreciate all the assets of the company, and the productive life of those assets, you have to look beyond the current cash flow and into the expected cash generated in the future.  But I will leave that for a later post.

Bad Timing

Sometimes your timing is so bad that you have to wonder if there is some intervention!

Shandong Gold Group Co., parent of China’s second-largest gold producer by market value, made a $785 million offer to buy Jaguar Mining Inc. (JAG), two people familiar with the deal said.

Shandong bid $9.30 for every Jaguar share, said the people, who asked not to be identified because of the information is confidential. That’s 73 percent more than Jaguar’s closing price of $5.39 yesterday in New York. The company has 84.4 million shares issued, according to data compiled by Bloomberg.

Full story here.

Week 19: Liquidating Jaguar, Adding to Atna, Aurizon

Last week was another good week for my portfolio.  I tend to perform well in sideways markets.  In down markets, especially those like we’ve had recently where the correlation of all asset classes go to one, I tend to underperform on an individual equity basis, because the stocks I own are for the most part small caps and commodity stocks, and they get hit harder than the broader market.   I’m trying to mitigate that with my currently high cash position, and it has done its job and  dampened the effect.

I would, however, like to reduce my cash position at some point, as it is har d to make money when so much of it is doing nothing.  To do that though I would have to see some sort of light at the end of the European tunnel, and that is not likely forthcoming.

The only significant portfolio change I made last week was to sell my position in Jaguar Mining, and using the subsequent cash to increase in my positions in both Aurizon Mines and Atna Resources.  There will be more to come on both Atna and Aurizon in a future post.  I see Atna in particular as a interesting and soemwhat unique situation.   Atna recently received 100% interest in the Pinson deposit.  This is a game-changer for the company, and one that is not even close to being priced into the stock price.  Because Pinson does not have a full feasibility study complete, or even a PEA, investors are not aware of the economics of this high grade underground project.  But more on this later.  For now though I want to spend a few minutes talking about Jaguar Mining.  Since I have written about the company fairly extensively, I think its worthwhile to review why I have now chosen to go the path of full liquidation.

I can point to a number of reasons for getting out of Jaguar Mining.  At the top of that list is the company’s inability to generate free cashflow, even though the gold price has risen some 40% over the past 9 months.   The way that Jaguar has managed to match any increases in operating cash flow with correpsonding increases in capital outlays is uncanny.

Let’s compare this to another holding of mine, Aurizon Mines.

Aurizon, on the other hand, has done exactly what you’d expect a company to do in a rising gold price environment.  They have generated a great deal of cash.  The cash position of Aurizon has increased almost $40M since the beginning of the year.  Jaguar’s cash position, on the other hand, has actually decreased if you remove the effect of the convertible denbenture issued in the first quarter.

Of the two companies, the one that you would have to say is in a better position for expansion would be Aurizon.  But never a management team to be daunted by lack of available funds, Jaguar said in a separate press release that they are going forward with the development of the Gurupi project.

At the beginning of the year Jaguar provided a longer term outlook  of what to expect from the company.  I’ve provided one of the tables from this outlook below.  Pay particular attention to the requirements of Gurupi (which as the table indicates was supposed to start development this year, by the way), an estimate that one analyst on the conference call referred to as outdated and not in the “that number is too high” kind of way.

Jaguar is going to be forced to raise a lot more capital to fund Gurupi.

On top of that, Jaguar plans to refinance their outstanding debentures with senior debt.  Between the Gurupi financing and the convertible refinancing Jaguar is looking at a bond offering of $400M+.  This seems like a bit of a heroic expectation for a company that is struggling to produce any free cash flow at record high gold prices.

Another analyst on the call pointed out that the market might not be quite as responsive to new debt from the company as Jaguar management seems to think it might be.  Quite reasonably, the analyst referred to the existing debentures, which the market is currently valuing at a 13% interest rate.  He speculated that the market is suggesting that Jaguar debt would take a 15-17% coupon.

Management said that the offer sheets they had received were in the 9-11% range.  Forgetting for a minute that 9-11% interest rates are extremely high, you have to be a bit suspicious of the company’s ability to raise money at this level when there are debentures outstanding that carry the upside conversion option, at a 20-40% discount.

I could go on.

I bought Jaguar because in the low $4’s it was a undervalued NAV play.  The projects, if you tally up the value of each, are worth around $6-$7 per share, and maybe more at $1800 gold.  But at $6 per share, which is about the average price that I unloaded my position at, that NAV story is replaced by a cashflow story that to be quite frank about it, just isn’t there.

I’ll stick with Aurizon, with Atna, and with the big boys like Newmont and Barrick.

Week 18 Portfolio Update: Still Cautious but Getting More Optimistic

Last week I posted how I was of two minds; that while I still saw significant risks over the medium and certainly the long term, that I could also imagine a scenario where the market rallied in the short run.

I still think that is a likely scenario.  Especially after having watched Greece peacefully resolve not throw itself and the rest of Europe into utter chaos.  Yet I ended the week with more cash on hand then I began the week with.  Its just a tough market to hold any conviction with.

I am, however, a little more confident about the prospects of Europe than I was a week ago.  Why?  Well this weekend I spent my spare time looking  at Italy.  Last week I wrote a pretty negative piece about Italy. Having re-read those comments tonight, I think that I need to retract them in degree.  I had perhaps  read too many articles slanted with a negative spin on the Italian debt situation.  In truth, I think the situation there is somewhat more balanced than the WSJ, FT, and my other sources have given credit.

I plan to put out a post later this week describing what I have learned about Italy (as well as Japan, but more on that in a minute), but I’ll briefly summarize the main conclusions here.

Without a doubt, Italy has its problems; they have a lot of debt outstanding (120% of GDP), they have a dysfunctional political system that seems to readily make promises but not able to follow through on them, and they have an economy that almost certainly will be in a recession for months to come.

Still, Italian debt is not at the level yet that threatens the ability of government revenues to service it.  And that is really the bottom line.  While the path that Italy is on is not one of prosperity, it is going to take a lengthy recession and a move to even higher interest rates (8-9% at least), to really put the country’s ability to service its debt in jeopardy.

None of this is to say I have turned wildly bullish.  Greece, Portugal, and Ireland all look to be in a whole lot of trouble.  Its really just a matter of time.

What’s more, the real point of my research this weekend was to investigate Japan, and what I found there was frightening.  More on that later this week.

Anyways, back to the portfolio.  I actually lightened up a little on my gold stock holdings on Friday.  This is not an indication of any wavering of my thesis on gold.  It was simply prudent portfolio management.  The gold stocks I own have had a heck of a run over the last couple weeks.  Jaguar Mining has moved over 50% in the last two weeks.  Aurizon had a one day move alone of 10%.  Newmont has moved 15%, as has Barrick.  Gold stocks are finicky and they could just as easily fall back next week as they could break out.

A break out is possible however, and many of these stocks are back to that breakout level that they tested and then subsequently failed at in September.  This week should tell the tale.

On the oil side of the ledger, Coastal Energy is supposed to be releasing results of the A-09 well, which tested between the Bua Ban North A and B fields.  A hit in this area would prove up even more reserves for the company.  I continue to hold Coastal in hopes that with any market turn upward it will begin to be valued to reflect these recent discoveries.  Equal Energy continued to move higher last week.  In a normal market, without the overhang of Europe, I would be significantly more long Equal than I am right now.  Sandridge announced results last week and they showed better than expected production from its Mississippian wells so far.  Its just a matter of time before Equal begins to drill their Mississippian land and gets revalued upwards for it.  Equal remains cheap (look at my oil and gas comparison spreadsheet posted Friday for an idea of just how cheap).  As for Arcan, I await news both on the production front, and hopefully someday, on the takeover front.

I still have a bid in for Gramercy Capital at $2.75.  One of these days the market will have a crippling sell-off and that order will be filled.

Week 17 Portfolio Update: Of Two Minds

My portfolio was up rather substantially last week, along with the rest of the stock market.  To be honest, I would not have expected it to happen that way.

My portfolio is constructed against what I see as an eventual calamity in Europe, and my expectation that as the dominos begin to fall, perhaps extending as far as Japan, that investors will reconsider the grand 40 year experiment with fiat currency , and with that they will reconsider gold.

(I’m really starting to sound like a gold bug, aren’t I?)

The market, on the other hand, looked at the plan (or plan of a plan depending on how exact you want to be with your language) that the EU laid out on thursday and apparently began to wave the all clear flag.

So what happened?  How did gold rally at the same time as the broad markets?  Isn’t this a conflicting signal?

Well it is and it isn’t.  I think you have to look that the situation through two lenses to truly understand the response of gold, of the stock market and of the bond market.

The first lens is reality. This is what the bond market and the gold market are telling you, and it is all about the inadequacy of the bailout.

The WSJ laid out a fact based piece on the front page of the Saturday Journal.  Sometimes the facts are as damning as any commentary.  While the market rallied on Thursday, the bond market hardly budged.  Sometimes a chart is worth a thousand words.

Worse, on Friday Italy held an auction and was forced to issue 10 year bonds at above 6%.

In Friday’s bond auction, Italy was forced to pay more than 6% interest on its new 10-year debt, approaching levels that some analysts said the country can’t afford for long.

Its actually somewhat surprising that the market has so far shrugged this off.  First, it is a pretty scathing critique by bond investors.  One day after the grand plan announcement and Italy is paying higher rates than it was even a few months ago.

Moreover, as the above quote alludes to, this crisis began in August when Italian bonds rose from 5% to 6%.  The reason that this seemingly innocuous move up was met with such fear by the market is because Italy is basically on the precipice of falling off the cliff of solvency and 1% can throw them over the edge.  While Italian government revenues can withstand a 5% interest payment, they cannot withstand 6%.

That is how thin the thread is that Europe hangs to right now.  Italy owes $1.9t of debt.  When you owe that much debt, over the long run (as that debt comes due) whether you are solvent is more a question of perception than anything else.

Right now the perception isn’t so good.

And let’s look at little closer at some of the details of the plan.  First, the EFSF.  Do you really think that the EFSF, which according to the same WSJ article is expected to guarantee only the first 10% of Italian and Spanish debt after default (I thought this was supposed to be 20%?) is going to appease investors at future Italian and Spanish bond auctions who have just watched Greece take a 50%+ haircut?

And do you really think that Greece is going to be able to live up to the forecasts laid out in the plan?  The recap agreed to will lead to a Greek debt load that will peak at 186% in 2013 and that will fall to 120% by 2020.   That alone is worth reading twice.  But it gets better.  This will take place if you presume their growth scenario of 1 1/4% by 2013 and 2 1/4% by 2015. Seriously.

Given the scenes I’ve seen from Greece the last few days I wouldn’t be betting my pennies that the country will be growing at 1.25% in a little over a year.  It looks like a country in collapse mode.  As the WSJ points out in another article on Saturday:

Greece is the canary in the euro zone’s coal mine. The bloc’s prescription for a crisis spurred by overborrowing and overspending is a dose of radical fiscal rectitude, delivered fast. To regain the confidence of skittish investors, countries are being asked to rip up paternalistic policies that provided stability and comfort to legions of citizens but left the state reeling from the bill. The question is, can it be done without igniting society into revolt?

Greece has youth unemployment of 43%.  They have total unemployment of 16% and rising at a pace that is beginning to look parabolic.  And they haven’t even begun to fire the civil servants that they need to in order to meet the austerity measures they have agreed to.  The country is being ripped up at the roots and it is supposed to grow again in a year?

Moreover, the one mechanism that could make Greece competitive is off limits.  They are stuck with the Euro, which means they are stuck playing on a level currency field with Germany even when they are clearly world’s apart.

On final point.  The bailout, and future bailouts, are all going to have to be be paid for by someone.  Those someones are Germany and France.  Neither of these countries are a fortress of debt virtue.  Both have debt to GDP ratios of around 80%.  This point seems to get forgotten.  The bailout-ers are really not in that much better shape then the bailout-ees.

I could go on.  But you get the point.  This is not over by a long shot.

But, having given my critique, I did say that I was of two minds right now.   What is the other?

Well I was re-reading The Big Short this weekend for perspective.  By the summer of 2007, when the two Bear Sterns hedge funds collapsed, pretty much everybody that mattered knew that sub-prime was a big problem.  By February 2008, when Bear Stearns collapsed, you would have had to be in a bubble to manage money and still not know anything about subprime mortgages.  Yet the market plodded along, rallying at times, until the fall of 2008.  And it wasn’t until after the shit hit the fan, after Lehmans went belly up and credit essentially ceased to flow, that the stock market actually began to plummet.

I think that what has to be remembered is that most money managers investing in the stock market are not really being paid to quantify the scenarios in Europe.  Its out of scope to have to account for that sort of risk.  They probably just want it to go away so that they can return to what they are paid for and go home when they are supposed to.

This deal appears to give them the out, for a while, that lets them do that.  What this deal has done is stave off the final denouement for another few months.  Enough time that the market can perhaps gleefully rally and pretend again that all is well.

And who am I to argue with that logic?  I’m certainly not going to go out and buy bank stocks based on it, but if the market is going to tread water for a while longer, there are a number of stocks out there that could benefit.

With that in mind, I bought some stock this week.  The first is I bought back some Equal Energy on the news of their property disposition.  As I have already written this is a good deal because it is a deleveraging one.  And Equal remains extremely cheap by any metric.  There was a very good post on IV that pointed out that Equal’s Mississippian land in Oklahoma is worth $60M to $75M alone at the going rate of recent transactions.

I also opened a new position in Midway Energy.  Again pointing to a post on IV, Midway is trading very cheaply based on its current production and cashflow.  As teh excerpt below points out, you aren’t even fully paying for the Garrington assets, let alone the potential in the Beaverhill Lake.

With the stock only trading at $3.61/share we believe the stock is not even fully reflecting the value of the Garrington Cardium assets let alone any value for the Swan Hills Beaverhill Lake play. Our base valuation reflecting the 2012 cash flow is $3.00 and the Garrington upside potential adds another $2.50. We therefore believe that investors are getting a free ride on the 40 net sections of Beaverhill Lake rights at Swan Hills with their investment in MEL.

As well I have sold down the extra shares I bought of Jaguar when it got into the low $4 range, and replaced them with shares of Aurizon Mines in the mid $5 range.  Jaguar, which was up 35% this week, is an enigma.  There was no reason for it to fall as much as it did two weeks ago, and there is no reason it rose last week.  I think its pure manipulation.  I decided to lighten up before the manipulators changed their stripe.

Finally, one stock that I have not yet bought (back), but that I plan to is Gramercy Capital.  The company is cheap, and it probably is going to sell itself sooner or later.  I will be buying on any significant correction downward.

The Total Cost of Producing Gold

Last month I wrote a post about the second quarter results from OceanaGold .  In that post I looked at the company’s assertion that the quarter was not as bad as it appeared on the surface because the total mining costs had not changed significantly.  What had changed was that more of the costs were being expensed and less of the costs were being capitalized.  Below was a chart I provided showing how OceanaGold’s capitalized mining costs had varied over the course of the last couple of years.

To generalize the point of that post, looking strictly at expensed costs (cash costs) as a judge of a company’s quarterly performance has its flaws.

So just to refresh, the difference between expensed and capital costs is as follows.  Expensed costs show up on the income statement and factor into the commonly evaluated cash cost number for a company.  Under most accounting methodologies these are the costs that can be directly attributed to the ore being mined.  Capitalized costs, on the other hand, are hidden on the cash flow statement under the Financial Activities, usually showing up as Property, Plant and Equipment.  They can be one time charges such as a new pinion bearing housing on the ball mill, or they can be pre-mining expenses such as the stripping away of overburden to get to ore that will be mined later.

While the expensed costs get all the headlines, the capitalized costs don’t get much attention at all.  Yet both types of costs are equal in the place where it really counts: how the company’s cash balance changes from quarter to quarter.

The work I did for OceanaGold led me to wonder what the same sort of analysis would look like for other gold companies.  What are the total costs of mining on a quarterly basis and how do they differ from the reported (expensed) cash costs that get so much attention from the brokerage community?  What we are really interested in with any company is how much free cash they can generate.  If a company is generating a lot of operating cash but is plowing that cash right back into the mine as sustaining capital, well then they are running on the spot.  So total costs is what matters, be they lumpier and messier than cash costs or not.

Moreover I have to imagine that there is grey area when applying the criteria of what constitutes an expensed cost and what constitutes a capitalized cost.  The implementation whatever accounting methodology is used probably varies from company to company.  Simply looking at cash costs might ignore these discrepancies and paint a poor picture of what’s really going on in the operations.

To look at the effect of overall costs, what I have done is simply this.  I took the cash costs stated by each company for the last two quarters and added to those costs the additions to property, plant and equipment as reported on their cashflow statement.  Then I divided summation of these two costs by the ounces produced over the first two quarters.  Because PP&A is likely to be more variable, it might be worthwhile to do this over a longer time horizon, but for now this will have to suffice.

  This is an interesting result.  It is particularly interesting when you compare the list against the same list of companies sorted on the more traditional cast costs metric.

What you see is that the companies that are lowest on the cash cost scale are not necessarily the lowest on the total costs scale.

Now of course, like everything, these results have to be taken with a grain of salt.  One of the reasons that capitalized costs are not added to cash costs in for traditional analysis is because they are inherently lumpy.  One time purchases that should be capitalized could skew the picture of the quarterly performance of a company.  Brigus Gold is a good example of this.  They are ramping up their underground mine at Black Fox right now.  There are a lot of capitalized costs associated with that ramp up.

I went another step further by looking at costs for the full year 2010.  That graph is shown below.  Here a few of the companies (Lake Shore, Atna, Alacer, etc) drop off the list because they didn’t have comparable production for the period for one reason or another.

To make a few observations from the above graphs, the first being that OceanaGold does not look like such a high cost producer.  While their cash costs are higher than the norm, their capitalized costs have consistently been lower than normal.  I wonder how much this is caused by having a mature mine.

Another observation I would make is that Aurizon Mines truly is a (if not the) low cost producer.  Both OceanaGold and Aurizon Mine are cash generators, which should serve them well over the longer term as they develop their mines.

A final observation is that B2Gold is worth taking a closer look at.