Source: John Newell for Streetwise Reports 02/13/2019
Following a painful decline, some quality mining shares are poised for recovery. Fund manager John Newell at Fieldhouse Capital Management explains his process to identify them.
In the larger picture, the first chart shows the CDNX Index, which represents many of the junior mining companies we follow (but not perfectly). They tried to breakout in early 2018 after moving sideways for more than a year and half from the late summer highs of 2016. They then slipped back into a downtrend in early 2018 and then bottomed on December 24, 2018 at 528.
Chart courtesy of StockCharts.com.
Since that low, the index has climbed steadily up, about 13.5% in early 2019. However, what the CDNX chart above hides are the positive moves some companies made in the space, despite the difficult market. So, we will look at the traits of the companies that did well in 2018, for clues on what could continue to work in 2019. But first I will show charts that make us believe that 2019 could be a very good year in the precious metal space.
The Gold Chart shows that gold bottomed on August 16, 2018, yet despite a ~10% rise in gold off its lows, precious metal shares lagged, much like 2016. (First posted on August 22, 2018) (The Gold-Silver Ratio is how many ounces of silver it takes to buy one ounce of gold.)
Chart courtesy of StockCharts.com.
Historically, this ratio suggests that investors are willing to take on more risk when silver is outperforming gold and, therefore, more money goes into the riskier asset classes as the risk on trade takes hold.
When silver rises faster than gold, as it is now, it suggests growth and inflation are rising, giving investors reasons to look at all tangible assets to protect purchasing power.
In the chart on below we are beginning to see silver outperform gold after trading at historical highs.
Chart courtesy of StockCharts.com.
2018: THE PERFECT STORM
It was hard to make money in the last half of 2018 in this sector, with the U.S. imposing tariffs on China, the threat of higher interest rates, the short term strength in the U.S. dollar, coupled with the threat it would go higher, the lack of timely assay results, general investor pessimism, equity raises in a weak market, and lastly, tax loss selling—all contributed to a weak year overall.
The shotgun approach or a lot of names, ETFs, or precious metal funds did not do well in 2018. However, in stealth-like fashion, the tricky precious metal space had some big winners, and it was the rifleman’s approach in 2018 that did well, but it required work.
In 2018, we saw the takeovers of Nevsun, Dalradian, Northern Empire, Richmont and Klondex, to name a few. We saw exploration success with Sun Metals, Corvus, Westhaven, Great Bear and GT Gold. All the names, and I have missed some, were either taken over, had good exploration success or were part of jurisdictional diversification or consolidations of existing land positions (area plays), where property synergies made sense, as reasons for the share prices going higher.
2019: THE PERFECT OPPORTUNITY
First, we make a few assumptions. In the 1990s, gold companies found about 1.4 ounces of gold for every ounce they produced. Today, that number has dwindled to 0.03 ounces for every ounce produced and peak gold, by consensus numbers, took place in 2015. This is a recipe for going out of business if you don’t find, buy or merge more ounces into these companies to increase production or add to reserves.
So, it is with that in mind that we believe in the same approach we used in 2018, that is, careful research, looking at quality committed management teams, good properties in sound jurisdictions, a strategic large shareholder, some money in the bank and a reasonable timetable for news and results as we start to look for investments in the mining sector for 2019.
As we start 2019, exploration companies are priced for failure. The threat of more U.S. dollar strength and higher interest rates seem overblown and investor pessimism and doubts are high. However, this appears to be fertile ground for a new leg up in the on-going bull market in precious metals, base metals and strategic metals going forward.
WHAT WE DO
We start by screening approximately 1,500 companies, looking for long bases, accumulation patterns or a bullish technical formation that gives us a clue to where investor interest is or where investor interest could be going. Shares in companies that hold up better in down markets is also a big clue.
We then we go to conferences, road shows, meet with the company executives, and maybe even do site visits, meet the prospectors and geologists to get a feel for the company and its personal. We build on the fundamental story and opportunity and have technical targets where we see the share price potentially going.
We like to share the companies we like in pictures and the chart below is a good current representation of the kind of company we like. While this is not a stock recommendation, it represents all that we look for in a company—great management, good jurisdiction, good grades, improving cash flows, exploration success and a good solid base in the stock chart that helps us to know that most of the weak hands have left the market and the float has tightened up.
Chart courtesy of StockCharts.com.
IN SUMMARY
We believe the junior mining space offers a rare opportunity as a contrarian investment thesis, with many good, well run companies trading at significant discounts. Also, with the seasonal play not too far off, as we go to press, timely investments in this sector could prove rewarding in 2019 for investors willing to do their homework.
John Newell is a portfolio manager at Fieldhouse Capital Management. He has 38 years of experience in the investment industry acting as an officer, director, portfolio manager and investment advisor with some of the largest investment firms in Canada. Newell is a specialist in precious metal equities and related commodities and is a registered portfolio manager in Canada (advising representative).
This article was initially published in the February/March 2019 issue of
Resource World. Reprinted by permission.
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