In 2008, many investors watched as their portfolios plummeted. Those stocks slowly regained some ground in 2009 through 2011 but many have had disappointing returns in the last year or so. Some investors are wondering: Should they be bearish on juniors?
Adrian Day doesn’t think so. Adrian Day is the founder of Adrian Day Asset Management, an investment firm that serves its clients by investing in global value stocks, with a particular emphasis on resource stocks.
We sat down with Adrian Day at the Hard Assets Conference in Chicago, just a day after he gave a speech there. We asked him the one question that seems to be on every investor’s mind: What is the outlook for junior resource stocks?
Mr. Day turned out to be very bullish: "I don't think the boom is over," he said. "I think we have a long way to go. The thing about resources is that they tend to be extremely volatile. So it's very easy for people to get discouraged in one of these regular downturns that we have. But I don't think the long-term bull market is over."
Mr. Day then provided two proofs that back up his bullish belief: "There are two major areas that affect the prices of commodities," he explained. "One is the economic environment and the other is the supply/demand fundamentals." He spoke briefly about each to show why he believes in the long-term growth of the resources sector:
Of the economic environment, he said: "You're looking for global growth, low interest rates, easy money, and a decline in the dollar. If you get all four of those together, that's your perfect environment for commodities to go up."
Most of those factors are present in today's economy, as Mr. Day elaborated: "Despite all of the gloom and doom out there about the US economy and unemployment, and Europe – all of which I share and is very real – the fact is that the world economy is still growing. China's GDP growing at well over 7% is still very, very strong. It's leading the rest of the world. The economic environment of commodities remains very strong in my view."
Of the second factor contributing to his bullish position, the supply/demand fundamentals, Mr. Day said: "Not only are we seeing an increase in demand primarily driven by China, but we also have supply constraints. The producers of many metals are unable to keep up with the increased demand."
Then he gave two examples of how the supply/demand fundamentals are operating in today's economy: "The price of gold has gone from $250 to $1750 in the last 7 years but we are producing less gold today than we are 10 years ago. That's not because the companies don't want to produce more; it's because they can't produce more. And, there are record prices for copper in the last couple of years and there was a decline in copper production in 2010 and 2011, and it looks like we're going to have a third annual decline in copper this year. It's not that copper companies don't want to produce copper to meet demand; it's because they can't increase production."
"Over the last year, all of the juniors were very depressed," although prices of some stocks have risen in recent months, especially since QE3. The problem Mr. Day sees in the markets now is this: "There are too many junior companies out there to begin with and they can't all be successful. Many of the junior companies are running out of money."
So, with some juniors struggling and many juniors running out of money in spite of his long-term bullish outlook, we asked Mr. Day what he suggests to investors who are looking for the next company to choose: "The number one thing to look at when you are looking at juniors is: Do they have the cash to carry them through?" he instructed. "If they don't, they will find it difficult to raise the money. I don't mean they won't raise it, but they will raise it on very disadvantageous terms with dilution to existing shareholders."
Next we turned our attention to types of companies he likes.
The first kind of company Mr. Day talked about was royalty companies. "I love royalty companies. The biggest problem in the resource business is: If you are a producer, everything that can go wrong will go wrong. If you're an exploration company, it's equally difficult because the odds are against you. It's a very difficult business being a miner. Because it's a difficult business, the royalty business model is an excellent way of mitigating risk: Someone else is taking on the risk; someone else is spending the money. You participate with a royalty. You participate in the upside if things go well; if things go badly, you don't get your royalty, but don’t have to spend more money."
Along with resource companies, Mr. Day also mentioned some other types of equities that he is paying attention to for his clients at Adrian Day Asset Management: "We have about 25% of our assets in big producers; we have about 33% of our assets in exploration companies; and the rest is in small producers or hybrids or service companies. In the global area, we're pretty cautious… there's still a lot of risk in the market, in my view. On the pull-back, I want to buy income stocks in the US. I like business development companies. We're buying companies in Europe but not companies that sell to the Eurozone. We're also buying high-growth companies in Asia, trading at very good multiples."
Then we talked about specific companies that Mr. Day is watching. Investors should always do their own due diligence before investing in these, but it's helpful to know what has captured the attention of experts.
He listed six stocks that he liked:
"Altius Minerals (TSX: ALS) is trading for less than the value of their real hard assets (like cash and investments in other companies). Forget about all of the exploration and joint ventures. Altius has $163 million in non-allocated cash."
"Look at Virginia Mines (TSX: VGQ). The Net Present Value of their royalty on just one asset is more than the market cap alone. They have over $40 million dollars in cash. That's very strong for a junior exploration company."
"Franco Nevada (NYSE: FNV), among the seniors, is my favorite company. I've often said if I could only buy one gold company and couldn't sell it for five years, it would be Franco Nevada. Superb company; over a billion dollars in cash; great management; great growth in revenue. At today's price of gold, with no additions to their royalty stream, their earnings will double in the next 3 years."
Similarly, in silver, Mr. Day likes Silver Wheaton: "Silver Wheaton (NYSE: SLW) is my favorite silver company by a long way. Again, a very strong balance sheet."
"Sandstorm Gold (TSX-V: SSL): I think it's going to do very well, although I don't own it." But Adrian Day Asset Management does own shares of its sister company: "Sandstorm Mining (TSX-V: SND) is in coal, oil, natural gas, and coal. Its goal is to get into royalties in resources other than gold and silver. We own quite a bit of it. I like it. It has a good balance sheet."
Investors might be currently experiencing the doldrums of a market that has been worn down by juniors looking for money in a sea of depressing media, but Adrian Day believes there are some exciting opportunities in juniors for the long-term.
REFERENCES
http://www.hardassetschi.com/
http://www.adriandayassetmanagement.com/