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"Buy at the Bottom" says Adrian Day

on 6/4/2013

Investors have heard it before: "Buy low; sell high". But when is it at the bottom and when is it at the top?

At the Metals and Minerals Investment Conference in New York, held on May 12 and 13, we spoke to one of the speakers at the conference, Adrian Day of Adrian Day Asset Management. Adrian Day Asset Management manages segregated accounts in global markets and resource markets and the company is focused on long-term value equities. His book, Investing in Resources, came out 2 years ago and contains timeless lessons on resources and the factors that influence their prices.

He started by telling us what he was talking about at the conference: "I'm trying to answer the question: 'Is the bull market over?' Because of what happened to gold last month, and the gold shares being extremely weak in an already weak market, a lot of people are asking whether the bull market is over."

So is the bull market over? We wondered? "I don't think so. Not by a long way," said Mr. Day. "It's normal for long cyclical bull markets to have mid-cycle corrections. We saw that with gold in the 1970's. We forget that gold dropped in half in 1975 – 1976. It was down 43%. But also other markets: You look at the Japanese stock market. You look at the NASDAQ in the 1990's. That had a correction of over 40% just before it had its final leg up. So these major corrections in the middle of the bull market are quite normal. I think that's what we're seeing here."

There are a lot of factors that impact the price of resource stocks and the underlying commodities. They can make it quite complex for the average investor to know what to do. Mr. Day mentioned a couple of the price-influencing factors that we're seeing right now: "At the end of 2012 we had what's called the 'Great Rotation' when hedge funds (in particular) and institutions moved out of gold and commodities and moved into the equity market. It was a good trade for them. But I don't look on gold as a trading vehicle. I look on gold as a way of holding assets. Sometimes we're too short-term oriented with gold. I think the dollar's relative strength has been part of it. Also, the Federal Reserve is beginning to talk about when they are going to exit the stimulus. That has people worried about when it's going to end. I personally don't think it's going to end any time soon. I think they're locked in, frankly. But that has people nervous about a possible end."

Surprisingly, Mr. Day doesn't believe inflation is a factor for the price of gold. He said, "My bullish case for gold does not depend on inflation at all. We've had twelve years of gold going up without any significant inflation. We haven't had hyperinflation and yet gold has gone up. Gold is a hedge against depreciating currencies and with all the money being printed that we're seeing, that's a negative for the dollar, just as it's a negative for every currency around the world. All currencies are losing their purchasing power. At any given time, one is going to be relatively stronger than others. They're all losing their purchasing power."

Since prices are so unsteady right now, and since many investors have taken a beating in their portfolios in recent months, what should investors do? Mr. Day thinks that it might be a good time to buy. Here's why, and what types of companies he's looking at: "I think some of the gold stocks are just ridiculously cheap right now. We often think that gold stocks move before gold does. I think this time gold is going to move up before the stocks move. But the gold stocks are probably the better buy. Some of them are just ridiculously cheap. Not so much mining companies that still have fundamental problems in terms of cost pressures and in terms of replacing the ounces they have mined. But some of the good quality exploration companies are very, very cheap."

Next, Mr. Day listed several companies he is paying attention to that he believes are good quality buys right now:

The first company he mentioned was Virginia Mines (TSX: VGQ). "Their stock prices have not come down anything like the others. In fact, Virginia went from about $10 1/4 to about $7 1/2 in the mid-April crash and then was right back up to $10 again. That's unusual. I'm not saying Virginia is the cheapest or most depressed stock by any mines. But Virginia has a $300 million market cap and it has over $40 million in cash. That's $260 million market cap ex-cash. They have a royalty that starts next year. When that mine is up and running, that royalty after the first two years will give them about $30 million a year in free cash flow. $30 million a year free cash flow on a $260 million market cap ex cash is pretty good. But it means that everything else they have is free – all the exploration, all the ounces that they've discovered, all of it is free."

"I also like Altius Resources (TSX: ALS) which is, in many ways, similar to Virginia Mines but is in base metals," Mr. Day explained. "The company has $160 million in cash. They're not going to go out of business any time soon unless they do something really stupid with their cash. They've demonstrated over the years that they don't do stupid things with their money. That's a cheap one. It's selling at a little over $10 per share right now."

Mr. Day continued: "A junior exploration company I like a lot is Riverside Resources (TSX: RRI), trading at about $0.38 a share. [They have] three alliances with major companies, plus joint ventures; $6 million in cash. Six million for a company of that size is more than enough to sustain the business. Among the bigger companies, even though they are not that cheap, I think royalties are much better risk/reward buys than the mining companies themselves. Franco Nevada (NYSE: FNV); Royal Gold (TSX: RGL). These types of companies, because of their business model, are much lower risk than the mining companies. It doesn't mean they don't have risk."

"I still like copper," added Mr. Day, when introducing is final stock pick. "Copper is being hit two-fold this year. There are concerns about the declining growth in China and there are also expectations of a 6% to 7% increase in copper supply this year (led by Oyu Tolgoi in Mongolia). Both of those concerns are legitimate concerns but I think they're over-played. In the last couple of months of China's inventories of copper have gone way down. And at the same time, imports of new copper into China have started to increase again. When you already have copper, you don’t import more unless you intend to use it. And we're not down to 8-month lows in terms of inventories in China. So I think those imports are going to pick up. China's growth of 7.5% is still strong growth. It's not double-digit growth but it's still strong. On the supply side, Mr. Day sees delays in Oyu Tolgoi. "Rio Tinto is fighting with the government because they want to extract more tax from the mine than they had originally intended. Oyu Tolgoi is the first major world class copper mine in over ten years. And if you look ahead to the next ten years, there is nothing the size of Oyu Tolgoi that is likely to come into production. So after this year, production is likely to start to steady and then go down in the next few years."

For that reason, Mr. Day likes Freeport-McMoRan Copper and Gold Inc (NYSE: FCX). They are "a very good quality company selling at a very low price. It's selling at a forward earnings multiple of less than 9. That's at today's copper price. And it's yielding 3.5%. I think it's a very good company at a very good price."

Mr. Day had the last word in the interview when he addressed the concern that many investors are facing right now. We couldn't have said it better ourselves so we'll finish with a quote from him: "We don't know whether this is the bottom or whether we are going to see lower prices. Money in all markets is made by buying low and selling high. This period qualifies as 'buying low', whether it goes lower or not. But if you buy now and look with a 3 to 5 year time horizon, I think you'll do very, very well. We've seen these times before. This is the time to be buying, not panicking."

Adrian Day Asset Management website: http://www.adriandayassetmanagement.com/



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