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Exploration Insights Joe Mazumdar on Trade Wars, Gold’s Vomiting Camel, & Why Now Is a Good Time to Double Down on Strong Exploration Companies

August 17, 2018

Gerardo Del Real: This is Gerardo Del Real with Resource Stock Digest, joining me today once again is Co-Editor of one of the best resource letters in the business, Exploration Insights, Mr. Joe Mazumdar. Joe, how are you today?

Joe Mazumdar: How's it going, Gerardo? Thanks for having me.

Gerardo Del Real: It's going great. I appreciate you pronouncing my name correctly, not very many people get that right. Listen, it's been a few months since we spoke, I've long been a proponent that we needed one last wack in the gold and silver price. I've been on record saying that I thought it could go down as low as $1,050.

Joe Mazumdar: It was all you, it was all you that did it.

Gerardo Del Real: No, no, it wasn't me, it's been in the cards. So here we are sitting at $1,179. I would love to start by getting your take on the overall gold market, what you see, how you think things will develop, and then we can get into a broader conversation about base metals, geopolitics, and a couple of other points I'd love to touch on. But let’s start with gold. What do you see happening out there, Joe?

Joe Mazumdar: Well the graph looks, right now, somewhat similar to that graph from several years ago that was known as the Vomiting Camel. It's looking like that because it's dropped through the support level of $1,200, which was a very important support level and psychological level for a lot of people and now it's sort of free fall.

What we've seen on the gold demand side has obviously been week, but what we're looking for is the investment demand, the money that's going into the ETFs and in the second quarter it's been down by about a half, year on year. Most of that has been driven not by the European funds, which are still positive, but outflows from the US-based funds. That's where a lot of it's going out and what's driving that is moving money from gold into the equity markets and potentially bond markets, expecting higher interest rates, and basically leaving their sector.

We see it in the assets under management as well for the gold sector, or the precious metals sector. There's a bank, CIBC, that put out this note that basically said that back in 2011 when assets under management peaked around $54 billion, $50 billion of that or 95% of that was actively managed. So at that time you would have a lot of people attending gold shows, you would have a lot of people talking to these fund managers, a lot of meetings, a lot of that sort of stuff going on. Now, 7 years later in 2018, you've reduced that number in terms of actively managed funds to $10 billion, so you're down about 80%.

That's obviously impacting the ability of companies to fund development, fund operations, fund exploration importantly for us. So a lot of these guys are unable to do a lot under the current circumstances, but what we do see is some people that can get money and some people that can't, the haves and the have nots. Just this morning I woke up to look at the list of news this morning and I saw about $93 million dollars of proposed financing in the middle of summer, given where the gold price is, not only in gold but we see in copper, cobalt, and one is lithium.

So it's not as if there aren't people out there that will help you fund it, but the makeup of those people is much different. Institutional equity might not be there, so you might get more private equity, you might get more strategic investors, industry. So it might be a different make up, the whole pie has gotten smaller but also the people with the appetite have changed.

Gerardo Del Real: Do you feel that with that pie getting smaller that when there is a turnaround – and there always has been and always will be – that that will have a disproportionate effect to the upside, the way it's having a disproportionate effect to the downside right now?

Joe Mazumdar: Yes, the thing is that when we come up do we come up as high as before, I don't know. But in terms of the valuations for some good companies, we're waiting because as you know there still are some funds out there that are readjusting their portfolios, giving mandates away to other firms to run their portfolios, because as I mentioned the number of active managed funds is much less. That we're seeing reductions in companies that their news flow doesn't merit to that. So what we're seeing is them using a liquidity event like the end of a quarter to basically dump shares. We've seen that in some of the companies we own that are producers, so that sort of scenario is something that we'd like to buy but we're just waiting right now until all that bloodletting is gone.

Gerardo Del Real: Speaking of bloodletting, a good sign of a potential near-term bottom Vanguard, which obviously has $2.3 billion under assets in what was named the Vanguard Precious Metals and Mining Fund, it announced that in September the fund will be renamed the Vanguard Global Capital Cycles Fund. I have to believe that they're obviously pivoting out of a lot of the precious metals names.

How much of an effect do you see an event like that having on the overall gold price and the overall gold market? And is that a buying opportunity if you have the right timeline and the right horizon to hold?

Joe Mazumdar: Yes, I believe absolutely. When you see somebody is changing because of something mandated, something mandated by them to change what they are doing and they are selling not because of the actions of the company, then that's absolutely a reason, if you've got a high conviction towards the company, to come back in. The only issue is that it's very difficult to pick the bottom.

So you're going to have to be convinced that from here I can still get a double or a triple, maybe if I wait another week or two weeks it might be better, but it's hard to predict that. So what we're doing is sort of sitting on our hands a little bit longer for the summer and waiting for some of these funds, because it's not only Vanguard, I think there's another fund out of London that has the same issue.

We don't want to go down another 30% let’s say, and I think as long as we can convince ourselves we're not going to go down that much and if it does go down it's only 5% or 10%, that's okay. So I mean we're definitely looking at companies, we're definitely looking at reorganizing our portfolio, taking some hits on some companies to get those other companies that we want to expose ourselves to. I definitely think that even though it's summer doldrums, even though gold price is dropping below $1,200, the asset managers of actively managed funds are leaving. Personally I think this is a great time for us to re-look at our portfolio and start adding some companies that we really like or adding more positions in companies that we already own.

Gerardo Del Real: I absolutely agree. Last time we spoke you were focused on explorers, not so much producers, what's your approach this time around as you sit down with Brent Cook and you look at the portfolio and you talk strategy and looking forward. Do you still have a bias towards the explorers or are the producers now getting attractive enough to where they merit a bid, even if it's a junk bid, right?

Joe Mazumdar: Yes, definitely one of the ones that I'm thinking about adding a position to is one that we already own that's a producer that I think is very inexpensive. So that is definitely something that I'm looking at and we might look to add another producer but for a short-term investment that we've done before. We've done some of these short-term investments on liquid producers, so as long as the producer is liquid in terms of trading, solvent with respect to working capital, but they don't have to go back to the markets, and has been performing well in terms of generating free cash flow at these sort of price levels.

That's something we would want to look at seriously. We do not want a producer just because they're down 50% but as you look at it they're not generating any free cash flow, then in two quarters it'll have to go back to the market and that's maybe why the market is looking at them that way.

That's something that we want to avoid, but if somebody is well funded, doing well in terms of generating free cash flow and is only getting kicked because some of these funds are just selling their positions in the company, then that's a good opportunity.

Gerardo Del Real: Up until a few months ago, Joe, there was a pretty well established consensus that we were in the midst of a global reflation and now these trade wars and these tariffs that are being implemented, it seems like threatened on an almost daily basis, right, even if the implementation hasn't been severe yet, it's definitely having an effect all around on the gold price, definitely on the base metals price, how do you see geopolitics influencing and let’s keep with gold right now. Do you think that central banks like the Turkish Central Bank is having to liquidate some of its holdings in order to stay somewhat solvent, do you see that as a factor? And then I'd love to pivot to base metals.

Joe Mazumdar: Yes, there's a whole bunch of things going on geopolitically and it's hard to predict or keep everything in mind. I always think about gold as the last thing that comes out of the toothpaste after everything else has happened, then the barometer is gold. So yes, there are impacts. But with the US, they've obviously got some of the biggest gold reserves and looking at their deficit would the US ever sell gold, and it never has.

So I don't know if there's a big impetus to sell gold, so that might be their last resort for countries like Turkey and Kazakhstan, maybe Russia. They've been actually net purchasers and drove positive net purchases in central bank activity in Q2, so these countries are still buying. Even though I talk negatively about the ETFs they are still net positives, they're not net negatives yet, so that's a good thing. Right now we're potentially at a cusp, we could go either way. We think that we might go the way that will be favorable to actually start accumulating stocks right now.

Gerardo Del Real: Which means lower gold price, which is kind of what I see. Would that be accurate, Joe?

Joe Mazumdar: Yeah, the thing is that with exploration and the companies we're looking at, at lower gold prices, it even makes more sense to do grassroots explorations to find assets that work in this gold price environment because a lot of the brownfields exploration, which is near active mine sites, it has a higher probability of finding the same thing whereas if you could do more grassroots you might be able to find a new deposit that actually works in the current gold price environment.

We have seen M&A despite the market, despite the market with the equities and the fund managers and the reductions in actively managed funds, we see industry picking up the pace. We saw several M&A transactions or bids or discussions over the past several weeks, so the industry is still acting where investors are sitting on their hands. So if we can pick some of these assets that the industry still wants because they're dealing with flat to declining production profiles and the inability to potentially generate under these commodity prices, if you can find an asset that's better than the ones you have.

I think it's great opportunity for industry to fill their coffers if they've got cash, if they've got a stronger share position than the junior that they're looking at acquiring because some of these juniors in terms of the position right now might now have another choice, you know. We're seeing all cash bids, like the copper-gold at Timoka, cash bid for about 1.4 billion in this environment that's declining copper and gold prices, because the industry knows that they have to find more, they have to produce more, and there's just not a lot of assets out there that makes sense, that's really in terms of grassroots exploration what we're trying to do is get hold of those companies with good management teams, with good programs that have a higher probability to find something that makes sense.

Gerardo Del Real: The disconnect between value and share price is interesting to me. And you mentioned M&A – and I want to go back to base metals in a second – but you touched on M&A and even bids that sometimes have a 50%, 60% premium to the 20-day weighted trading average, those are being rebuffed oftentimes by the companies being courted. Does that speak a bit to the disconnect between the share price of a lot of these companies that have great assets and great management teams and what the market’s willing?

Joe Mazumdar: Absolutely, so that's what we were talking about in the letter last week, is that M&A is a quick fix for the valuation gaps to get somebody up there and whether the management team sees that as a good bid because I don't want to build it or a bid that doesn't take into account all my valuation. What's nice about one of the ones that actually said I don't want this bid even though it's all cash in an environment that nobody’s actually doing all cash bids. It's suggesting to me that their shareholders as well are sort of saying, “Okay, we're backing you because we think it's underpriced as well.” Otherwise I would be giving my shares to the suitor, which I'm not, because I think that they could buck up another $0.25 to $0.30, whatever it is.

So even though shareholders know that there's an issue here in terms of valuation gap and they know that the suitor really wants the asset, so for me the M&A helps us understand what's going on in the market on the industry side even though the equity investors are a little bit, let’s say, in the summer sort of mentality at least in terms of staying away from the sector right now. The industry is not staying away.

Gerardo Del Real: There's been a couple of private equity funds that have recently submitted successful bids and taken assets private. That's not something that we see a lot of typically. It was interesting to me, it's supportive of I think both of our theses that a lot of these companies, the share price is just completely out of wack with reality.

Do you see a continuation of that? I mean the bottom line, Joe, is that a lot of these producers, the balance sheet is trash and it's not getting better with this drop in the gold and silver price and, frankly, a lot of the potential suitors just aren't in a position to participate in accretive M&A. Do you see more private equity activity here in the third and fourth quarter?

Joe Mazumdar: Yes, the flow of money is going to private equity and they have mandates and they have longer periods where the funds have to stay, longer investment horizons. They have an advantage over some of these other funds that might see redemptions within a year or so or they hold funds for much shorter periods and it's more about a quarterly return as opposed to these guys that are looking for a big pay day in two to three years when the market turns and they know that these other companies will need this asset. There's an advantage there, there's a definite advantage in terms of philosophy and investment focus that private equity is much more flexible to take advantage of versus institutional equity, there's definitely an advantage and investors in those private equity funds know that.

The industry on the other hand is very suitor specific, what they need, what they want let’s say at a specific time let’s say. So one person may be looking for geopolitical diversification and might buy an asset that you might think that oh jeez, that's not such a great asset, but they are willing to buy it because they are in some place that they don't want to be in anymore and they're looking for an asset in a place that's safe. Whereas a company that's got a big portfolio of assets in a safe jurisdiction might not buy that asset, so it's almost got the reverse of it because of the paucity of assets that actually are really tier 1 assets because of the paucity of those assets.

We're more looking at the shopping lists now of potential suitors that do very little exploration and the only way to fill their pipelines are via acquisition and seeing what they need or what they are looking for. Like we saw at Newmont take the stake, 50% in Galore Creek, a decent size copper-gold asset that's always been infrastructurally challenged. But we also know that Newmont had to give away Batu Hijau, sold it, and so that dropped the copper and gold reserves. Also, local opposition to the Conga project improved, forced them to take their equity stake of that asset also off their reserves, and Galore is sitting there with reserves so that's something easy that they can add. So is there now a push by the industry to take infrastructurally challenged assets and safe geopolitical jurisdictions over those ones that potentially are high margin but in a more risky environment. Is that the way we're heading, which is another question.

Gerardo Del Real: Interesting. Let's talk base metals, I think you covered M&A pretty well and the approach there. Obviously copper, lead, zinc, the past 60 days have been tough. The past 30 days the selloff has accelerated. I absolutely believe in the demand drivers for copper and zinc and I don't believe trade wars are sustainable. It doesn't mean that they don't escalate in the short term, but how do you feel about the trade wars as they stand now? Do you see an escalation there and what's your take on the overall base metal space? We can start with copper if you like.

Joe Mazumdar: Well in terms of the underlying for copper with green energy and that's the future and a lot of it's being mandated by big economies like in China and the Eurozone. It's a growth that's not completely dependent on the US, it might be more dependent on outside economies, but as we know trade is important. So where are these vehicles going to come from? Are they going to be exported, is the demand going to be local? Free trade helps everything and if we get to a point, and the sentiment currently is that some of these markets will be closed, how much can anybody individually consume because still, the US consumer is the most important consumer in the world and if you don't have access to that consumer, that hinders your ability to grow production because you might not have the kind of demand you want.

So right now we're sort of in a precipice. Is it going to happen, is it going to happen, how much, how severe could it be? We're seeing everybody trying to imbed that risk in the valuations and the commodity prices, which are at a historic low compared to equities. I mean equities meaning S&P 500.

Gerardo Del Real: Right.

Joe Mazumdar: I think like you, I think it's temporal and there's no way that it could be long term because I just don't see the sanity in doing it. But the whole issue is can we stay solvent as long as all this irrational behavior continues? That might last longer than we do. But it's hard to predict the politics, it's hard to go from tweet to tweet with respect to trying to manage your portfolio, which is basically what a lot of people are doing.

Gerardo Del Real: Well put, well put, Joe. You and I haven't had the pleasure of arguing on Twitter yet but I see that you now have a Twitter handle.

Joe Mazumdar: Oh yeah.

Gerardo Del Real: How can people get a hold of you?

Joe Mazumdar: The Twitter handle is pretty easy. It's just my name, @JoeMazumdar. I don't post a lot of stuff related to the letter but if there's something thematic that we're interested in I'd post that and also on my site visits. I was just in Mexico last week so I posted a few photos from that visit. I'm still a little bit of a neophyte with Twitter, so you'll have to be patient with me on that one.

Gerardo Del Real: And the website, www.explorationinsights.com, correct?

Joe Mazumdar: Yes sir, yes, that's right.

Gerardo Del Real: Perfect. Tough markets, Joe. Any parting words of advice for subscribers or potential subscribers or frankly just speculators that are dabbling in this space that maybe got in a year or two ago thinking we've hit a bottom in gold and gold juniors and we're going to make a fortune and frankly it just hasn't played out that way yet, any advice there?

Joe Mazumdar: Well I'm taking that advice as well so, for me you have to have a conviction on the company with respect to assets, management, what they're trying to do. If you really believe in that company, I think given the current market it might be time to double down on that conviction.

Gerardo Del Real: Thank you so much, Joe. Anything else you'd like to add, anything I didn't cover?

Joe Mazumdar: Nope, I think we're good.

Gerardo Del Real: I like it, thanks again. I look forward to having you back on in a couple of months and we'll see if golds back up above $1,200 or near my $1,050 call, which hopefully we just get it done and out of the way.

Joe Mazumdar: Well yeah, your $1,050 would be close to the $1,060 we hit the last time we experienced the Vomiting Camel.

Gerardo Del Real: You got it, and that's kind of my thesis, we've got to break down before we can break out, let's see if we can get each to happen in succession.

Joe Mazumdar: Alright then, sir, I'll talk to you later.

Gerardo Del Real: Thank you, Joe.

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