Watching for Capitulation in Precious Metal Stocks

The Gold Report |

Looking to leverage the upside of inevitable rising precious metals prices without the risk of buying mining company stocks? In this interview with The Gold Report, Dudley Baker, founder of Common Stock Warrants, shares his approach to evaluating companies for longevity and the opportunities warrants in those companies might play in the right circumstances.

The Gold Report: A lot has changed in the resource space since we interviewed you last. From your perspective in Mexico, how did we get to where we are today?

Dudley Baker: I stay abreast of the views of our friends—Rick Rule, Frank Holmes and many of the others in the business. Despite the toll low gold and silver prices have taken on companies and portfolios, I remain confident that those of us still invested in this sector will be greatly rewarded for our patience. It's just a matter of time.

We are four years into this pullback right now, which means we have to be getting close to the end of this bottoming process. Two recent events stressed to me that we are near a bottom. One was the folding of our friends Casey Research into Stansberry & Associates Investment Research. Over the last decade Doug Casey has built an empire of services and expert newsletter writers. That he would join forces makes me think we must be near a bottom.

A second one that hits even closer to home for me is that I recently received an email from my brokerage firm at market close on Friday that it was going out of business. This was a total shock. We have used Penn Trade for the last 10 years. The parent, Pennaluna & Company, is based in Coeur d'Alene, Idaho, and has been in business since 1926. Most of the firm's client base included resource investors. That is a dramatic contrarian sign that maybe, just maybe, we are close to a bottom.

TGR: If that's the capitulation that Rick Rule has talked about, what would the signs be that regular investors are starting to come back?

DB: Let's face it. The average investor does not want to step in right now. For me, if I can find opportunities, I'm still going into this market. Is it premature? Perhaps. But I don't want to miss all the upside coming. I'm afraid average investors are going to wait until we have one hell of a rally before they get their confidence back. It's going to take something well north of $1,250 an ounce ($1,250/oz) gold before the generalist takes notice, and at that point there's a high probability that it will be too late.

TGR: What if, as many have predicted, we end up with sub-$1,000/oz gold?

DB: It is always a possibility that we could go down from here. I do not want to see lower prices, but it could break down. If we break the previous low, $1,070/oz, there's no support until we get to $1,000/oz gold. That could happen really quickly and the faster the better. Let's get it over with. If we have to have a final cleansing, bring it on. Let's not drag this thing out for months. Then we can get a fresh start on a new uptrend.

The more likely scenario is that we have already bottomed. Of course, no one knows for sure. That is why we have to make our own decisions and be prepared for whatever happens. It is scary to step into these markets right now, but this is the game you have to be playing today. You have to be a contrarian, even if that means being a little early.

TGR: During this bottoming process, where is it that you're finding the best opportunities? What types of companies are best positioned to come back strongly?

DB: I have a whole basket of resource and non-resource companies in my portfolio. The challenge right now is timing. Who has good properties and the cash to survive this downturn? The ones that fit that description include New Gold Inc. (NGD:TSX; NGD:NYSE.MKT), Sandstorm Gold Ltd. (SSL:TSX; SAND:NYSE.MKT), Quaterra Resources Inc. (QTA:TSX.V; QTRRF:OTCQX), Starcore International Mines Ltd. (SAM:TSX) and Pilot Gold Inc. (PLG:TSX). These are companies that are going to weather this downturn and be great performers when the markets turn.

TGR: Quaterra recently announced that Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) is investing $7.1 million ($7.1M) over the next year that will be used to explore the Bear copper project in Yerington, Nevada. Is that an example of how some of these juniors are surviving by joint venturing with majors?

DB: I have followed Quaterra for over a decade and been in and out and made some really nice money. In 2006, the stock rose to over $4/share. The company has restructured to become more of a copper play and it is sitting with around $4M in cash, weathering the storm. It is headed up by Tom Patton, one of the legends in the business. For a small company, Quaterra has incredible upside potential. I'm always looking for a minimum 500–1,000% potential when I go into something. This could be one of those companies when the market starts heating up.

TGR: Are you looking for the same thing with Starcore International?

DB: Starcore is a small gold producer in Mexico. It is producing some 19,000 oz (19 Koz) gold equivalent per year and sitting on $5M in cash. This could be a sleeper now that it has purchased the Creston Moly assets in Mexico out of bankruptcy for $2M. Those assets were purchased for $195M just four years ago. Starcore management was savvy to pick that resource up for less than a penny on the dollar. When the market turns, Starcore is going to be an interesting little play.

TGR: Pilot Gold has been the exception to the rule and actually realized a share price increase when it released results on the Kinsley Mountain project in Nevada. We hardly ever see stocks go up on good news anymore. How did management accomplish that?

DB: The share price had been beaten down so badly to the low-CA$0.30s that it was due for a pop to the upside. This is also just another really interesting company. It has the Nevada property and a joint venture in Turkey with Teck Resources Ltd. (TCK:TSX; TCK:NYSE). Plus it's sitting with around $12M of working capital. It is so important to me that we don't wake up one morning and one of our companies disappears. Cash takes the worry out of the game.

TGR: Is New Gold well funded?

DB: New Gold has over $300M in cash in the bank. It has producing mines in Canada, the U.S. Australia and here in Mexico, plus a pipeline of development projects.

TGR: Sandstorm is a royalty streaming company. Is this a good time for the royalty companies to be investing, to be looking to the future?

DB: I would think so. Sandstorm just announced it is raising $150M+ to acquire new streams by financing junior mining companies. That will be something to watch.

With so many mining company share prices beaten down, if you're not already in, you can step in at this price and build a really nice core portfolio of interesting companies that will help you sleep well at night.

TGR: If you were to pick one other company from the bargain basement we are now in, what would it be?

DB: Another interesting one that is definitely going to survive is Endeavour Mining Corp. (EDV:TSX; EVR:ASX). This company has been a favorite for quite a few years. It's sitting in the mid-$0.50 range right now. It is a gold producer with four mines, all in West Africa. Currently, it is producing over 500 Koz of gold a year and it has $50M in cash. Just think, if gold goes up $100–200/oz or more, this is going to be a cash cow.

TGR: One way to take advantage of these opportunities is to buy stock. Another way is to buy stock warrants, and that is what your website is about. Can you explain the difference between those two?

DB: Once you've done your research and you know you like a company like New Gold or Sandstorm Gold, the next step is to see if the company has warrants trading. Common Stock Warrants is a complete database of all stock warrants trading in the U.S. and Canada for all industries and sectors. A lot of companies in the resource sector struggle to raise money in this environment. Many include stock warrants in transactions to make them more appealing. Management has to decide whether to make those available for trading. Every transaction that Sandstorm Gold has ever done has included trading stock warrants. The last Silver Wheaton Corp. (SLW:TSX; SLW:NYSE) warrant expired about a year ago, but for the last decade the company offered a long-term warrant that was really interesting. Today, we are focusing on the resource sector, but a lot of warrants are coming out in pharmaceuticals, biotechs, gaming companies and financial organizations as well. Several hundred companies now have stock warrants trading. And many of the biotech stocks have five-year windows. That is a wonderful opportunity.

Stock warrants are similar to options. They have an exercise price and an expiration date, both of which are very important. Both New Gold and Sandstorm warrants run around CA$0.20 as opposed to, say, $3 or for the common stock and they both expire in 2017. If the bottoming process takes another couple of years, you're going to lose that $0.20. But that is better than buying a $3 stock that drops to $1. You're going to lose less money with the stock warrants if you use proper money management. Each investor has to determine appropriate risk exposure. A warrant allows you to get in with less money, but in a rising market, you could end up making twice as much. What better time than now?

I'm always looking to make at least double what I could make by buying the common stock. If the common went up 100% in value, we'd like to think the stock warrant is going to go up 200%; that is 2:1 leverage. Otherwise, it's not worth taking the risk to buy the warrants.

Another company that just announced a warrant is Dalradian Resources Inc. (DNA:TSX). This is a small exploration company with a gold project in Northern Ireland. One warrant already trading expires in 2017, but the company's $35M offering could be an even better deal.

These are just a few examples of the opportunities that are available right now for those contrarians brave enough to act when the mainstream is holding back.

TGR: Thank for your time.

Dudley Baker worked for the IRS for 29 years, which gave him an extensive "numbers" background. He has 35 years of accumulated knowledge and experience in trading stocks, options, leaps, futures, options on futures and warrants. In March 2005 he founded and launched a new market data service, Precious Metals Warrants, which provided detail on mining and energy warrants trading on the U.S. and Canadian exchanges. The service was expanded in May 2013 to include all stock warrants trading in the U.S. and Canada and for all industries and sectors and the name changed to Common Stock Warrants.

Source: JT Long of The Gold Report (9/24/15)

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1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report and The Life Sciences Report, and provides services to Streetwise Reports as an employee. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Silver Wheaton Corp., Quaterra Resources Inc. and Pilot Gold Inc. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
3) Dudley Baker: I own, or my family owns, shares of the following companies mentioned in this interview: New Gold Inc. Wts, Sandstorm Gold Ltd. Wts, Quaterra Resources Inc., Starcore International Mines Ltd., Pilot Gold Inc. and Endeavour Mining Corp. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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