Less Correlation Among Commodities Demands More Careful Selection

Philip Richards
Philip Richards

Commodities from coal to gold once traded in close correlation, but today the graph looks helter-skelter. This means Philip Richards of RAB Capital has had to think on his feet when choosing names for his company’s Special Situations Fund. In this interview with The Gold Report, Richards explains how commodities markets have changed in recent years, and he lists companies of interest in the gold, silver, nickel, vanadium, zinc and oil and gas sectors.

Richards is the executive director, founder and president of RAB Capital Limited, having co-founded the company with Michael Alen-Buckley in 1999. He is the investment manager for the RAB Special Situations Fund. Prior to joining RAB, Richards was at Smith New Court from 1987 to 1998 (later Merrill Lynch) where he was a founding member and executive director of the European equity division. At various times, he was responsible for Belgian, French and Italian equity research at Smith New Court and, after its acquisition by Merrill Lynch in 1995, he became a managing director of European research and later managing director of investment banking for Belgium and Luxembourg. Richards holds a Bachelor of Arts Honors from Oxford University (Corpus Christi College) in philosophy, politics and economics, was a captain in the Royal Green Jackets (British Army) and received the AIM Entrepreneur of the Year Award in 2006.

Interview by J. T. Long of The Gold Report

The Gold Report: Philip, your March update on the Special Situations Fund showed a 4.21% increase during Q1/14, compared to 1.29% for the Bloomberg World Mining Index. You noted that cold weather and concerns about China, Ukraine and South Africa are driving commodity markets short term. Are you worried about the impact of a slowdown in China on commodities and your funds?

Philip Richards: A slowdown in China is a concern, but it’s one of many, and it isn’t an overwhelming concern. Ukraine has had an effect on the gas market. Strikes in South Africa drive the platinum price. Specific events in specific countries can drive specific commodity prices, but they don’t drive all commodities.

Royal Nickel Corp.’s Dumont is one of the top three undeveloped nickel sulfide deposits in the world.

In the boom years of 2005–2007, there was a correlation among commodities. Iron ore, coal, nickel and even gold and silver tended to move together. I attribute that to the amount of speculative money involved in commodity markets.

Today, that correlation is greatly reduced. For example, this year the nickel price has been extremely good due to the Indonesian export ban, but also because of extremely strong demand growth. On the other hand, while there’s still reasonable demand growth for iron ore, the increase in supply has been enough to send the price down. In the energy sector, the coal price is down very sharply and the uranium price has been really bad, while the oil price has been relatively stable and may even be improving.

TGR: With commodities going in different directions, how do you decide what goes in the Special Situations Fund?

PR: The Special Situations Fund tends to invest in early-stage companies, which makes it hard to invest for the short term. Sometimes, you have a chance to take profits more quickly than you might expect, but you have to invest with the expectation that you’ll be in it for the long term. Therefore, we look for long-term structural factors.

Victoria Gold Corp.’s Dublin Gulch area could easily hold in excess of 10 Moz gold.

Among the metals, we particularly like zinc and nickel going forward. Both have positive demand profiles, with nickel being the stronger of the two. Both also are in short supply. The Indonesian export ban is hurting the nickel supply. Three big zinc mines will close between now and 2016.

We’re less positive on copper and have much less exposure there. On the precious metals side, we have exposure to gold and silver, with the emphasis on gold. In the energy sector, we have quite a lot of exposure to oil, some exposure to uranium and very little exposure to coal.

Largo Resources Ltd. should be generating $100M in annual cash flow by 2016, which makes it extremely cheap right now.

TGR: A quarter of your fund is in industrial and base metals. Given the impact of the Indonesian export ban on supply, what’s the best way to get exposure to the nickel market?

PR: There are few quality nickel plays. Royal Nickel Corp. (RNX:TSX) appears to tick all the boxes. Its Dumont nickel deposit in Québec is close to good infrastructure: paved roads, rail, power and a couple of small cities to provide a work force. Dumont is one of the top three undeveloped nickel sulfide deposits in the world. At current nickel prices, its net present value (NPV) is about $1.1 billion ($1.1B), while its market capitalization is only around $70 million ($70M). We expect the nickel price to go higher, so its $1.1B NPV will likely rise again. The company estimates that each $1 per pound on the nickel price adds $500M to the NPV, so the sensitivity is huge.

Royal Nickel is very cheap for a project at the last stage of predevelopment. It has a bankable feasibility study. And although it needs final environmental permitting, the Québec government is being very supportive, so we don’t expect problems there.

The company is looking for a strategic partner to develop Dumont, and we think it has every chance of success, given what’s happened in the nickel market.

TGR: The market seems to like it. The price is way up from January and the company just released Q1/14 results. Does the company have enough money in the bank to move forward until it finds a partner?

PR: Yes, it has enough money to continue through 2015. I expect it will soon have an industrial partner in place. The company has publicly stated that it is having material conversations with more than one party.

TGR: Your preference for zinc is based on the dwindling supply story. What companies do you like there?

PR: Our biggest holding is Trevali Mining Corp. (TV:TSX; TREVF:OTCQX; TV:BVL). The company has a project in New Brunswick, Canada, and is just bringing a project in Peru into production.

TGR: Trevali just reported some drill results. Did they meet your expectations?

Both of Trevali Mining Corp.’s projects are commercially viable.

PR: Yes. Both deposits are commercially viable. I think the gearing to the zinc price is pretty high.

For this investment to work, we need to be correct about the zinc price. Zinc is currently a little over $0.90/pound. Assuming the price heads north of $1, as we expect, Trevali will do very well.

TGR: You also have some holdings in vanadium. What’s the supply-and-demand story there?

PR: Vanadium has two main potential demand factors. The first, and most immediate, is in steel. Since the Chinese earthquakes, for example, the need for vanadium for building earthquake-proof structures has become very important there. As an alloy, it’s also used in automobile and aircraft production, to reduce the weight of vehicles and planes. Longer term, vanadium will play a role in storage batteries. That could create a quantum leap in demand.

The total world supply market is about 127,000 tons (127 Kt). Demand exceeds that slightly, at 136 Kt. Supply is concentrated in China, South Africa and Russia, with China being the biggest producer.

Largo Resources Ltd. (LGO:TSX.V) is about to commission a new vanadium production facility in Brazil, which will be a welcome addition to global supply.

Vanadium pricing has been weak for some time. With restricted supply and a structural long-term upshift in demand, we expect vanadium pricing to improve over the next couple of years. Largo offers a cheap entry into vanadium.

TGR: When will Largo’s Maracas project be in production?

PR: It’s ramping up right now, and I expect it to be running at full production by the end of June. This company should be generating around $100M in annual cash flow by 2016, which makes Largo extremely cheap right now.

TGR: What companies do you like in the gold space?

PR: One of our main holdings is Victoria Gold Corp. (VIT:TSX.V), which has a deposit called Dublin Gulch. The main drilled-out portion of Dublin Gulch is the Eagle deposit — the most advanced gold project in the Yukon. It has reserves of 2.3 million ounces (2.3 Moz) and a resource close to 5 Moz. In our view, the Dublin Gulch area could easily hold in excess of 10 Moz. The company has a full bankable feasibility study for a project with an NPV of about $1.2B and a strong internal rate of return.

For this to succeed, one needs a rising gold price. For people who expect gold to remain at current levels, this might not be a compelling story. But for those who believe in higher gold prices — as we do over the next couple of years — Victoria Gold is very cheap now.

The company is at the end of the predevelopment process. While it needs to get financing in place, a rising gold price would facilitate that. The current market capitalization is only $42M. It has nearly that same amount in cash. That puts the enterprise value at around $10M. Once the financing is in place, I expect this story to do very well.

TGR: Some of the experts we’ve talked to hold that developers are in a better situation than the producers right now, because developers can wait until the gold price goes up before selling their resource. When will Victoria be in production, and will that coincide with a higher gold price?

PR: That’s a good question. I believe the answer is yes. The company sold some properties in Nevada, so it is sitting on a cash pile and can afford to wait several years before building, if necessary. Victoria Gold will get a partner or it will self-finance. It can afford to choose its time.

TGR: Endeavour Mining Corp. (EDV:TSX; EVR:ASX) just released its Q1/14 results. Is it positioned to survive long term?

PR: Endeavour is a producer in the process of ramping up. Its 2014 production guidance exceeds 400,000 ounces, which makes it a decent midsized producer. Its cost is just below $1,000/ounce ($1,000/oz). At that level, it is profitable with gold at the $1,280/oz level, but clearly, it has a high enough cost that it will be leveraged to any increase in the gold price.

Endeavor looks pretty cheap on a forward valuation that assumes a rising gold price. People really don’t buy gold stocks assuming a falling gold price. In their own way, both Endeavour (an established producer) and Victoria Gold (a proven deposit in a safe jurisdiction) give very good leverage to a rising gold price.

This is a great time for investors to take an interest in companies like Largo and Endeavor. Both have big projects that are now coming to the point of reality. One can buy in at share prices that are cheaper than they were a few years ago.

TGR: About 44% of the fund is in the oil and gas sector. What supply-and-demand fundamental for oil appeals to you?

PR: To some extent, our exposure is due to the return/risk profile on the individual stocks.

What is interesting about oil is the steadily rising demand, which now exceeds 90 million barrels per day (90 MMbbl/d). Of that, demand from the Organisation for Economic Co-operation and Development (OECD) region — meaning North America, Europe and Japan — accounts for only 37 MMbbl/d. The balance of 53 MMbbl/d is demand from non-OECD regions. This is a huge change from 20 years ago, when the OECD was the only important demand source for oil. While demand for oil from the OECD area has declined from 42 MMbbl/d since 2007, demand for oil from the rest of the world has grown. That growth has offset some of the decrease in OECD demand. If demand in both areas were to increase in tandem, we should see an increase in demand overall.

On the supply side, although there are some increases in supply coming through, we think shale oil production from the U.S. will not exceed 4 MMbbl/d, given that shale oil fields tend to decline at a faster rate than traditional oil fields.

In a nutshell, one could say while demand is likely to continue to grow, the same is not true with supply.

There could be price wobbles. Ramped-up production in Libya or more onstream production in Iraq might depress the oil price. Longer term, we think the oil price should do very well.

TGR: Are you worried about the Ukraine situation?

PR: Not very worried, but if something went wrong, it would only increase the pressure on oil supply.

TGR: What companies do you like in the oil and gas space?

PR: In the Special Situations Fund, we have big positions in Falkland Oil and Gas Ltd. (FOGL:AIM) andMadagascar Oil Ltd. (MOIL:LSE), and a smaller position in Bahamas Petroleum Co. Plc (BPC:LSE). All three offer large upside prospects without too much downside risk.

RAB Capital also hosts the Redstream Fund, which invests in a lot of upstream oil companies.

TGR: Falkland recently acquired Desire Petroleum Plc (DES:LSE). Did that diversify its chances of finding oil?

PR: Broadly speaking, yes. A proven oil field in the north of the Falklands called Sea Lion is being brought into production by a consortium of Premier Oil Plc (PMO:LSE) and Rockhopper Exploration Plc (RKH:LSE). Falkland Oil has 40% of the licensed area surrounding Sea Lion.

We think, on three wells that are planned at Sea Lion for 2015, Falkland’s share of the oil from the properties it acquired from Desire Petroleum could be equivalent to 200 million barrels. It also has its original properties on the south side of the Falkland Islands, which are bigger prospects.

In the north, Falkland Oil is drilling in a known geology alongside an existing oil field. In the south, quite a lot of work has been done, so it’s not complete wildcatting, although the risk is higher. In total, we believe that Falkland Oil is likely to get at least a couple hundred million barrels from the safer drilling prospects and the possibility of 1–2 billion barrels (1–2 Bbbl) from higher-risk drilling prospects and bigger targets.

TGR: Does the election of a new Bahamian government mean it will be easier for Bahamas Petroleum to get licenses to drill?

PR: We think so, yes. We believe the prime minister supports drilling as an opportunity for the nation. The company has some very big fold-belt structures, which it intends to drill and is looking for drilling partners right now.

TGR: When might drilling start?

PR: It depends on the farm-in negotiations, but we think it’s quite likely that both Falkland Oil and Bahamas Petroleum will be drilling in 2015.

TGR: Madagascar Oil Ltd. recently reported pilot test results from the Tsimiroro field in Madagascar. Were you happy with those results?

PR: Yes. Independent experts put the field at 1.7 Bbbl. We’ve seen some estimates that the field could extend as high as 3 Bbbl. It’s a big field, but the oil is low quality. So, the flow tests are very important.

The company has declared the field to be commercial. It is likely to do up to 75,000 barrels in sales on a test run in the local market. The heavy fuel oil it produces is very suitable for use in local power stations.

This is a low-grade oil, which will undoubtedly sell at a discount to the world benchmarks, but there’s an awful lot of it, and it can be cracked and upgraded. Also, it is low in impurities such as sulfur, which makes it attractive to most refineries.

TGR: Many of the companies in your portfolio operate in Canada. How much weight do you give geopolitical risk versus commodity fundamentals?

PR: Canada is well represented, but we’ve also talked about companies operating in the Falkland Islands and Bahamas. Endeavour is mostly in Africa.

Geopolitical risk is important. We prefer companies that are operating in a Western jurisdiction or a jurisdiction in Africa that has proven itself to be reliable. We have found it difficult to protect shareholders’ interests in companies in the ex-Soviet Union countries.

TGR: You ended your last update by saying you were positive on the structural and long-term prospects of natural resources throughout 2014. How positive are you? When you get excited about a sector, how do you adjust your portfolio based on those predictions, given your long-term approach?

PR: We’ve said that structurally, we think oil, nickel, zinc and vanadium will be good. We’re also pretty happy about gold and silver.

Iron ore, which we have liked in the past, has shocked us with excess supply. We were surprised by the relentless ramp-up of companies like Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) and Fortescue Metals Group Ltd. (FMG:ASX). We are concerned that supply is a bit too strong in iron ore. As to copper, although there’s no particular player to point at, supply seems to be coming on.

Overall, we think natural resources will be a better place to be than in recent years. But remember, the correlation between different natural resources is breaking down. One has to pick and choose the commodity more carefully than perhaps one did in the big boom of six years ago.

TGR: Philip, thank you for your time and your insights.


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1) JT Long conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining 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: Largo Resources Ltd., Trevali Mining Corp., Victoria Gold Corp. and Royal Nickel Corp. Streetwise Reports does not accept stock in exchange for its services.
3) Philip Richards: Either the fund or I have positions in all the companies discussed. 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 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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