Juniors Operating from the Driver’s Seat: Adrian Day

Adrian Day has spent years making money for clients by steering them into and out of positions in precious metals equities. While higher commodity prices are always welcome, the founder of Adrian Day Asset Management says in this interview withThe Gold Report that he maneuvers toward more telltale fundamentals like strong balance sheets and sound business plans. He believes investors should shift toward companies helmed by experienced managers with skin in the game and with exceptional projects, and names a handful that fit the bill.

The Gold Report: In an interview with The Gold Report after the March Prospectors & Developers Association of Canada convention, you said that gold had bottomed and that it would be a mistake to sell it too soon. Since then the ongoing situation in the Ukraine and mixed buying and selling news from China has further blurred the gold picture. What is your near-term forecast for gold?

Adrian Day: When you have a market that’s declined the way gold has, it would be a mistake to imagine that it’s going to bounce back quickly. There’s little question that gold has bottomed. I think we’re going to see higher prices for the rest of the year.

TGR: Gold fell back in late March. What was behind that?

AD: Two major items hurt gold in March. One was the Chinese economy. The manufacturing and export numbers have not been good. History tells us that recessions are bad for gold and if the Chinese economy went into a recession that would have a negative impact on gold.

The second item was concern over monetary tightening, particularly in the United States. U.S. Federal Reserve Chairman Janet Yellen initially made statements that focused on ending additional bond buying. That set a negative tone. More recently she and other Fed people have made it clear that monetary policy is going to remain easy for some time.

I think the market grossly overacted. China is still growing at over 7% a year with under 2% inflation. That’s real growth of more than 5%. Frankly, it’s not that much different from when China was growing at 10% with 5% inflation.

TGR: What’s the trade in gold now?

AD: At the early stage of a bull market or a recovery from a correction, we tend to see everything move. But the senior miners go first for obvious reasons: they have more liquidity and the names are well known. We saw that in the rally from December through March when even names like Barrick Gold Corp. (ABX:TSX; ABX:NYSE) and Kinross Gold Corp. (K:TSX; KGC:NYSE) moved up.

Frankly, we can talk about everything that’s wrong with the senior miners but they’re very cheap and they’re the ones producing. If the gold price moves up, the companies that actually produce gold should move up too.

TGR: What is your prognosis for investors in the junior gold sector?

AD: In May or June we’ll probably see gold move up to $1,350–1,370 per ounce ($1,370/oz) and I suspect we will begin to see some of the juniors move up more. The juniors move more rapidly as a recovery develops.

TGR: With so many juniors out there, where should investors focus?

AD: Investors should focus on companies that have good balance sheets because that enables them to move ahead with their plans without excessive dilution. They should also look for projects that could potentially be taken over. The senior gold producers are hungry for both reserves and mines. We’ve seen this recently with the takeover of Osisko Mining Corp. If you’re Barrick producing 7 million ounces a year (7 Moz/year), that means each year you have to find another 7 Moz. That’s difficult. Juniors and exploration companies with coveted assets will be in the driver’s seat.

TGR: Investors want to know how they should manage their gold portfolios through the summer months. Refresh? Reload? Rebalance? What’s your advice?

AD: A little bit of everything. If there are stocks that have moved ahead of themselves, it would be a good idea to sell them and raise the cash for any additional market weakness, which I would expect to see over the summer.

Another strategy, unless you are trading in an individual retirement account, is the opportunity to take tax losses. That’s always a sound tactic in the gold space.

TGR: Adrian Day Asset Management (ADAM) has had some success with the prospect generator model. These companies find economic deposits and then bring in partners to help or fully fund further exploration. Is that the biggest asset of these companies?

AD: Prospect generators’ biggest asset is their ability to preserve their balance sheet. The average exploration company has to spend a lot of money to find economic deposits. By its nature an exploration company constantly has to go to the market to raise more capital. The prospect generator model obviates that huge downside by using other people’s money. The other big asset prospect generation gives these companies is exposure to multiple mining projects. A lot of exploration companies might only be able to drill one or two projects at a time. While the majority of a project likely belongs to someone else, some of these prospect generators have 5 or even 10 drill programs going on at the same time using other people’s money. If investors buy a basket of prospect generators, they are getting exposed to perhaps 60 or 70 drill plays, which is a good thing.

TGR: Please tell us about some prospect generators that you’re following and may even be buying.

AD: There are several but my favorite remains Virginia Mines Inc. (VGQ:TSX). In its early days Virginia was more of a pure prospect generator, but its main asset today is a royalty on Éléonore, Goldcorp Inc.’s (G:TSX; GG:NYSE) next gold mine, which should start up by Q4/14. Virginia was one of the few gold stocks that went up last year and the year before. But it’s down this year. It’s down because there’s a misunderstanding of an Éléonore technical report from Goldcorp. NI 43-101 rules allow companies to include only reserves. That means Goldcorp must exclude over half the resource and high confidence resources from that study. Goldcorp has continued to emphasize, however, that this is a long-life, robust mine that will operate for at least 20 years. And Goldcorp is continuing to drill.

TGR: The Éléonore royalty is considered one of the best royalties held by a junior. Virginia recently bought another small royalty, too.

AD: Virginia is buying little royalties all the time. It did another deal last year with TerraX Minerals Inc. (TXR:TSX.V; TXO:FSE). Virginia is always looking for projects that can enhance value. It has over $40 million ($40M) in cash—it’s in the driver’s seat. I would use the price decline as an opportunity to buy.

Another prospect generator is Almaden Minerals Ltd. (AMM:TSX; AAU:NYSE). I think it’s a good price right now. The company’s key asset is the Ixtaca gold-silver deposit in Mexico, where Almaden decided to go it alone. It just released a preliminary economic assessment (PEA), and a PEA can include resources, whereas a feasibility study or technical report, such as Goldcorp’s on Éléonore, can include only reserves. These are high confidence resources—about 85% is in the Measured and Indicated category.

Almaden has completed all its infill drilling, so it could likely convert much of the resource to reserves without additional drilling. Ixtaca is a low-grade, bulk-tonnage project with good infrastructure and lots more drill targets around. It has a reasonably high capex for the size of the deposit but Almaden isn’t in the business of building mines.

TGR: Almaden’s share price was once above $3. Now it’s well below $2.

AD: The stock went way above where it should have. Stocks tend to overrun on the downside just as they overrun on the upside. Almaden has continued to drill that project for the last year or so with excellent results, but it’s been a bit of a yawn for the market. The market has almost come to expect good results.

TGR: What’s going to push the stock back above $2?

AD: Good question. Over the next 12 months Almaden can complete a prefeasibility without spending much money. That’s normally a very weak period for a stock. It is going to continue to drill other targets and if it makes another discovery on a nearby target, I think that changes the picture. Almaden has $12M, $2.5M in gold bullion, plus$6–7M in shares of juniors. Almaden also has Duane and Morgan Poliquin—the father and son team that runs it. They’re two of the best people in the business.

TGR: Perhaps one more prospect generator?

AD: One we’ve been buying recently is Riverside Resources Inc. (RRI:TSX). Riverside remains a pure prospect generator. The company does both traditional joint ventures and strategic alliances, a sort of twist on a traditional joint venture. Riverside has alliances with Antofagasta Plc (ANTO:LSE) and Hochschild Mining Plc (HOC:LSE). Riverside works mostly in Mexico, but also in British Columbia and the U.S. Again, it has about $9.5M, plus $3M in equity from other juniors. The key to Riverside is the activity. It will launch at least three drill programs this year, with more than $6M being spent by its partners.

TGR: Would you say that Tajitos or Penoles is Riverside’s flagship asset?

AD: I’m not really buying Riverside for any one project. To me that’s the beauty of a pure prospect generator. With Virginia the royalty is the number one asset. With AlmadenIxtaca is its number one project. With Riverside and with other prospect generators that we own, we can’t really say what their key projects are because over the last five years those key projects have often changed.

TGR: Royalties are another staple of ADAM’s gold portfolios. You stick mostly with large royalty equities like Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) and Royal Gold Inc. (RGLD:NASDAQ; RGL:TSX). Are there some small-cap royalty equities that you’re buying?

AD: We largely stick with the larger ones because if you have a lot of money to put to work you go to the big-cap names first. If I could only pick one gold stock I would pick Franco-Nevada. That’s a cornerstone of a portfolio. The reason I like royalty equities is the same reason I like the prospect generator model—it minimizes risk and the upside takes care of itself.

One of the smaller ones I like a lot is Gold Royalties Corp. (GRO:TSX.V). That’s a $6M company. I should point out that ADAM is a 10% owner.

Gold Royalties now has 20 royalties after acquiring a package of Québec royalties, one of which is perhaps three or four years from production. The company received its first royalty payment earlier in the year from Metanor Resources Inc.’s (MTO:TSX.V) Bachelor Lake gold mine. It might appear that Gold Royalties doesn’t have a great balance sheet—about $500,000—but it has an extremely low burn rate. Gold Royalties believes it can raise money when there is something to buy. Gold Royalties has come to me twice saying, “We want to buy this and we’re raising some money.” I like that concept. The stock has declined significantly in the last month. This is an incredible opportunity to buy it, but it is very thinly traded.

TGR: Another one?

AD: I like Callinan Royalties Corp. (CAA:TSX.V) a lot. The stock has a yield of 4.6%. Much of its cash flow is from HudBay Minerals Inc.’s (HBM:TSX; HBM:NYSE) 777 mine, which is a base metal mine near FlinFlon, Manitoba. The 777 mine is good for at least another eight years. President and CEO Roland Butler is an extremely good steward of other people’s money. Butler is Callinan’s largest shareholder and I always like to see management with strong positions. Butler thinks most royalties for sale are overpriced because there’s a lot of competition. He’s taken the unique approach of trying to generate royalties through exploration alliances with prospect generators. For example, he did an exploration alliance with Evrim Resources Corp. (EVM:TSX.V) in Mexico. Evrim is another one of my favorite prospect generators, albeit a smaller one. Callinan has about $28M and is buying back shares.

TGR: You’re on a roll.

AD: Another is Solitario Exploration & Royalty Corp. (SLR:TSX). Solitario has three main assets. One is the majority-owned Mt. Hamilton gold project in Nevada. Money is being raised to put that into production. The second is the Bongará zinc project in Peru. There’s not a lot of a big zinc mines coming onstream over the next three or four years. Solitario is carried to production on Bongará but I would not be surprised if it converted its 30% interest to a royalty. The same goes for the joint-venture PedraBranca platinum-palladium project in Brazil with Anglo American Platinum Ltd. (AMS:JSE), the largest platinum producer in the world. Solitario is carried to production there, too, and if you’re a South African platinum producer with all the headaches in South Africa, you’re looking for platinum deposits elsewhere.

TGR: It’s noteworthy that you’re long on all these names.

AD: By nature I’m not a trader. I much prefer to find a really good company with good management and a good balance sheet that I can hold for many years. If investors have a really good position in Callinan, for example, and see the stock run up to $2.20, I have no objection with trimming a little—with the emphasis on “a little”—and then look to buy it back if it drops back to $1.80. These are definitely long-term positions; they’re investments, not trades.

TGR: What are some other well-funded juniors with promising projects that could warrant a long position?

AD: Mandalay Resources Corp. (MND:TSX). It’s traded on the Toronto Stock Exchange but it doesn’t have a high profile in North America. I think that’s one of the reasons the stock is so low. Mandalay has producing assets in Australia and near-term production assets in Chile, primarily gold and silver. It’s a $300M company that pays a 3.3% yield. It’s trading at $0.98 and I think it’s just a steal. We’re buying away on that one.

Another well-funded junior is Asanko Gold Inc. (AKG:TSX; AKG:NYSE.MKT), the former Keegan Resources. Asanko has a strong balance sheet, an experienced management team and a very large gold resource at its flagship Esaase gold project in Ghana, West Africa. Development is moving slowly but all the ingredients are there. To me, this is a long-term hold while Asanko develops Esaase and puts it into production.

Another company that has good funding is Rye Patch Gold Corp. (RPM:TSX.V; RPMGF:OTCQX). It has a good balance sheet and a royalty on Coeur Mining Inc.’s (CDM:TSX; CDE:NYSE) Rochester gold-silver mine in Nevada. Rye Patch can’t sell that royalty at the moment but it’s probably worth about $20M on its balance sheet. Rye Patch ended the year with about $8M. Basically, Rye Patch’s cash plus the value of the royalty equals the market cap. All the exploration that Rye Patch is doing—three exploration projects in Nevada—comes for free. That’s what I really like.

TGR: Parting thoughts for investors?

AD: If gold goes to $1,800/oz, Barrick, Kinross, Newmont Mining Corp. (NEM:NYSE) and others are all going to do well. But until then you need to stick with companies that have good people, good balance sheets, and strong business plans. Stick with the best whether it’s the seniors, juniors or exploration companies. Don’t be too quick to take profits, but keep an eye on companies that deviate from their business plan.

TGR: Adrian, thank you for your insights.

Adrian Day, London born and a graduate of the London School of Economics, heads the eponymous money management firm Adrian Day Asset Management (www.adriandayassetmanagement.com; 410-224-2037), where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the new EuroPacific Gold Fund (EPGFX). His latest book is “Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks.”

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DISCLOSURE: 
1) Brian Sylvester 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 independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Virginia Mines Inc., Almaden Minerals Ltd., Metanor Resources Inc., Mandalay Resources Corp. and Rye Patch Gold Corp. Goldcorp Inc. and Franco-Nevada Corp. are not affiliated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Adrian Day: I own or my family owns shares of the following companies mentioned in this interview: Franco-Nevada Corp., Goldcorp Inc., Royal Gold Inc. and Virginia Mines Inc. Clients of Adrian Day Asset Management own shares in all companies recommended in this report. 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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