Investing in Junior Mining Companies

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Investing In Junior Mining Companies
Part I of an Interview with Marshall Auerback
~ By Kevin Michael Grace, December 23rd, 2010

Marshall Auerback is Director of and Corporate Spokesperson for Pinetree Q: What would you say best characterizes good management?
Capital Ltd, a Toronto-headquartered diversified investment, financial
advisory and merchant banking firm focused on investing in early stage A: For the most part, mining companies tend to be run by geologists and
micro and small-cap resource companies. Pinetree, which has a market mining engineers, so they always think of drilling holes, and when you ask
cap of $475 million, is invested primarily in Uranium and Coal, Oil & Gas, them about return on capital, return on equity, these are foreign concepts
Precious Metals, Potash, Lithium and Rare Earths and Base Metals. Mr to them. So we like the idea of a guy who has some idea of internal disci-
Auerback was previously an advisor to a number of fund management plines, where they actually look at hurdle rates, returns on capital, returns
organizations, such as PIMCO, the world’s largest bond fund management on equity. When they think in those terms they’re more likely to be able to
group, RAB Capital and David W. Tice & Associates. He has a BA from exploit a resource intelligently rather than where they say, it’s great, but
Queen’s University and a law degree from Corpus Christi College, Oxford. we need x prices to make money. We want to know they can make money
when copper’s at two bucks, as well as when it’s at four bucks. You’d be
amazed at how few people look at this.

Take the large gold companies, for example. Over the last several years, if
you look at what the gold price has done, and you look at their profitability,
for the most part they haven’t done a particularly good job of generating
profits. They always have an excuse: labour costs, transportation costs, or
our hedging strategy didn’t work. If you contrast a Newmont or a Goldcorp
with a BHP or a Rio Tinto, I think the consolidated base metal groups
have actually done a much better job of instituting internal disciplines, and
they’re much better run companies as a result. This is what you try to find
on a micro level.

Q: Geologists sometimes seem to take the attitude that companies
come and companies go, but we’ll always be here, drilling holes.
Q: What does Pinetree look for in junior mining companies?
A: That’s 100% right, and it drives me crazy. That deposit in the ground
A: The first thing we want to look at is to make sure the company has a might always be there, but the company itself might not always be there.
decent asset. We want to make sure that there’s actually something there, The more successful companies tend to be those run by businessmen
that you’re not dealing with a totally speculative situation. Married to that, who are not necessarily married to the mining business. To give you an
there has to be a good management team. We tend to back the jockeys example, Robert de Crespigny, who established one of Australia’s largest
that have had success in the races before. Obviously, we tend to start with gold companies, was trained as a lawyer, and I think that was a plus.
companies when they’re fairly small, and we do take a proactive approach
in terms of providing inputs on management development strategies. I’ll give you another illustration. In the early 2000s, I was working with a
We’re not micromanaging the companies, but clearly we’ve seen what company, and I said you’ve got a really good deposit, but it’s not making
works and what doesn’t work, so we like to think that our inputs are very any kind of real money at $300 or $325 an ounce gold. Your deposit is go-
beneficial. And clearly, you want also to have a smart guy at the top run- ing to have value on a long-dated call-option basis, but what do you need
ning the thing, because even a good asset can be run into the ground. to do to retain your essential staff and stop drilling for the next several
months to safeguard it enough to keep the deposit on care and main-
Q: Everyone says that finding companies with good management is tenance until times get better. And most of the people at that company
key to success, but isn’t that not as easy as it sounds? looked at us like, “But that’s not what we do with our money. If we get
money, we drill.” And I’d say, why do you want to drill it now when you’re
A: I agree with you, but I’ve been involved in the mining business in one losing money, and you’re not going to be able to exploit the reserve to its
form or another for over 25 years, and one is always struck by how many maximum potential anyway? But they never really quite got that.
of the same charlatans, crooks and promoters reappear in every single
cycle. It’s a pretty small world. But usually if you’re well-plugged into the Q: Wouldn’t you say that given the consolidation with the TSX
network, you get a good sense fairly early on who’s good and who’s not and the NI 43-101 protocols, the mining business in Canada is no
good. longer the Wild West we once associated with the Vancouver Stock
Exchange?
Q: So you look at what the principals have done in the past?
A: I think that’s true. There’s been a serious effort to make the exchanges
A: Absolutely. We know that in portfolio management they say past perfor- much more compliant with conventional regulation. We don’t think Vancou-
mance is no guarantee of future performance, but it’s a helpful signpost. ver is the cowboy market it used to be, but we think it still has an extremely
valuable role in helping to develop a lot of these small caps. We think the
Q: You interview the management? consolidation with the TSX has helped. In the aftermath of Bre-X there was
a sense you have to tighten this thing up. I can tell you from the people we
A: Oh yeah, and we also look at the asset itself. We have very qualified deal with, there are so many more compliance forms you have to fill in and
technical people who will go down there and determine whether yes, this regulatory hurdles than there used to be, and that’s not a bad thing. It’s
is for real, or no, this is, to quote Mark Twain, a hole in the ground with a definitely changed for the better. There’s still maybe the odd fraud lurking
liar on top. You’ve got to be able to make the technical assessment, but out there—there is in any business—but it’s come miles from where it was
the second stage obviously is to have a team in place that actually knows 15, 20 or 30 years ago.
how to exploit the asset sensibly.

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The Prospects For Gold, Silver and Base Metals
Part II of an Interview with Marshall Auerback
~ By Kevin Michael Grace, December 30th, 2010

Marshall Auerback is Director of and Corporate Spokesperson for Pinetree because of this supply shock and this capital-market shock the capacity
Capital Ltd, a Toronto-headquartered diversified investment, financial advi- hasn’t yet come onstream. That’s not likely to happen for another year or
sory and merchant banking firm focused on investing in early stage micro two.
and small-cap resource companies. Pinetree, which has a market cap of
$475 million, is invested primarily in Uranium and Coal, Oil & Gas, Precious Q: It’s been said that gold and silver are no longer traditional com-
Metals, Potash, Lithium and Rare Earths and Base Metals. Mr Auerback modities because they have become alternate currencies. What do
was previously an advisor to a number of fund management organizations, you think?
such as PIMCO, the world’s largest bond fund management group, RAB
Capital and David W. Tice & Associates. He has a BA from Queen’s Univer- A: I think there’s something to be said for that, but I don’t think we’re ever
sity and a law degree from Corpus Christi College, Oxford. going to go back to a gold standard. I’ve now been in the investment
business for 28 years, and this is first time I can recall that you really can’t
Q: Where do you see the prices of gold and silver going? make a compelling case for any paper currency. Maybe the Norwegian
krone or the Canadian or Australian dollar. But Japan is mired in debt and
A: I’ve been on record as saying we could easily see $3,000 or $4,000 an has a serious deflationary problem; the US, we all know what their prob-
ounce in gold. If we have this continued credit and monetary dysfunction lems are; with the Eurozone, for the first time in history you have a cur-
for several years to come, and if we then have an inflationary blow-off– rency union where the very existence of the currency is now perceived by
which is probably how this endgame finishes–that’s when you get your some to be under threat. In that sort of environment gold is viewed as an
final push to the $3,000, maybe $4,000 level. insurance policy, and that is a vote of no-confidence in the official sector. I
think that the notion of the omniscient and all-powerful central banking elite
Q: Silver has had an extraordinary run this year. Do you think the has gone by the wayside.
gold-silver price ratio has been out of whack, and we can continue to
expect better gains from silver?

“
A: It’s up 82%, while gold is up only about 29%. If you look at the historic Gold is viewed as an insurance
relationship, the ratio got down to 20 to 1, while at its peak it was as high
80 to 1. You can probably expect a lot more outperformance with silver. policy, and that is a vote of no-
Q: Junior miners actually produce wealth; they don’t just push paper confidence in the official sector
back and forth like the Wall Street companies that caused the 2008 -Marshall Auerback
crash. To what extent do you think this will protect their stocks in the
coming economic shakeout?

A: You’re right; they do produce something, and it’s a finite product, as op- I don’t think gold’s rise is an inflation-deflation story yet. But if this massive
posed to infinite paper. So there is real value in what they do. On the other stimulus continues and starts to generate production bottlenecks, higher-
hand, when there’s total dysfunction in the credit markets that obviously capacity utilization, fuller employment, etc, at that point you might see gold
hurts them because they are all very capital-intensive companies. So they revert to its tradition of an inflation hedge.
are all still dependent on a properly-functioning credit market.
Q: Where do you see base metals going?
In 2009, when the junior mining companies got completely bombed,
people said this is crazy, they’ve got huge amounts of cash on their bal- A: I think we’re at a stage now where you have to be a little more selective.
ance sheets, and they’ve got these great deposits. And I would say, yeah, I know some people are very bullish on copper. I personally am a little
but the cash is more apparent than real. It’s something they’re going to more cautious, because I think what happened is that you’ve got a cartel-
have to run down; and if they don’t secure additional capital funding, then like structure in place which has helped to keep prices under control. We
clearly they won’t be able to produce the assets. They’re not going to be also like uranium; we think it has the best supply-demand characteristics.
able to monetize, which is ultimately what you want them to do. I think
the distinction you make is important but subject to the overriding proviso Q: How important is China’s role in base metals?
that we have a credit system that doesn`t completely fall apart, as it did in
2008. A: It’s very important, and that’s another thing we’ll have to keep monitor-
ing. We take a very simple view—you’ve got 2.5 billion in people in Asia,
Q: The number and the dollar values of private placements and and they’re getting wealthier, and they will consume more. I think that’s the
bought-deals have exploded since the summer. case for the structural bull market, and I don’t think you see that changing
for the next several years. But you will have hiccups. China is now going
A: That’s a function of the fact that the capital markets have begun to through a serious inflationary problem that’s starting to get out of control.
normalize. That’s why I think this commodities cycle might be perpetuated The official numbers are about 5.1% inflation, but everyone knows the
a big longer than people think, because the way that it normally works is real numbers are closer to 10% or 15%. If that continues, the Chinese
that you get higher prices, and then people start supplying a lot of capacity authorities will ultimately respond by tightening credit conditions, and
in response to those higher prices, and then you get a demand shock, and they will probably overtighten, because when you’ve got inflation firmly
then of course you get overcapacity and then prices go down, capacity is embedded in the system you’ve almost got to go to the other extreme.
cut back. But it didn’t happen that way this time. We were just starting to So that could create a short-term growth shock which would create some
ramp up capacity when we had the Lehman shock. So we didn’t have so short-term issues in commodities. I don’t know whether this will happen in
much of a demand shock as we had a supply shock, and now what’s hap- 2011 or 2012, but I do see it as a real risk from a tactical, as opposed to a
pening is that demand is beginning to normalize and increase again, but strategic, standpoint.


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The Prospects For Economic Recovery
Part III of an Interview with Marshall Auerback
~ By Kevin Michael Grace, January 5th, 2011

Marshall Auerback is Director of and Corporate Spokesperson for Pinetree A: Hopefully, they’ll come to their senses and work out some sort of re-
Capital Ltd, a Toronto-headquartered diversified investment, financial structuring along the lines of what you had in Uruguay or New York City in
advisory and merchant banking firm focused on investing in early stage the 1970s. You say, we’re going to extend maturities out 20 years and pay
micro and small-cap resource companies. Pinetree, which has a market a non-punitive interest rate.
cap of $475 million, is invested primarily in Uranium and Coal, Oil & Gas,
Precious Metals, Potash, Lithium and Rare Earths and Base Metals. Mr Q: How bad will the European fallout be?
Auerback was previously an advisor to a number of fund management
organizations, such as PIMCO, the world’s largest bond fund management A: If the crisis is restricted to, say, Portugal, Ireland and Greece, then it’s
group, RAB Capital and David W. Tice & Associates. He has a BA from not really much of a problem. If it starts to spread to Spain, then it will
Queen’s University and a law degree from Corpus Christi College, Oxford. spread to Italy and could ultimately spread to France. Then it could get
very, very serious in terms of impacting global growth. But with Greece,
Q: The EU has a monetary union but not a fiscal union. I always you’re talking about a place with a GDP not much bigger than Chicago.
thought this a non-starter, but it’s only recently the chickens have If the ECB backstops the bonds in the way they’ve been doing, they can
come home to roost. What do you think is going to happen? thereby ensure the overall solvency of the European monetary union.

A: I wrote a paper on this. It basically said this is a monetary-fiscal halfway Q: It has become a maxim that bad news in Europe is good news for
house, and it can’t work. You either go the full nine yards and have a America. But don’t we all live in a global economy?
United States of Europe, or you just break it up and go back to various
national currencies. The crisis is increasingly pushing these countries in A: You’re right. It’s good for America only to the extent that if the euro
the direction of more federalization and the establishment of a European- weakens, the dollar strengthens, which allegedly gives the Federal
wide bond market. That’s a proposal that’s been made by the European Reserve or the US Treasury more leeway to reflate. If the European crisis
Central Bank, even though it’s opposed by the Germans. That would give becomes serious enough, it affects everyone. When Lehman went bust,
the EU a quasi-federal fiscal function. When the ECB buys bonds in the it affected everyone because the credit channels are quite interconnected
secondary market it is in a sense doing this, so we are gradually moving in globally.
that direction.
Q: Do you see the Canadian and US economies diverging?

“
Currency devaluation A: They already are diverging, but this is a matter of degree. At the end of
the day for better or worse we will live and die with the US economy. If the
is a soft way out US were to double dip, which I don’t think is likely right now, but if it did,
then it would clearly impact Canada. Australia is booming right now, but
-Marshall Auerback that’s because it has essentially become China’s coal mine. So Australia
is leveraged to China in much the same way—maybe not to the same
degree—as Canada is to the US.

Q: There’s a rising feeling in Germany that they cannot serve end- Q: The Australian boom has occurred despite a soaring dollar, yet we
lessly as an ATM machine for the PIGS [Portugal, Ireland, Italy, still see the argument that Canada cannot afford dollar parity with the
Greece, Spain]. US.

A: What the Germans fail to realize that they’re in the same position. I’ve A: The argument is that a heavily export-dependent economy must remain
called the euro the roach motel, and Germany is in the penthouse suite. competitive by keeping its currency weaker, but of course if everyone
They have a slightly stronger balance sheet than the PIGS, but they’ve does this, it impoverishes everyone. The Germans, for example, have
all ceded their fiscal sovereignty because they’ve joined a supranational learned how to export with a much stronger currency. Currency devalua-
currency union. So if the periphery starts to implode, that’s going to af- tion is a soft way out that enables you to resist the harder decisions which
fect Germany’s ability to export to those countries. Their current account would improve productivity or profitability through other means. In a full-
will come under pressure; their growth will slow; their budget deficits will employment economy—and Canada’s not there yet—why would you want
rise; and they will experience many of the same problems of the outlying to export everything anyway? It seems to me the objective is to get the
countries. output consumed domestically.

Q: There was an alternative for Ireland—they could have left the euro. Q: Economic recovery is so dependent on China, but there are
serious questions about China. I recently wrote a story about rare
A: They could do that. Or they could choose the Iceland solution. They earths, and in the course of my research discovered there are major
could say, sorry, we can’t afford to back up our banking system anymore, rare-earth bootleg operations in China. What does this say about the
so the bond holders are going to have to take a haircut. Iceland effectively power of the central government there?
guaranteed deposits for Icelanders, but they didn’t extend it beyond that.
They devalued the kroner by about 75%, and now they’re growing again, A: If you go to Chinese provinces, you find that the Communist Party ex-
and unemployment is back down to 7%. The Irish are chasing their tails. erts relatively little centralized control. That’s the problem with their credit
They keep cutting their budget deficits and trying to cut spending, which system as well. The other problem is you’ve got these guys in the Army
aggravates an intensely deflationary spiral which is causing GDP to col- that run these little operations and are a law unto themselves. In China,
lapse, which causes their budget deficits to rise even further. we are not dealing with a classic liberal democracy, which is governed by
the rule of law, and that is another risk we have to be aware of in the long
Q: Is there a way out for Europe? term.


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