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Operating
out of Uruguay, Carlos Andres' Frontier Research Report provides a
vastly different perspective. In this exclusive interview with The Energy
Report, he gives us some insights on global mineral exploration and
production in areas that are more "out of the way" than what we
usually consider. He tells us about two very exciting companies with huge
investment potential in projects located in Namibia and Ethiopia.
Companies Mentioned: Allana Potash - Bannerman
Resources Ltd. - Extract Resources Ltd. - Forbes
& Manhattan
The Energy Report: Carlos, as publisher of the Frontier
Research Report based in Uruguay, you seek out attractive undervalued
situations in the metals mining area and in energy and agricultural minerals.
Can you explain your philosophy in making investment selections for the
portfolio that you follow?
Carlos Andres: Sure. We've chosen the junior exploration space because
we believe it gives investors the best bang for their buck. It's high risk
but it can also provide the highest imaginable returns. By investing in
well-researched companies, with strong management and highly prospective
projects, investors can make many multiples of their initial investments as
companies successfully transition from explorer through development to
producer.
However, we can dramatically reduce the risk involved without reducing the
upside by doing our homework. We apply our well-honed expertise and lengthy
experience to differentiate opportunities that may appear high risk on the
surface but actually have critical value drivers in their favor. With this in
mind, we target emerging and frontier markets because investors and analysts
tend to lack knowledge of or experience with these countries, and therefore
tend to associate fear and high risk with them. In contrast to this tendency,
refined expertise and experience can be the biggest differentiators in
clearing the fog of "perceived" risk in order to unearth overlooked
opportunities in these less traveled and less understood markets.
Emerging and frontier markets provide opportunities to buy high-quality
companies at a discount simply because of the "perceived" risk
factor. So we look at places such as Mongolia, which is a resource-rich
country that is just beginning to realize the benefits of 20 years of
liberalizing its markets. As a result, foreign direct investment has been
steadily increasing, the rich resource endowment is starting to be developed
and the country is experiencing historic economic growth. From a broader
perspective, there are emerging and frontier market economies in South
America, Southeast Asia and Africa with similar stories, although they all
have their own unique twists. Countries like Colombia, Peru, Chile, Brazil,
Guyana, Argentina, Ghana, Namibia, Tanzania, Botswana, Ethiopia, Indonesia,
Papua New Guinea and others all play an important role in meeting historic
and rapidly increasing global demand for natural resources.
TER: You live in Uruguay, which is a place most people have maybe
heard of but couldn't find on a map to save their lives.
CA: That's probably true. Many think it's a landlocked dictatorship in
South America. They have the South America part right. Still others boldly
identify it as a country in Southeast Asia. Yes, it's off the radar for most,
but a lovely place nonetheless.
TER: You obviously have a different perspective on viewing resource
companies and opportunities there versus somebody who does this from a nice
office in a high-rise building somewhere in the U.S. or Canada. Can you give
us a little perspective from your point of view and tell us what investors
there think if they're even involved in these kinds of investments?
CA: Sure. From a retail investor standpoint, I'm not sure how folks in
South America invest their money. But I do know that in terms of wealth
generation and economic growth, natural resources play a big role. How much
of the capital investment comes from South America itself and how much of it
comes from the major capital markets like Canada, London or Australia, I'm not
sure. But South American retail investment is growing and therefore
transaction and market cap levels in the local stock markets in places like
Peru, Colombia and Chile are growing. As a result, there are mergers in the
works between these exchanges to develop a world-class capital market in
South America, if that's any indicator. This is also prompting many
Canadian-, Australian- and London-listed miners to adopt local listings in
the South American countries in which they do business. This is a growing trend,
and companies often proudly report the percentage of their share ownership
that is local. Certainly the focus down here among the general population is
natural resources. That is how most wealth is generated, whether it's in
agriculture, forestry, mining, or oil and gas. It is a significant factor
here and there is an acceptance of it and orientation toward it.
TER: Rising prices and struggling economies are causing many countries
to rethink their tax and mineral royalty laws to increase their percentage
take of the commodities produced by private companies. How is this going to
affect companies developing new mines and producing from existing ones?
CA: Governments in countries that are rich in natural resources with
populations that may be relatively poor are going to look toward their
natural resource endowments to provide economic relief to their populations.
Natural resource extraction is often one of the bigger contributors to an
emerging country's economic growth. It's quite natural for governments to
look to it as a source of revenue and they are going to want a bigger piece
of the pie. The question is how far is the government going to take
it—either in the form of royalties against revenue or increasing income
taxes against company profits. A government can also take an ownership
interest in the company, which some do. Sometimes governments will pay for
this interest, thereby becoming a JV partner or sometimes they do not.
Depending on the details and the manner in which these reforms are introduced,
companies and foreign investment capital often successfully endure the
burden. However, in a worst case scenario,
governments can also outright nationalize a company and take it over. We've
seen this in Bolivia and Venezuela, for example, with another round of gold
mining nationalization on the horizon apparently, and South Africa is
threatening such legislation.
On the other hand, in Ghana, a very mining friendly country, it is required
by law that when you get your mining permit, 10% of the company will go to
the government for free. And it works very well because the government
approached the issue in a mature and transparent way in consultation with the
industry. Many of the gold majors profitably operate mines there and it is a
premier exploration destination in Africa. Ghana is the second largest gold
producer in Africa, behind South Africa. In addition, the government imposes
royalties on revenue and income taxes on profits.
So if an explorer or a producing major is assessing
various emerging or frontier markets, these are important considerations.
Typically, a happy medium can be found between the industry and constructive
governments seeking to increase the benefits to citizens from their natural
resource endowments. However, companies have to remain ever vigilant in
watching for changes in government attitudes. Reading the tea leaves is an
important skill set for mining managers.
TER: So, a risk factor component is incorporated into the prices of
many of these companies that have big operations in those areas. I guess
that's the price you have to pay if you want to play the game?
CA: That's right. It's part of the equation.
TER: There was quite a bit of controversy recently with the Australian
government wanting to raise taxes on the mining industry there. Will that
have an impact on future development?
CA: The Australian government at the time was led by Kevin Rudd, the
former prime minister—and he is the former
Prime Minister for a reason. He proposed a 40% super-profits tax on mining companies
across the board. It was done by surprise without consulting the industry at
all. The number appeared to be picked arbitrarily without taking into account
the profitability of Australia's mining sector or its ability to pay the tax.
Obviously, miners have varying ranges of profitability so some might be able
to pay it and some might not. The government just threw a big number out
there. It was a big and unnecessary risk politically and Kevin Rudd lost.
Mining companies got up in arms and the public was sober and rational enough
to recognize that the mining industry represents a
significant part of the Australian economy and a lot of jobs. Ultimately,
Kevin Rudd had to step down. The government has now gone into negotiations
with the big mining companies, which have acknowledged that they are willing
to pay some higher taxes, but it has to be done rationally and intelligently.
What has happened is, instead of extending to all mining companies in all
mineral sectors, now it seems to be focused on the bulk mining industries,
like coal and iron ore, but it likely won't affect
gold or silver mining companies and a lot of the mineral miners outside of
the bulk industrial commodity sphere. It also appears that the tax will be
less than 40% when implemented but it is still in negotiation. In the
meantime, mining and exploration in Australia continues.
TER: You follow at least a couple of companies in your portfolio in
the energy and mineral fields. One Australian name is Bannerman
Resources Ltd. (TSX:BAN; ASX:BMN), which is a uranium explorer and
developer with a big project in Namibia. How will the recent Chinese takeover
offer impact the company's prospects?
CA: We like Bannerman a lot. China has 26 nuclear power plants
currently under construction. Russia, South Korea and India have another 21
under construction between them. As a result, they are all shopping for a
stable supply of uranium. Namibia is one of the more stable uranium rich
countries in which to go shopping, to keep all these new reactors fed.
Namibia is home to the largest uranium mine in the world, the Rossing mine,
owned by Rio Tinto and is the fourth largest uranium producer. Currently, the
country only has two advanced-stage deposits. One is owned by Bannerman and
is known as the Etango project. The other is owned by Extract
Resources Ltd. (TSX:EXT; ASX:EXT). Both represent world-class deposits in
terms of size.
We like Namibia as a mining jurisdiction. It represents a somewhat mature and
stable mining friendly jurisdiction, despite the fact that it had a recent
hiccup where the minister of Mining and Energy proposed government ownership
of the country's mining licenses and the imposition of a super-profits tax.
But the uproar has calmed down as discussions have taken place and the
government has made it clear that it has no intention of killing the goose
that lays the golden eggs. So Namibia represents a fairly stable mining
jurisdiction. When the nuclear energy companies around the world go shopping
for sources of uranium for their power plants, they obviously want a stable
supply from jurisdictions that are outside geopolitical hotspots, which are
prevalent in the Northern Hemisphere at the moment. Of course, this isn't
always possible. For example, Kazakhstan is the largest uranium producer in
the world but hardly the most stable place to mine. It has evolved into that
position over the last few years.
In contrast, Namibia has been a stable mining jurisdiction for a long time.
So in this context, Bannerman has a very attractive established deposit where
it has defined 213 million pounds (Mlb.) of uranium. That's a lot of uranium
and it is currently selling in the spot market for about $50/pound (lb.).
This makes the resource worth $10 billion (B) while the company's current
market cap is $100 million (M) with about $20M in the bank. The mine may cost
$700M to build and it may need to come back to capital markets sometime next
year for more cash. However, Bannerman has a definitive feasibility study
that is due to be completed by the first quarter of
next year. A positive study will enhance shareholder value and set the stage
for a mine development decision and bank financing.
In this sense, Bannerman is extraordinarily cheap at current prices on an
enterprise value per pound basis and it will likely be taken over sooner or
later by someone. The company is in discussions with Indian, South Korean and
Russian groups in addition to the Chinese. The Chinese bid failed because
Bannerman decided that China was trying to take advantage of a weak market to get an extremely valuable resource for
almost nothing. Kudos to management for holding out. I hope it can continue
to hold out for a better offer. The one Achilles' heel is its low cash
position. But we feel that it could probably come back to the market and get
more cash if necessary given the high value that the project represents and
its advanced nature. The company also needs a $70/lb. uranium price to unlock
the true value of the project. Given the supply/demand picture shaping up in
the uranium market over the medium to long term, we suspect it will get it.
The price of uranium had just reached $70/lb. when Fukushima hit and that cut
it down to the $50/lb. range.
TER: Most of us know that the Chinese are out there trying to tie up
almost every available resource in the world that will supply them with raw
materials. What impact do you think that is having on resource investments in
general?
CA: That is a good question and it's an important one to contemplate
as an investor. Mining projects around the world are confronted by
governments that want a bigger piece of the pie and at worst might want to nationalize
their projects. In addition, big, state-owned enterprises coming from China,
India and others are looking to buy publicly traded mining companies
outright. Thus, capital coming from the main public natural resource markets
like Canada, the UK and Australia, has to compete with these forces around
the world.
It is impossible to say how this competition will play out in the end, but I
don't think state-owned enterprises and national governments can run Western
capital off the playing field because the mature natural resource markets in
the world are in the West. The expertise for finding these resource deposits
and defining, developing and operating mines actually rests in the West as
well. They need Western capital, expertise and technology to operate
effectively. So a balance will have to be found between the giant state-owned
enterprises from emerging countries like China and India, and Western
capital, technology and management. How it plays out in the end is anybody's
guess. But eventually market and geopolitical action will define the balance.
It's probably safe to assume that in meeting their resource needs, behemoths
like China and India will have to be content, at least to some extent, on
being customers rather than owners.
TER: Another area that is generating quite a bit of excitement because
of the growing need for food is the potash business, which produces
fertilizer. Can you give us a little background on what's going on there?
CA: Most people probably don't realize that the fertilizer used to
grow the food they eat does not come from animal manure; it is mined. There
is a complex of three minerals—nitrogen, potassium (potash) and
phosphorus—that makes up the bulk of fertilizers used around the world.
Potash, in particular, is interesting from a supply/demand perspective
because, in terms of production, it is the rarest of the three. It is also
bulk mined and, thus, is mined and priced by the ton. The commercially viable
and producing deposits are extremely deep—1,000 meters underground. So,
consider that this bulk-mined commodity has to be brought up from the depths
by the ton and shipped by the train carload. It is a
very capital intensive mining development enterprise compared to developing
your average gold mine. When you talk about developing a potash mine, we're
talking about $3B–$4B, whereas you can often develop an open-pit gold
mine for roughly $100M–$200M.
What is even more intriguing is that the world's potash supplies are highly
concentrated. You only have commercially viable potash deposits in 12
countries being produced by 13 companies, resulting in 80% of this bulky
product being exported for use in some 160 countries. So, you have very
constrained supply amidst broad global demand.
On the demand side of the equation, China and India have huge populations, in
case you didn't know. This requires them to tax their arable land very
heavily, hence creating a large and growing demand for potash. China is
planting much of its arable land three times a year
to meet rising food demand. That kind of activity strips the land bare of the
nutrients it needs, requiring heavy use of fertilizers such as potash. This
dynamic is playing out across Asia as its population increases, urbanization
continues, the middle-class grows, and incomes rise. One last piece of that
puzzle is the geography of potash supplies. Potash production is dominated by
Saskatchewan Canada; Russia; and Belarus. Belarus is right next door to its
dominant and overbearing neighbor, Russia. A vast majority of the world's
available potash comes from those sources alone. Think about the geopolitical
consequences of Russia and Canada controlling this critical agricultural
fertilizer. It makes for a very interesting story.
To make a long story longer, demand is rising dramatically,
led by Asia, and potash is an irreplaceable fertilizer. There is no
substitute. The majority of the world's potash is controlled by two
countries, and supplies, although voluminous underground, are costly to mine
and distribute. As a result, demand is rapidly outstripping supply, leading
to a dramatic rise in potash prices over the last few years. This creates an
opportunity to explore for and develop supplies that are both geographically
diversified and located at shallower depths, making them cheaper to mine.
TER: Well, if Canada ever goes Communist, we're in trouble.
CA: That's right. And, just to add a little to the drama, because
Belarus is in very deep economic trouble at the moment, Russia has taken a
huge interest in a state-owned potash company, Belaruskali. In order to
secure financing, Belarus has had to put up that company as collateral. So,
Russia now has its teeth in the Belarus supply as well. The price peaked in
2008 just before the global financial crisis at something like $1,000/ton,
where over the recent decade it had been $50–$200/ton. It has fallen
back down to $400–$500/ton. That price level now makes certain
locations or mines possible that weren't possible at lower prices. The higher
prices are driving potash exploration.
TER: What do you like there as an attractive investment opportunity?
CA: At the moment, we've recommended Allana
Potash (TSX.V:AAA; OTCQX:ALLRF). It represents a high-risk, yet potential
high-reward situation that is located in Ethiopia. This frontier market is
slowly opening its markets and stabilizing both economically and politically,
featuring a democratic government. In the process the country has become
mining-friendly and is experiencing historic economic growth. However, it is
early in its development and, therefore, still carries substantial
jurisdictional risk. What's exciting about Allana's Dallol deposit is that it
is massive in size, high grade and sits at very shallow depths in comparison
to the deposits in Saskatchewan or Russia. It is also attractive to China and
India because it is located outside of the geopolitical influence of Canada
and Russia. As a result of this and the fact that Ethiopia is rich in other
important resources, both China and India are very active there. They are
building out infrastructure to help stabilize the economy and promote its
growth in order to extract those resources securely.
Another interesting fact is that Allana is a Forbes
& Manhattan (F&M) deal. We didn't know that when we first began
looking at the company. F&M CEO Stan Bharti is a big driver behind the
development of the Dallol potash project. These folks are proven mine
developers. Allana has defined a huge resource that's open in all directions.
It's a promising project and the company has roughly $60M in cash headed by a
proven management team. There are two critical risks facing the project. One
is the country risk we just spoke of and the other is the very hot and remote
location of the deposit, where the lack of transportation infrastructure is
an issue. Product has to be shipped roughly 600 miles from the desert
valley-like location to get to the main port in Djibouti. Allana will
transport the potash by truck initially. What will really unlock value here
is the proposed railroad, which needs to find funding. The government of
Ethiopia is mining friendly and supportive of this project and the Chinese
and Indians have both pledged a great deal of money
to develop railroad infrastructure. The big question is: When will this
railroad development take place relative to Allana's potash mine development?
We are bullish on the company despite the risks mentioned. We believe the
strategic importance and location of the project, along with the deep pockets
and influence of the Chinese and the Indians, will go a long way to mitigate
risks.
TER: That's definitely one to keep our eyes on. The potential is
certainly big, and it sounds like a matter of timing and financing now. Do
you have any closing thoughts you'd like to leave with us?
CA: During a down market, we always encourage
investors to remember that to profit in the high-risk, high-reward
exploration space we have to buy low and sell high. Therefore, down markets
are our best friends. It allows us to purchase well-researched high-quality
companies at steeply discounted prices and this greatly reduces our risk.
Further, we believe uranium and potash are critical natural resources where
demand is rising faster than the ability of miners to supply it. Therefore,
these are good sectors in which to deploy capital at current prices. Of
course, this should be done with speculative capital only and no leverage so
that you have the staying power to wait for the trend to catch up.
On the supply front, all mining is capital intensive. It takes a long time, in terms of years, and a lot of expertise in
the face of extraordinary risk before a deposit can be found, defined, developed
and brought into production. We believe that the demand part of this current
equation is sustainable because of the structural demographic changes
happening in Asia to drive prices higher.
Despite current market turmoil, the trends driving higher prices are here to
stay, making this a lucrative space. We don't want investors to lose sight of
that when they are thinking about short-term market volatility. So, the trick
is to not be afraid but to buy good quality companies when they're cheap,
like now. Then we hold on for the ride because eventually market turmoil
gives way to underlying fundamental supply and demand dynamics.
TER: We greatly appreciate your insight.
CA: Thanks for having me.
Carlos Andres is the managing editor and chief analyst of
the Frontier
Research Report, a natural resource–oriented monthly investment
newsletter focused on high-risk, high-reward junior exploration companies in
emerging and frontier markets. Mr. Andres applies a potent mix of world-class
expertise and lengthy experience in identifying countries and companies where
"perceived" risk is much higher than "actual" risk, providing
opportunities to profit significantly on the difference. Mr. Andres has been
a natural resource analyst and investor for over 15 years.
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