The Commodity Investor Q&A
With Matt Badiali
November 5, 2008
Q: When will Seabridge Gold get a buyout bid? – K.S.
A: Seabridge owns two of North America's largest undeveloped gold projects. Kerr-Sulphurets-Mitchell in British Columbia contains 34 million ounces of gold resource, and Courageous Lake in the Northwest Territories holds another 9.5 million ounces.
Seabridge Gold and its peers - Gabriel Resources, Gammon Gold, and Orezone Resources - don't actually mine gold. They own resources and are likely buyout targets.
The market almost always overestimates the risk in resources, valuing them at about $30-$50 an ounce... far under what they'll eventually collect in a buyout. (In 2006, for example, you could have bought Cumberland Resources for $55 an ounce... and sold your shares to Agnico-Eagle for more than $100 an ounce about a year later.)
So one strategy for making money in gold stocks is to buy hugely discounted gold resources – like Seabridge's – and wait for a rich mining company to buy out your shares for a fat premium. This was a great strategy in the 2007 gold bull market. That year, 115 companies spent $77 billion on mining acquisitions in North America alone (nearly the same amount spent in the entire world in 2006).
These days, however, that strategy has gone sour.
Few junior miners make any money, even with producing mines. That means they need to sell shares to raise cash. Today's market looks at mining stocks like week-old fish... The TSX Venture, where most of these stocks list, has fallen 63% since May. So mining companies are spending their own cash to stay alive. Instead of acquiring new assets from explorers, those miners are trying to sell off their own properties.
That's why shares of the explorers have fallen so hard. Seabridge, Gammon, Orezone, and Gabriel are down an average 72% from their peak prices. Right now, the market is valuing Seabridge's blue-chip resources at $8.90 an ounce.
Eventually, a major mining company will find these projects too attractive to ignore. But until mining firms feel that financial Armageddon isn't around the corner, deals won't take place. My guess is we have about six to 12 months before we start to see the market unfreeze.
Q: When will the Canadian oil sand projects rebound? – J.K.
A: The Canadian oil sand projects are going through some hard times in this market. Suncor Energy – the biggest blue-chip oil sand company – is down about 60% since it peaked in May.
Suncor takes heavy, low-grade bitumen and turns it into light, sweet synthetic crude. It spends more to produce a barrel of oil than a company pumping out of a well in, say, Texas.
In addition, Suncor saw its costs skyrocket over the past two years. The Canadian dollar rose 25% against the U.S. dollar from 2006 to its peak. Copper (for pipes) was up 86% from 2006 to its peak. And diesel fuel soared 132% from 2006 to its peak. Likewise, with oil sand companies pouring into Canada's sparsely populated tundra, salaries ballooned to absurd levels.
When oil prices were up around $120 per barrel, oil sand companies could get by, even with bloated expenses. But at $60 per barrel, those economics won't fly. Let me show you...
The "benchmark" crude oil (West Texas Intermediate) sells for about $70 per barrel. Tar sand oil sells at a slight discount to that price. But Suncor still clears about $23 on each barrel.
Now if oil drops back to $60 a barrel, a 14% decline, Suncor's earnings per barrel fall 52% to $10.90 a barrel.
If you do a quick and dirty calculation, you see Suncor shares would need to fall to $23.67 to stay in line with earnings. The stock trades around $23 right now. So the market's already factoring in a lower oil price.
And Suncor's actually in a pretty good position. It survived the last bear market when oil hit $12 a barrel. Companies with higher costs are either going to pull out or go bankrupt before the trend turns up again.
I'm actually a long-term bull on the oil sands. Exports from Venezuela, Mexico, and Nigeria will continue to decline. We'll need a long-term, stable North American supply of oil. The only answer to that question is the Canadian tar sands.
I'll just have to see oil pick up before I'm ready to buy again.
Good investing,
Matt
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