Mining stocks may have moved from a bear market to a place where they are becoming contrarian plays, says Mike Niehuser, founder of Beacon Rock Research, opening opportunities for value investing. With the concept of "Too Big To Fail" unknown in the mining world, the field of companies is shrinking, making room for potential winners. In this interview with The Gold Report, Niehuser warns that companies need more than good projects and cash to outperform their peers and details a dozen miners that should be on the radar of investors.
The Gold Report: We are coming to the end of 2013, and you've been busy visiting projects and attending conferences. What are some themes you see in metals and resource stocks?
Mike Niehuser: It is clear that following the PDAC Convention last spring, conferences seem to be down in numbers of attendees and participating companies, probably a result of challenges raising money or running out of money. But it feels as if we have moved from a feeling of fear of what's to come to an acceptance of how to move forward. What is interesting to me about the recent Metals & Minerals Investment Conference in San Francisco is that the commentators all seem to be reaching the same conclusion but with different words. It's similar to several people witnessing a traffic accident; the result is plain to see, but the way it happened can be perceived quite differently.
TGR: Are you referring to mining stocks?
MN: There seems to be a definite consensus that we are at a bottom for mining stocks, but the question nobody dares to touch is how long it will last. Exeter Resource Corp. (XRC:TSX; XRA:NYSE.MKT; EXB:FSE) had a nice little chart in its corporate presentation going back to 1983 for small-cap mining stocks. It showed bottoms lasting a couple of years prior to 2000, with greater volatility, in 2008, for example. I'm thinking we may be in for a couple of years that could be positive. This would imply that we have moved from a bear market to the place where mining stocks are becoming contrarian plays. I suspect this is how we begin to move off the bottom. I don't see an immediate massive sector rotation back into mining stocks, but this is fine for me because it favors company selection and value investing.
TGR: That seems optimistic. How do you know that?
MN: There are a few success stories out there that have appreciated. Companies still get rewarded for results, they just need to be material and faster than their cash burn rate. Also, appreciation generally follows companies with good capital structure and insider buying. All this is just basic value investing for those with the potential to deliver more than their peers. With a smaller field of companies, the market has already culled the herd, and 2014 could be a much better year. The sector and companies will be under pressure. This will provide further opportunities at year-end, especially with further declines in metal prices.
TGR: What do you see for metal prices?
MN: Certainly the Federal Reserve tapering, or reducing its bond buying, is getting all the attention, but I think this is misleading because the Fed is genetically predisposed to easy money in one form or another. I am shocked to see the velocity of money dropping like a rock. If you go to the Federal Reserve Bank of St. Louis' website and look up the chart for the Velocity of M2 Money Stock, velocity is at the lowest level in more than 50 years. How we are not in a full blown depression can only be a result of ongoing bond purchases by the Federal Reserve, funding government largess.
Quantitative easing (QE) suppresses interest rates, which benefits those with access to capital markets like large corporations, and good luck to the rest of us. The drop in velocity is a rational response to the administration's "fundamental transformation" that has increased uncertainty and led to holding higher cash balances. This causes deflation in the short run. When holders of cash are shaken seeing the value of their position eroded by QE, the horse will be out of the gate.
It is interesting that the leading economic indicators are positive, but this indicator is heavily weighted to low interest rates. So, in effect, the Federal Reserve is grading its own papers. With the appointment of the new Fed chair I don't anticipate any changes in QE. If you pulled QE out in 2013, we probably would have negative growth over the last four quarters.
I don't like QE because it is a Keynesian mechanism based on the premise that individuals are subject to animal spirits, or, in effect, are stupid. This is offensive to me. I would prefer what Friedman suggested for a passive monetary policy that didn't try to trick consumers and investors, but trusted their individual judgment for consumption and investment.
QE is like meth—it makes you feel warm and pretty out on the street. It allows you to steal from others without concern. QE redistributes wealth. It is the drug that enslaves the user and robs seniors of their independence and from receiving a fair return on their savings. It promises the young an education at an inflated price, it places an extra burden on the productive and it destroys the middle class. If you want to see who is getting rich, go to Washington to see how the dealers are doing.