The Haiku of Finance for 12/20/12

Transparency rank
Check it before you invest
Avoid corruption

Cardero Resource Corp. (CDY) Tries To Do Something

Cardero Resource Corp. (CDY / CDU.TO) is part of the Cardero Group.  Don't confuse the names.  I'll be talking about the junior explorer today and not its parent.  This company is out looking for coal, or iron, or something.  The thing with families of prospect generators is that they must move along quickly if they can't find anything worth mining at a given project.

The CEO knows his coal, so at least they put the right person in charge.  Their corporate structure is unique; they have separate wholly-owned coal and iron companies presumably to accommodate the properties they're exploring.  I don't often see that in a company that was itself created from a prospect generator parent.

Now, about those properties.  Carbon Creek is an aptly-named British Columbia coal deposit that is showing some progress.  They released a pre-feasibility report for that property in November 2012 and yet the share price has slightly declined since then (hint:  not a good sign of market confidence).  Read that study yourself.  It estimates the project's cash cost of production at $74/ton.  Their base case assumptions on what this product can earn in the world market might be optimistic.  Look at the EIA's data on sales prices of coal by mine size in the U.S. for 2011.  Cardero's cash cost is barely breaking even with mid-range mine sizes.  The spot coal price for the U.S. is currently under CDY's cash costs.  Maybe that's why the stock market's not impressed.  If they plan to sell the coal to non-U.S. markets where the spot price is higher, they'll have to build out the rail and power infrastructure at the site.

Check out their Sheini Hills iron project in Ghana.  They've got a local JV partner but that doesn't impress me much.  That partner's CEO is also running several other Ghana-connected companies, so perhaps he could explain how he can manage all those different entities.  Ghana currently ranks 64th on Transparency International's corruption index.  The political climate for a project is extremely important if it is to successfully avoid corruption or nationalization.

They've also got a Minnesota project.  They already have two 43-101 reports from January 2012 that conclude the two properties merit more work.  The good news is that their Q3 financial statement for 2012 shows over $10M in cash on hand as of July 31.  The bad news is that they also lost almost $3M that quarter.  They'll still be spending money to prepare the Carbon Creek project for production, so they'll need to raise more capital next year.  Existing shareholders should expect further dilution.

Cardero Resource Corp. is a risky bet on the viability of Canadian coal outside the North American market. It's also a bet on unproven resources in Ghana and Minnesota.

Full disclosure:  No position in Cardero Resource Corp. at this time.

The Haiku of Finance for 12/19/12

Keep drilling dry holes
Exploration waste of time
Throw money away

Rye Patch Gold Corp. (RPMGF) Marches On

Rye Patch Gold Corp. (RPMGF / RPM.V) is one of those ubiquitous gold exploration companies that makes the investor relations rounds.  I first blogged about them in October 2010 when I noticed they had leased out geothermal rights to generate some cash and loosen its rocks.  Here's an update on how they're faring.

You wouldn't know it from the way their management biographies are currently written, but the CEO is a geologist.  That's a plus in my book and they do make a "qualified person" statement.  

Their Rochester project is the subject of a legal battle with another company.  Their Wilco project has an NI 43-101 report from 2008 showing extremely low grades on site and an estimated cost of over $1M to continue drilling.  Their other projects also show discouragingly low grades from exploratory drilling in 2008 with little follow-up exploration since that year.  

The company seems to have enough cash on hand for at least another three quarters but their lack of success in exploration raises questions about what they can do with this money even if the Rochester question is settled in their favor.  Note 1 in their Q3 2012 financial statements admits that their continuance as a going concern depends upon raising more capital.  BTW, I don't see any financial statements for Q1 of this year.  

Maybe Rye Patch will get lucky with one of these properties, but I won't stake my own money on such an outcome.  Maybe they can keep leasing out land to geothermal explorers.

Full disclosure:  No position in Rye Patch Gold Corp. at this time.  

The Haiku of Finance for 12/18/12

Find a magic goose
Feed it inflation diet
Lay a golden egg

Cerberus Makes Hasty Exit From Freedom Group

Investment decisions should always take fundamentals into account.  I say "should" because sometimes a portfolio manager's fiduciary duty to satisfy a client's whims take priority over a sound investment in a healthy, market-dominant company.  Cerberus is selling its stake in Freedom Group because that will satisfy CalSTRS' demands.  This decision has nothing to do with whether the investment in question has been a winner.  The chief product of this particular sector has seen record-breaking sales in 2012.  Cerberus is a middle step between institutional investors and the capital markets.  It has to pay as much attention to future rounds of fundraising as it does to the performance of present holdings.  Satisfying CalSTRS now assures a future audience for Cerberus' fund offerings.

Some investors let emotions rule their thinking.  Big news events that hit close to home have an impact that financial models can't measure.  Bad news about one school can upset teachers anywhere, and their plan sponsors' money managers are paid to listen.  A state pension plan forcing its money manager to leave a healthy firm should be able to explain to its pensioners why it won't be able to pay their benefits if it can't achieve its target discount rate.

Full disclosure:  No positions in entities mentioned.

The Haiku of Finance for 12/17/12

Debt would make some sense
Buying a cash-flow asset
To hedge inflation

Financial Sarcasm Roundup for 12/17/12

It's been some time since my last blast of outright sarcasm.  That's too long.

The U.S. has finally enacted permanent normal trade relations with Russia, more than two decades after the Cold War ended.  Uncle Sam sure takes his sweet time recognizing reality.  The Jackson-Vanik legal regime was a Cold War blunt instrument intended to hold the Soviet Union and its Warsaw Pact allies accountable for their human rights violations.  Now Russia's internal freedom is on par with that of the West, which says more about the West than it does about Russia.

Uncle Sam will probably be just as slow in recognizing the weak demographic assumptions underpinning entitlement spending.  The slowdown in legal immigration due to the prolonged recession is probably offset by the large numbers of illegals who remain here and have kids.  The irony of illegal immigration is that our own government encourages illegals to apply for benefit payments while they are paid off-the-books income that can;t pay into Social Security or Medicare.  Illegal immigration makes the unfunded entitlement problem worse and no one in our business or political elite even cares.  My solution is simple.  If you apply for benefits, please include your U.S. birth certificate or naturalization papers with your application.

Meanwhile, private equity firms have learned nothing since 2008.  They are using more leverage than ever to buy companies whose earnings will be destroyed in the next round of the recession.  Borrowing at record-low interest rates isn't such a great idea when the earnings needed to pay back those debts won't be there.  I'll be watching the headlines for the first private equity firms that go bankrupt next year.

Sell-side analysts have learned nothing from last decade's master settlement.  Some Morgan Stanley banker got his firm smacked for coaching Facebook on how to materially mislead analysts.  That $5M fine is peanuts, so this is hardly going to hurt anyone other than that one banker.  State regulators are paying attention while the SEC is asleep.  My readers should be grateful that all of my articles reference facts already in the public domain.  Anyone idiot can mislead analysts on a conference call.  Only a genius like me can tell the truth.

I think I'm losing my touch.  These boring news items aren't getting me fired up enough to be truly sarcastic.

The Limerick of Finance for 12/16/12

Crony capitalists shout hooray
For bailouts the rest of us pay
There will be some more
So quit keeping score
Just wait for the reckoning day

Some Things You'll See While Driving Along a Mining Stock S-Curve

I sift through a lot of materials on mining stocks looking for anything that fits my risk tolerance.  A lot of movement in a junior mining stock's price is defined by an S-curve often attributed to Pierre Lassonde, a legend in the mining industry.  The Lassonde Curve posits that a mining company's life cycle has four stages:  exploration, feasibility, construction, and production.  Valuation is the vertical axis and time is the horizontal axis.  A company's valuation climbs rapidly during the exploration phase until it peaks with a pre-feasibility study, at which time it troughs during the feasibility and construction phases as the market realizes just how difficult it is to raise the large amounts of capital needed to make it to production.  The valuation bottoms out at the end of the construction stage, when the bulk of the company's capex budget has been spent.  Once in production, the valuation starts to climb again.

A lot of random stuff can drive an S-curve's movement.  Mr. Market can have his way with a junior stock's valuation.  Sometimes macroeconomic news clobbers a stock even if it showed progress with an NI 43-101 report showing above-average 2P reserve grades.  Announcements of positive developments like a pre-feasibility study, successful financing, and permitting approvals can "de-risk" a junior stock and make the S-curve jump northward.  I think the term "de-risk" is overused.  I chuckle when I hear exploration-stage companies say they've de-risked a project simply by walking around the site or looking at a map of old claims.

Juniors like to say they're exploring a Carlin-type mineral trend, but there's only one such trend in the world.  Nevada has a well-known geology and mining techniques useful there may not be applicable elsewhere in the world.

I'm a big fan of aeromagnetic surveys, especially if they save money by accelerating a drill program.  I've noticed that some old-school prospectors view them skeptically, possibly because such surveys pose a threat to their careers.  Exploration companies that use the hot spots from geospatial data to focus their drilling programs can reduce the possibility of striking dry holes.  One key limitation of these surveys is their usefulness only in areas with layers that generate contrasting magnetic signatures.  A uniform geology won't yield much useful data from the air.

LIDAR surveys can come in handy after an ore body has been mapped, so engineers can estimate the feasibility of mining with a given topography.  Competent mining executives can put these surveys in the proper order.  That's why I need to see a geologist as the CEO of an early-stage mining company.  I don't mind seeing a mining engineer running the company at a later stage once they have enough data and money to begin constructing a mine.  I don't ever want to see a mining CEO whose sole background has been finance or consulting, because that tells me the main investors and board members just want to flip a hopeless property to bag-holders.

Engineering studies can produce isometric models of an ore body.  These are pretty to look at but mining executives can easily gloss over them in presentations to non-engineer audiences.  It's easy to say "veins are open in all directions" because that's what investors like to hear.  It's harder to point to a vein and explain why that part of the geology leaves it open.  It's also easy to ignore now complex the geology can be while drilling down into an ore body.  More complexity means a higher cash cost of production; that S-curve's movement upwards will be slow and sticky.

Driving along a mining stock's S-curve is a little bit like driving a coastal highway.  It can be thrilling and nail-biting.  The difference is that the highway's curves are defined on a map but the stock's valuation curve always changes, even after you've convinced yourself it shouldn't.  The long-term trend of a junior's S-curve should be upwards if they are prospecting good grades, because that's what major producers want to acquire.  There's an old truism:  "If you've got grade, you've got it made."

The Haiku of Finance for 12/15/12

Low water levels
Hurting riverborne commerce
Where is stimulus?

"Sovereign Man" Simon Black Reveals Lack of Military Budget Knowledge

I need to address something that a blogger going by the moniker of Simon Black, a.k.a. "Sovereign Man" posted on his blog.  His credibility rests partly on his claims of having been a military intelligence officer in the United States armed forces before becoming an globe-trotting investment guru.  Today he posted an article in which he claims he was tasked to make long-term budget forecasts for his military unit when he was a second lieutenant.  I have problems with this story.

It is possible that a 2LT could be asked to assist with a budget forecast if he were a battalion staff officer but the battalion executive officer (XO) would not have handed off such a task without some detailed guidance on where to look for data.  Sovereign Man's other posts have hinted that he was independently deployable for much of his early career, which makes little sense if he were fresh out of a military academy and initially assigned to a battalion staff.  If he were leading a platoon or detachment, which is what he would have had to do to be eligible for his exotic adventures, it is very unlikely that he would have been tasked to work on the battalion's budget.

Anyway, what really unnerves me about the substance of his claim is that he states he was "responsible for requesting how much money my unit would need to operate… 2, 3, 4, 10 years down the road."  That is simply impossible.  I have over 17 years of military experience at every echelon of the United States Army from platoon to theater, both active and reserve component.  I have participated in numerous budget planning sessions both as a commander and staff officer.  Not once did any of my MTO&E or TDA units ever prepare a budget forecast that extended past a single fiscal year.  Battalions and lower echelons have no way to estimate their budgetary needs farther than a year in advance, and certainly not the "2, 3, 4, 10 years" that Simon Black claims he did.  This is because Congressional appropriations for Operations and Maintenance (O&M) accounts that fund tactical units are tied to a one-year fiscal cycle.

I'd like to hear Simon Black tell us all exactly which unit he served with and how he reconciled his duties as acting budget officer with whatever fantastic James Bond mission schedule he claims he executed. If he's really so intelligent, he can figure out how to reach me.

The Haiku of Finance for 12/13/12

Fed sees jobless rate
More hiring will change Fed's stance
Until then, inflate

The Haiku of Finance for 12/12/12

Attend a meeting
Hear exec pitch some hot stock
Blog it out later

"Strong" Estate Tax Targets Middle Class And Ignores Super-Rich

Warren Buffett wants a strong estate tax.  This has a populist, common sense appeal in light of his advocacy for higher income taxes and generous charitable giving pledge.  Uncle Warren's argument is that plutocratic-enabling tax policies harm democracy.  Let's consider the circumstances of today's plutocracy to determine whether any changes in tax policy will really weaken their hold on power.

The estate tax plan from United for a Fair Economy, which Mr. Buffett has endorsed, reduces the estate tax exemption threshold from $10M to $4M.  This will harm the middle class and those who try to raise their status into the upper middle class more than it will harm billionaires.  The ultra-rich who signed up for Mr. Buffett's big giving pledge have already structured their estates to pass into tax-free foundations and giving vehicles they control through trust agreements.  George Lucas' designation of the proceeds from Lucasfilm's sale to a charity he favors is a classic example of how the ultra-rich can always avoid estate taxes.  Giving your own money to a non-profit you control is a legal way to continue paying your living expenses.  The aspirational middle class may not have access to the same kinds of estate-preservation strategies unless they can afford very competent wealth managers and tax attorneys.  This is why the proposed policy's endorsement of a strong graduated tax on larger estates is meaningless.

True estate tax reform would begin with the elimination of the tax deductibility of charitable contributions.  That won't happen, of course.  Non-profit executives who derive their funding from endowed foundations would lobby against it and so would wealthy donors who fund political campaigns.

I'll give you a plan for real, comprehensive tax reform.  Have the U.S. Treasury study the history of tax collection in the U.S. and identify the point on the Laffer Curve that maximizes gross revenue.  I suspect it's somewhere between 16% and 19%, which means Warren Buffett probably isn't undertaxed at all if he pays 17.4%.  Once we've identified that optimal point, make that the flat tax rate for all income with no deductions, exemptions, or carry-overs for any reason.  Taxing earned income, unearned income, capital gains, and estates at that one rate will enormously simplify the government's operations.  It will also render redundant the hordes of accountants and attorneys who perform little productive work.  Tax planners represent as much of an overhead burden for the economy as tax collectors.  I know the federal government will never adopt my plan because I can't bundle as many campaign contributions as Warren Buffett.