Verdmont Capital

Wednesday, August 26, 2015

Aguia Resources (AGR.AX:$0.19) - Successful Completion of A$9.5Mil Financing - Stay in the Name

Aguia Resources (AGR.AX:$0.19) successfully completed a A$9.5Mil non-brokered private placement. An overview of the placement and the company’s intended use of the funds can be found here.

These developments are very encouraging given that the raise was done at par with the previous days close and at a premium to the 20-day VWAP $0.16/sh. The company is now fully funded as it looks to exploit its aggressive development and exploration plans.  

Congrats to Aguia management for making this happen, in what has been a horrible junior mining market.

Aguia Resources, which Verdmont Capital helped finance at $0.06/sh in 2013, has been one of the top performing junior mining stocks over that period.

AGR.AX – 2 Years
Source: Verdmont Capital S.A., Bloomberg

Aguia Resources vs. the Market Vectors Global Junior Miners Index – 2 Years (normalized)
Source: Verdmont Capital S.A., Bloomberg

We continue to recommend that holders of Aguia hang onto their positions. The company is now fully funded to commence development of its Tres Estradas project. Furthermore, there is still a considerable amount of potential exploration upside at AGR.AX’s Joca Tavares and Cerro Preto Targets. There should be a considerable amount of positive news flow associated with the advancement of these various initiatives.

Oshkosh Corp (OSK:$40.01) - Good Trade

Oshkosh Corp (OSK:$40.01) inked a $6.7Bill contract for a replacement vehicle for the Humvee.

The company has market cap of $3Bil, so a $6.7Bill contract is a big win. It also moves their business more towards defense, which should bring in a different set of institutional buyers. Defense revenue is on the sticky side, so it should help prop up the multiple as well in today's volatile environment.

Some color from the Stifel analyst yesterday:

“”After market close, the Department of Defense announced that Oshkosh (OSK, $38.52, Buy) received the winning bid for the much anticipated Joint Light Tactical Vehicle (JLTV) contract. We believe this is the positive catalyst investors have been waiting for, given the slowdown seen in the rental channel. The contract win should provide stability to Oshkosh’s revenues, earnings, and cash flows as the Defense business becomes a larger piece of the investment story. Shares carry a 1.8% dividend yield and an 8% FCF yield, trading at 6.7x our 2016 EBITDA estimate (FY1 EBITDA 2yr average: 7.2x).””

In addition to an improving fundamental backdrop, the chart looks good. Use a stop of $38.00/sh, which is where the stock was roughly trading before the news, based on the “good news indicator” approach. If it fails to hold the pop off of this solid development, which does not appear as if it was traded into, we are missing something.

OSK – 1 Year
 Source: Verdmont Capital S.A., Bloomberg

Analysts are lukewarm on the stock as well, so more upgrades are arguably due to play out. Only 50% of analysts have a buy rating on the stock. This is on the low side relative to the market.

Aggregate Analyst Price Targets and % Buy Ratings (green) – 3 Year
Source: Verdmont Capital S.A., Bloomberg

Monday, August 24, 2015

iShares JP Morgan USD Emerging Market EMB:$107.09 - Going Lower

Watch the mutual fund flows out of emerging market debt. We do not see how a logjam does not play out as investors/speculators dart for the exits.

Flow into EM Bonds (% of Assets)

With the emerging market currencies collapsing and equity markets getting crushed, look for EMB to follow them lower.

EM Bonds (EMB:$107.09) vs. EM Equities (EEM:$32.75) - 1 Year (normalized)
Source: Verdmont Capital S.A., Bloomberg

Emerging Market Bonds vs. EM Currencies – 15 Years

Lots of juice left in shorting EMB if weakness continues to play out. EM bonds got hammered in 2008. Even if we don’t a crash in the magnitude of the last financial crisis, there is still lots of meat on the bone in shorting EMB.

EMB – December 2007 to Present
Source: Verdmont Capital S.A., Bloomberg

Wednesday, August 19, 2015

Mr. Bubble, is Worried about Bubbles : Short Idea - iShares JP Morgan Emerging Markets ETF (EMB:$107.94)

Alan Greenspan knows a thing or two about bubbles. He played a key role in creating at least 3 of them. He has now gone from causing bubbles, to calling bubbles.

Frankly, we prefer when public officials go quietly into the night, especially after dropping so many turds when they were in “public service.” We guess Alan is trying to protect his legacy, so he has jumped over to the other side of the fence. We would imagine that the crazy speaking fees he receives, for peddling influence and access, act as further motivation to remain relevant.

We cannot imagine that current Fed officials, who are trying to keep the debt bomb stitched together, are super pumped that Alan is out there stoking bubble fears. After all, they are just playing the same game he was when he was wreaking havoc on the financial system and spewing double talk.

Thanks to Alan, we had two terms of Bill Clinton, LTCM, the tech crisis and the housing bubble. Other than Barney Frank, we cannot think of anyone more destructive (Barney Frank is still by far the most repulsive – what a slob).  We went from the greatest generation to the worst at an unbelievable clip. Bill Clinton and his ilk led the charge, while Alan Greenspan helped finance it. Thanks again for our current predicament baby boomers!

Anyway, Alan might be onto something with his bond market call. As we have learned with our oil short, and are currently learning with our Royal Bank of Canada short, timing is everything when trying to short something. We are looking to buy puts on the iShares JP Morgan Emerging Markets ETF (EMB:$107.94).

The stars are aligning for emerging market bonds to get whacked. If there is a bond bubble, the epicenter of it will be in emerging market and high yield debt. If the bond market cracks, the emerging market bond correction of 2008 will seem like a speed bump in comparison. 

Emerging market equities are breaking down and cyclical commodities have fallen into the abyss - are EM bonds set to follow? We are having a difficult time finding reasons to suggest that they will not.

iShares JP Morgan Emerging Markets ETF (EMB:$107.94) – 2007 to Present
Source: Verdmont Capital S.A., Bloomberg

Monday, August 10, 2015

VC Commodities Comment : Barron's Says Buy Gold and Oil : Relative Value is There (Kinda) : Watching the USD and Yields for a Turn

The following Barrons article suggests that now is the time to buy oil and gold.

Now, of course, we have seen similar articles by various market participants over the past few years. Had you followed the advice in similar themed pieces, you would have been killed.

The Barrons article mentions how there is a strong case to be made from a relative value standpoint, which we tend to agree with. Both the equity and bond markets are currently priced for  perfection, whereas the commodity market has digested a barrage of negative news and sentiment is quite depressed.  

In tune with this, the relative performance between traditional equities and commodity linked companies, should not diverge by such a wide margin, as both are linked to global growth dynamics over the long term.  Based on this logic, making a relative value call when discussing commodities is not totally off the mark.

MSCI World Index vs. the CRB Commodity Producers Index – 5 Years
Source: Verdmont Capital S.A., Bloomberg

Getting this trade right however, and most trades for that matter, comes down to timing. We recently tried to play the relative value theme outlined above, and had to exit quickly, when it became evident that commodities were due for another leg down. The one hole in the relative value argument, is that if you pull up a longer term chart of traditional equities to that of the commodity producers, it paints a completely different picture.

Commodity related equities have still outperformed traditional equities by a wide margin since the commencement of the “commodity super-cycle” roughly 15 years ago. The market is currently figuring out how much of that super-cycle argument was built on complete B.S. and how much of it made fundamental sense. Regardless of where you fall on that side of the discussion, the long term chart serves to sober up those who think commodity related stocks are completely washed out. That isn’t necessarily the case.

MSCI World Index vs. the CRB Commodity Producers Index – 15 Years
Source: Verdmont Capital S.A., Bloomberg

There is a trade shaping up here in the commodity complex and we want to be there in size when it happens. When prices are collapsing and sentiment is dour, you want to become increasingly more positive, as opposed to vice versa. In fact, we believe there is a very profitable trade to be made in commodities and related stocks between now and the end of the year.

During the past couple of trading sessions, we have seen a reversal in some key commodities and commodity related currencies. This is despite the fact we have seen a strong jobs number in the US and a rising US dollar. This reversal, in light of US dollar strength, is a good sign, and we removed our short position in the Canadian dollar this past Friday as a result. We have also seen significant selling volume in some key commodity focused equities, and that volume is subsiding, which is a hallmark of capitulation.

We are watching the US dollar and 10 year yields for clues as to when we should become more aggressive within the commodity trade. We would like to see the trade weighted US dollar fail to breach $100 decisively. Furthermore, and ostensibly linked, we would like to see the 10 year treasury yield breakdown anew. A falling 10 year yield would be indicative of falling real-yields, which would be a major tailwind for the commodity trade.

Trade Weighted USD – 5 Years
Source: Verdmont Capital S.A., Bloomberg

10 Year US Treasury Yield – 5 Years
Source: Verdmont Capital S.A., Bloomberg

Thursday, August 6, 2015

Aguia Resources (AGR.AX:$0.16) - Good Momentum on Rising Volume

Aguia has been a great surprise for us, in what has been a horrific junior resource market. One of our only investments in the space. An example of how good management is often able to pull a rabbit out of a hat when you need them to.We are hanging on.

AGR.AX vs. S&P TSX Venture – Since Verdmont Invested in Sept 2013 (Normalized)

Friday, July 31, 2015

Gold and Silver Fall into the Abyss / Gold Company All-in Production Costs ($/oz) / Gold Producers are in a Tough Spot (ABX.T:$9.37) / Now What?

Gold and Silver are Getting Creamed

We have been involved in the precious metals sector for many years. As personal investors, investors on behalf of our clients and in conjunction with Verdmont Capital’s corporate finance work. We have been staying clear of the sector for some time, and are happy to have avoided most of the onslaught.

Frequently, we can attribute a touch of luck to our successful investment calls. We come out with a thesis, and if everything aligns properly, we do ok. There is often a fortuitous event, or extraneous kicker, that helps push our call over the finish line. With our bearish call towards the gold sector, we can say that there was no luck involved.

We took a sober look at the sector, stripping out all the wild emotion that comes along with it, and saw that nothing was working in its favor. As active investors know, sometimes the best investments decisions are those associated with the investments that you do not make.

Our bearish long term stance, which was outlined in prior notes (, was predicated on the belief that the gold trade was just not working. Inflation was non-existent and gold was not reacting positively to news that played into its crisis hedge status. When an investment or an asset class fails to respond to events that are typically bullish, it is a sign of a sick trade.

Further to this, all of the factors that had contributed to the bull market in gold, commencing in 1999, began to work against it. We have summarized these drivers below.

Table 1: Gold – What Happened?
The US dollar became increasingly attractive relative to the other major currencies.
Real interest rates in the US were beginning to reverse a multi-year slide.
Excessive monetary easing was not contributing to a pickup in inflation.
The Chinese miracle was not going to send commodities to the moon into perpetuity.
The limited supply theory regarding the commodity complex, bolstered by the “peak oil” theory, began to unravel.
Gold’s status as a crisis hedge was severely damaged by its inability to weather various systemic shocks.
The traditional stock market has continued to surprise to the upside.
Source: Verdmont Capital S.A., Bloomberg

Looking at the above drivers, it becomes clear that it has been difficult to muster up a bullish view on gold and related equities over the past few years.

Granted, from time-to-time, we traded various precious metal names to play swings in sentiment. Our trades were on both on the long and short side of the market. We would probably give our trading performance a “C” grade over the past few years. Winning more than we lost, but no doubt taking the odd hit.

One of the big trades in the precious metals sector, had been playing the bounce of both gold and silver off of well-established support levels. Support for gold was at ~$1,200/oz and the floor for silver had been ~$20/oz and then ~$15/oz. These support levels have been broken, only recently for gold, which has supercharged the selloff in the complex.

Gold Bullion – 5 Years
Source: Verdmont Capital S.A., Bloomberg

Silver Bullion – 5 Years
Source: Verdmont Capital S.A., Bloomberg

Gold Producers are in a Tough Spot

It is worth noting, that the $1,200/oz support level for gold was not just an arbitrary price point established by the market. The market hung onto $1,200/oz as a floor, because it was the widely accepted price where gold companies could remain profitable. In other words, if prices broke $1,200/oz, many gold producers would fail to breakeven, resulting in negative earnings and an inability to devote additional capital to the funding of new projects.

This has created a heighted degree of concern in the market about the ability of various companies to execute on their existing business plans and objectives. Looking at sustaining cash costs and total all-in costs, outlined below, it becomes evident that these fears are not unfounded.

All-in Sustaining Cash Costs ($/oz)
Source: Verdmont Capital S.A., Bloomberg

Senior Gold Stock Total All-in Costs – Trailing and Forecasts

We would imagine that there are a few management teams in the precious metals sector feeling the proverbial heat. At this point, it isn’t necessarily the share price they are the most concerned about. At current spot prices, the ability of various companies to service their debt obligations, and meet the various covenants often embedded within them, becomes increasingly more important.

Unfortunately, when you are boxed in by a collapsing market, your options become fewer and the decisions that need to be made become that much more difficult. If we don’t see a quick snapback in the price of gold, look for gold companies to take some drastic measures to stay in the game. In addition to ongoing cost cutting measures, and a likely dividend freeze, various companies might have to become more aggressive in an effort to shore up their balance sheets. This may involve equity sales, the shedding of assets and/or taking on additional debt.

Each of these options are what we like to call “dusty”, or, fraught with issues. Very simply, selling equity would involve diluting existing shareholders at prices close to 15 year lows, asset sales would be at done at fire sale prices (if at all) and the costs associated with issuing additional debt are becoming increasingly prohibitive.

Using Barrick Gold (ABX.T:$9.37) as an example, you can see that the numbers are moving in the wrong direction. The company has never had more debt in its capital structure, while at the same time, it is bleeding-out due to historically low profitability (or lack thereof). These numbers are setting up to be that much more troublesome given the recent collapse in gold.

Barrick Gold (ABX.T:$9.37) – Debt and Margins – 1989 to Present
Source: Verdmont Capital S.A., Bloomberg

The equity market has taken notice of Barrick’s predicament, which is of no surprise. What is surprising however, is that the stock is now trading where it was in 1990 (yes, 1990). This is despite the fact that we have just witnessed one of the strongest gold bull markets in recent memory.

Barrick (ABX.T:$9.37) – 1985 to Present
Source: Verdmont Capital S.A., Bloomberg

We have gone from watching the stocks, to following what is going on in the debt market. During times of heightened duress in any sector, equity stories typically become debt driven ones. The debt markets begin voting as to whether certain organizations will survive, and if so, how strong they will be coming out the other side.

Once again, using Barrick as an example, the debt markets are becoming concerned about the solvency of the company. This becomes evident when you look at value of Barrick’s bonds in the market, and the corresponding spike in yields. You can also see that the company’s credit default swaps, or the cost of insuring bond holders in the event of a default, have also jumped considerably.

ABXCN 4.1 5/01/23 - Yield and Spread to 10yr US Treasury – 1 Year
Source: Verdmont Capital S.A., Bloomberg

Barrick 5 Year Credit Default Swap – 5 Years
Source: Verdmont Capital S.A., Bloomberg

The issues facing Barrick are not specific to the company. If you pull up other names, such as Newmont’s debt for example, you are seeing a similar theme play out. By and large, all of these producers are getting caught with their shorts down. 

A couple of articles today in Bloomberg, highlight the problem facing natural resource related companies. The debt market is beginning to riot and various companies are due to begin writing down the book value of their assets.

So, to wrap things up, the gold trade remains sick and the producers are on the ropes. Without a quick bounce in the price of gold, expect more bad-to-shocking news from well-known companies.

Now What?

Looking at what drives physical gold and silver, which we outlined in Table 1 above, it is tough to make a fundamental argument on owning bullion at the present time. Granted, experience suggests that the time to buy something is when the market thinks there is no reason to own it. We get that. Right now though, let’s wait and see. Iron ore, oil, thermal coal, met coal, copper, nickel, etc., have all gone to levels unfathomable a couple of years ago. Why not gold and silver? We have not seen anything to suggest to us that the onslaught is over.

In terms of the large cap equities, there is no question that they are cheap – and have been getting cheaper. In terms of our view as an investment? We have a “you first” approach. Yeah, sentiment is low, and yeah, they are cheap. As we outline above however, this is deservingly so. There is no need to be a hero here. Remember, gold stocks represent a fraction of the investable equity market cap out there. Go where there is a reason to own something, other than hope. Hope has not worked with gold stocks for 5 years now. The one bright spot is that the strong US dollar, moderating sector labor costs and plunging energy costs should be good for producer profitability at some point.

Market Vectors Gold Miners (GDX:$13.64) – 5 Years
Source: Verdmont Capital S.A., Bloomberg

In terms of the juniors, as our friends at Stifel in Boston like to say, its OVAH. Once again, from a contrarian standpoint, that’s good. We are looking to trade the juniors before the year end. Luckily, we have been on the right side of the trade and have some powder dry. We imagine that the trade will show up in conjunction with a topping in the US dollar, a stabilization in the oil selloff, Chinese bubble fears subsiding and Canadian stocks in general catching a bid.

Market Vectors Junior Gold Miners (GDXJ:$19.25) – 5 Years
Source: Verdmont Capital S.A., Bloomberg

S&P/TSX Venture Composite – 5 Years
Source: Verdmont Capital S.A., Bloomberg

As always, please call your Verdmont Capital representative to discuss our in-house investment view across various segments of the market.