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 Fri Apr 15, 2005
Tip of the Day: Betting on Structural Bulls and Common Sense
    Publisher: Kaiser Research Online
    Author: Copyright 2005 John A Kaiser

 Tip of the Day

April 15, 2005

Betting on Structural Bulls and Common Sense

One style of bottom-fishing involves looking for inefficiencies in the market where a stock is cheap because the market does not understand the company's fundamentals or has just plain overlooked them. The problem with this approach is that such opportunities are hard to find, and usually do not offer huge gains as a result of rectification of the "inefficiency". Another style of bottom-fishing involves looking for companies which are still missing certain pieces that are in the process of being put into place by management, but this process involves time and some uncertainty that everything will indeed fall into place. Yet another style of bottom-fishing involves looking for companies where exploration may move an early stage project sharply toward a large dream target. These are the traditional speculative plays which I analyze in terms of dream targets and the rational speculation model. But there is another kind of bottom-fish whose success potential hinges on macro developments far beyond the control of management. The simplest variation of this type of bottom-fish is a company with a deposit that is marginal at current metal prices. Other variations include projects handicapped by infrastructural, political or permitting related obstacles. This Tip of the Day introduces a new medium priority bottom-fish buy recommendation in the $0.20-$0.29 range called Copper Fox Metals Inc (COF.P-V: $.25) whose future hinges on the destiny of metal prices and provincial politics. In what follows I will first explain the macro context for this speculative bet, and then briefly touch upon company details. A more detailed writeup will be published at a later date.

The metal price context: structural bulls versus cyclical bears
The argument between the cyclical boom-bust bears and the Asia rising structural bulls is currently tilting in favour of the bear camp. The exploration junior market is being weighed down by concern that rising interest rates and high oil prices will induce a global recession that will curtail metal demand in early 2006 just as new supply from expanded production capacity comes on stream. This "bust" scenario is the standard consequence of the reality that the raw material supply cycle always lags the business cycle. The cyclical boom-bust bears argue that this time is no different and the market is for the moment in agreement. The structural bulls argue that while they do not dispute the cyclical dynamics of the raw material market, the current situation is different in that the business cycle is in the midst of a structural shift in demand due to the rise of Asia as a major global economic force. In this scenario the resulting quantum shift in demand is expected to overwhelm the supply from full mine production, ushering in a 3-5 year bull market of higher real metal prices during which the mining industry scrambles to permit and develop new mines.

Ignoring the looming cyclical bear victory
That scenario, of course, is extremely bullish for exploration juniors. The problem with the structural bull scenario is that we do not know if it is still the case that America is the dog that wags the Asian tail. The cyclical bears believe that the Asian economy will grind to a halt if the American economy slows. Furthermore, even the structural bulls concede that the American trade deficit is an unsustainable situation. The real question is whether or not the Asian economy has reached the critical mass which will allow it to become the biggest consumer of its own production. If this critical mass has been reached, then it will not be a case of Asia catching a severe cold if America sneezes. The downdraft in the market is saying that Asia is getting a bad cold. Is the market correct? The structural bulls argue that we are in the transition zone between a waning old mega cycle and an emerging new mega cycle that is building on a substantially larger base of human potential whose acceleration capacity has been lubricated by an unprecedented phenomenon called the Internet. They dismiss the current downdraft as mere chop in the overlap zone of the fading and rising mega cycles.

The Political Context: who will govern the province of British Columbia?
An outcome in favour of the structural bulls has positive implications for the mining industry in British Columbia, a province of Canada that was an exploration pariah during the nineties while the socialist New Democratic Party was in power. The environmental and aboriginal lobbies had the ear of the NDP during this period, with the result that serious obstacles were erected to hinder exploration and mine development. The perception was that British Columbia wanted to double as a destination site for tourists and a giant Indian reservation with movie-making and technology concentrated in a few urban centres. By the time the 21st century arrived and the NDP was ousted in favour of the centrist Liberal party weak metal prices had rendered exploration and mine development in British Columbia irrelevant. But in recent years strong metal prices and a less hostile attitude toward exploration and mine development have turned British Columbia into a very attractive exploration target. The situation is especially intriguing because the province has not experienced major exploration since the early eighties. British Columbia is set to receive a lot of attention from exploration juniors and mine developers, but there is a hitch. On May 17 British Columbians have a provincial election where the choice is between re-electing the Liberals' Gordon Campbell, who handicapped himself with a DUI while on vacation in Hawaii, or reinstating the NDP. The feeling is that if the NDP get back into power, an anti-mine development attitude will once again sweep the province and scare away exploration dollars. Because politics in British Columbia is a fickle phenomenon more often than not guided by emotions rather than common sense, there is a risk that the NDP will win.

My bet is on the structural bulls
I believe that although in the short term the cyclical boom-bust bears will appear to have been correct, the Asia rising structural bull has sufficient momentum to emerge relatively unscathed, and by the time 2006 arrives the jaws of the cyclical boom-bust bears will hit the floor. The 50 year mega cycle of the rising American middle class, the ideological battle between communism and capitalism, and the reconstruction of post-war Europe and Japan is over. A new mega cycle lubricated by the global connectivity created by the Internet and fueled by an Asian population base ten times bigger than that of the post-war mega cycle is underway and is not going to stop because Americans stop trading IOU's called treasury bills for consumer goods. To think otherwise is to be blinded by western arrogance.

My bet is on common sense
With regard to British Columbia, my experience during the 3 decades I lived there was that the public oscillated between the extremes of a right wing Social Credit and left wing NDP government, with each turnover resulting in "retaliatory" policies that sowed the seeds of discontent assuring future ideological retaliation. The election of the middle-of-the-road Liberals broke that cycle. There is no compelling emotional reason to kick out the incumbents, and, should the NDP indeed slip back into power, there is no real need for ideologically retaliatory measures. In terms of manufacturing and knowledge working Canada is in no better shape than the United States vis a vis Asia, but in terms of extracting and supplying raw materials Canada is in much better shape. Common sense says that it does not matter who wins the election, both parties will keep British Columbia open for business as far as mine development is concerned.

Copper Fox: a bet on the structural bulls and common sense
Here is a new bottom-fish buy recommendation in the $0.20-$0.29 range perfectly suited for a bet on the structural bulls and common sense. Copper Fox Metals Inc (COF.P-V: $0.28) is a capital pool that went public on September 9, 2004 with a plan to acquire from insiders an option on a major copper deposit in northwestern British Columbia. Copper Fox presently has 6 million shares issued and 7 million fully diluted, but Copper Fox will have 25,402,700 shares issued and 30,606,240 fully diluted if the major transaction and associated private placements are completed. The special meeting will be held on May 25, 2005, a week after the BC election. There is some risk that if the NDP wins the British Columbia election, Copper Fox may reject the major transaction, but my impression is that major shareholders are inclined to take the optimistic view that a victorious NDP government would operate with common sense.

Details of the Shaft Creek option
Copper Fox will acquire an option to earn 100% of Teck Cominco's stake in the Shaft Creek copper-gold-molybdenum-silver deposit by spending $5 million by December 31, 2006 and another $10 million by December 31, 2011. Copper Fox can also vest for 100% by delivering a positive bankable feasibility study after spending at least $5 million. The catch is that Teck Cominco retains back-in rights it can exercise any time. The right consists of one choice from among three options: 20%, 40% and 75%. The maximum back-in requires Teck Cominco to arrange Copper Fox's share of project financing. Upon Copper Fox delivering a feasibility notice Teck Cominco will have 120 days to decide which of the three back-in options it wishes to exercise. Alternatively it can choose to retain a 1% NSR or receive $1 million in Copper Fox stock. Because there is an underlying minority interest, Copper Fox will either end up with a "carried" 23.3% net interest at worst, or a 93.4% net interest at best. One can assume that if the project's numbers are weak, which would be the case if historical metal prices prevail during the decision period, Teck Cominco will let Copper Fox keep 100%. And if the project economics are robust with the structural bulls having won the argument, Teck Cominco will back-in for the maximum interest. The option being transferred to Copper Fox was secured by Guillermo Salazar on January 1, 2002. The price of copper then was $0.65 per lb and the price of gold was $278 per ounce. At the time there was little, if any, talk about structural bulls and a new mega cycle.

Shaft Creek is a world class but marginal deposit
Shaft Creek is a giant low grade copper porphyry deposit with an indicated resource of 1.7 billion tonnes of 0.192% copper, 0.012% molybdenum, 0.16 g/t gold and 1.67 g/t silver, plus an inferred resource of 1.8 billion tonnes of 0.121% copper, 0.0078% molybdenum, 0.12 g/t gold and 1.56 g/t silver at a zero cutoff grade. Shaft Creek is a world class 3.5 billion tonne copper-molybdenum-gold-silver deposit located 70 km from the nearest road in an area lacking power. At current metal prices ($10/lb moly) this giant system has a gross in situ value of US $42 billion with an average rock value of about US $11 per tonne. It was discovered in 1957, explored by Hecla during the sixties and seventies, and then by Teck which has done no work since 1981. Over 67,000 metres of drilling has been done.

Tackling Shaft Creek with a Small is Beautiful approach
The global resource, however, is not the story. Copper Fox's goal is to demonstrate the feasibility of open-pit mining a high grade core of 465 million tonnes identified through a 0.35% copper-equivalent cutoff. The gross value of this "starter pit" is $10 billion with US $21 per tonne rock value at prevailing metal prices and grades of 0.359% copper, 0.024% molybdenum, 0.25 g/t gold and 1.99 g/t silver. At $21 per tonne rock the high grade Shaft Creek core has significant economic potential. However, at the metal prices that prevailed in January 2002 when Teck did the deal, the rock value shrivels to $9 per tonne at which value even the high grade core of Shaft Creek is worthless. The Shaft Creek story thus hinges on the structural bulls winning the debate about future metal prices.

Treat Copper Fox as a bet on the Structural Bulls
During 2005 Copper Fox plans to spend $1.3 million on 5,000 metres of metallurgical drilling and 1,500 metres of exploratory drilling. The project is at the metallurgical stage in the exploration cycle where the goal is to establish metal recoveries and the best recovery process. The drilling will also confirm metal grades, in particular that of molybdenum which may hold the swing vote in the feasibility of this deposit. The implied project value based on 30.6 million shares fully diluted is $8 million if Teck Cominco does not back-in, and $33 million if Teck Cominco does the maximum back-in. These values are very cheap if the prevailing metal prices turn into a long term reality, and offer tenfold upside potential for either a $500 million dream target (the scenario under which Teck Cominco would back-in), or a $100 million dream target (the scenario where Teck Cominco would take an NSR). Copper Fox and its Shaft Creek project are thus a clear cut bet on the argument between the cyclical bears and the structural bulls.

*John Kaiser does not own shares in any of the securities mentioned herein

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