Killian Charles, a mining analyst with Industrial Alliance Securities in Montreal, was tired of hearing how gold companies were doomed to failure because of the listless gold price. So, he started “auditioning” companies for Gold Idol. In this interview with The Gold Report, Charles talks about what attributes got companies through to the next round and what got them sent home.

COMPANIES MENTIONED: CLIFTON STAR RESOURCES INC. : DALRADIAN RESOURCES INC. : FORTUNE MINERALS LTD. : GOLD CANYON RESOURCES INC. : GOLDEN QUEEN MINING CO. LTD. : GUYANA GOLDFIELDS INC. : INTEGRA GOLD CORP. : LYDIAN INTERNATIONAL LTD. : MIDAS GOLD CORP. : MIDWAY GOLD CORP. : PMI GOLD CORP. : ROMARCO MINERALS INC. : SABINA GOLD & SILVER CORP. : SULLIDEN GOLD CORP. : TOREX GOLD RESOURCES INC.

The Gold Report: I recently read a 63-page report Industrial Alliance published in December titled, “Gold Idol: Finding the Next Profitable Producers.” What prompted that theme?

Killian Charles: We were getting tired of seeing press releases and technical reports that focused largely on upward sensitivity analysis with elevated gold prices. Of course, projects look very good at elevated gold prices. We wanted to tone down the rhetoric a little bit and put them on even footing.

Investors think, “Oh my God, gold is $1,200/ounce ($1,200/oz)—everything is going to die out there!” That statement does not apply to all projects, just as it does not apply to all mining companies or producers. Some producers will struggle at $1,200/oz, but some can continue making money. We hoped to find projects that could eventually fall in the latter category.

TGR: American Idol found talents like Carrie Underwood and Clay Aiken. What did you discover when you crunched the numbers in Gold Idol?

KC: There’s still a predisposition in this market for large projects with middling grades. We wanted to see if lower grades could be balanced with higher production rates. We also wanted to see if this also resulted in a higher net present value (NPV). The connection was there, but we were surprised by the link’s weakness. We had expected a solid correlation between the two.

We tried including strip ratio in the mix, which improved the correlation, but not dramatically. Investors shouldn’t just be focused on grade. There are so many different risks at a mine. I believe the impact of strip ratio can be underestimated. If the rock happens to be a little bit harder and a company is moving a lot of tonnage, the mining operating expense (opex) can quickly get out of control since it’s largely leveraged to the strip ratio.

TGR: Could you explain strip ratio?

KC: The strip ratio describes how many tons of barren material have to be mined to access a single ton of ore.

TGR: Let’s talk about your thesis for the market.

KC: Honestly, our thesis shouldn’t be market dependent. Otherwise, you could overvalue projects. Investors still need to do due diligence and get a good idea if the project can work in a bull or a bear market. Investors need to focus on a longer investment horizon. I can’t help but feel that a lot of investors are weak hands. They move in and out too fast. Following momentum is a bad way to invest and doubly so in the mining industry. If a project works in a variety of commodity scenarios, it will eventually be recognized. At the very least, it will survive to the next bull environment.

TGR: You had some criteria that companies needed to have before they got included in your analysis: an economic study, no other assets in production, capital expenditures (capex) to develop the asset below $1.5 billion ($1.5B) and a value of less than 15 times capex divided by market cap. Why are those important?

KC: I think the mining industry is moving on from large projects—projects with capex over $1.5B. Large projects are just too hard to manage and cost overruns become problematic rapidly. Right now there’s no appetite from producers and there’s definitely no appetite from the equity market to finance large projects.

We wanted to make sure that the companies had an economic study of some sort because overestimation ends up being a large problem. Too many “back of the envelope” calculations are simply ridiculous and set unrealistic expectations. I don’t have the time or the team to develop a perfect mine plan for all the projects at the resource stage and, honestly, neither do most people out there, so we have to rely somewhat on these third-party engineering firms to produce something that we can judge. I know many people will disagree with my statement but, at the very least, it’s a more accurate starting point.

As for capex divided by market cap, we wanted to avoid projects that had an execution risk. If the market cap is $10 million ($10M) and the project’s going to cost $600M to build, odds are the company will have a hard time raising the money.

TGR: The market effectively did some filtering for you there.

KC: It doesn’t mean that these projects won’t come back. We feel that the 15x capex to market-cap ratio is elevated enough that most companies can meet this criterion. If the market cap comes back into an acceptable range, we could definitely take another look at them and include them in our compilation.

TGR: In one scenario, you used $1,200/oz gold, $20/oz silver and a 7% discount rate. In scenario two, you used $1,000/oz gold, $15/oz silver and a 10% discount rate. What were the companies that ultimately survived your scrutiny?

KC: We divided them into three groups based on how their projects perform in our more stringent second scenario. Our first group consists of projects with a positive NPV at $1,000/oz gold. Those companies areDalradian Resources Inc. (DNA:TSX); Golden Queen Mining Co. Ltd. (GQM:TSX); Guyana Goldfields Inc. (GUY:TSX); Lydian International Ltd. (LYD:TSX); Midas Gold Corp. (MAX:TSX); Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.MKT); PMI Gold Corp. (PMV:TSX.V; PVM:ASX; PN3N:FSE), which is now the focus of an acquisition by Asanko Gold Inc. (AKG:TSX; AKG:NYSE.MKT); Sulliden Gold Corp. (SUE:TSX; SDDDF:OTCQX; SUE:BVL); and Torex Gold Resources Inc. (TXG:TSX).

Then we had a second group that was more marginal. Their respective NPVs varied between $50M and negative $50M. These projects were on the inflection point and could go either way.

TGR: What are some likely candidates to move away from the cusp and into the first group?

KC: There are a couple of projects that with revaluation have a good chance to move up: Gold Canyon Resources Inc. (GCU:TSX.V), Romarco Minerals Inc. (R:TSX) and Sabina Gold & Silver Corp. (SBB:TSX.V; RXC:FSE; SGSVF:OTCPK).

TGR: What are the most interesting names among the survivors?

KC: The interesting ones are currently entering construction, which can limit financing risk. Guyana Goldfields stands out. It has almost all it needs to enter into construction and has a pretty simple mine.

PMI Gold is the focus of an acquisition by Asanko Gold. Fingers crossed that it’s going to work because Asanko’s and PMI’s projects are so close to one another it make sense to merge them.

Torex came out with very good numbers and is moving along nicely. Similarly, Lydian International’s project may have some political issues in the short term, but then it has clear development opportunities.

TGR: Lydian has a big gold mine in Armenia, which isn’t a well-known mining jurisdiction. What are your thoughts on that country?

KC: Mining in any country that doesn’t have a Western mentality toward investment can mean there may be misunderstandings, but that doesn’t mean that there’s going to be problems. Countries can say they’re against mining, but every single nation in the world has a mine of some sort in it. One hopes that there’s no corruption and the person a company is dealing with actually can make a decision and doesn’t expect a bribe at the end of the day. Luckily, most nations avoid that. Then again, I live in Quebec and even we seem to have problems with corruption! Mining companies can avoid a lot of unfortunate accidents as long as management is of decent caliber and the company is transparent.

TGR: What’s next for Lydian and its Amulsar project?

KC: There should be more information available about the permitting process and obtaining the mining license and the license to operate in the country. Lydian is also updating the feasibility report and moving onto financing.

TGR: Could you update us on some companies you have discussed with us in the past?

KC: There is Integra Gold Corp. (ICG:TSX.V), which was a single property with lots of potential but a lot of the ounces can feel separate even if they are close to one another. We’re finally seeing the story come together. The company updated its resource estimate. Integra is expecting to put out a preliminary economic assessment (PEA) in the coming weeks that will continue tying it into a single front. The location is still excellent and it’s still fairly high grade. Once the story comes together, investors are going to start paying attention to this simple project in a safe jurisdiction with what could be a textbook mine.

Another company is Clifton Star Resources Inc. (CFO:TSX.V; C3T:FSE), which is hoping to put out its prefeasibility report in the first half of the year. The company’s PEA only used a small portion of the entire resource because the project is proximal to the town of Duparquet, Quebec. Clifton Star wanted to avoid unnecessary complication with the municipality until it properly opened up a dialogue. It wanted to make sure that there wasn’t any misunderstanding that arose from a PEA that made an assumption that a portion of the town had to be moved. By avoiding that, it left 2 million ounces in the Measured and Indicated category that are starting right at surface and are easily mineable, so there’s great upside there if negotiations do work with the city. The PEA underestimates the potential of that project, but I like seeing a management team that does a top-notch job and doesn’t overpromise.

TGR: Do you think that eventually Clifton Star will produce concentrate or doré?

KC: Concentrate excludes some opportunities because smelters are only willing to pay for a certain amount of gold. If there are any penalties through elevated elements in the concentrate, the company could also lose out a little bit. However, it definitely saves on capex. The plant would be much smaller and less equipment is needed. The prefeasibility study will give us a good idea of which plant is better. The key is that the project can work both ways. If Clifton Star wants to get into production faster, it can start producing a concentrate, sell the concentrate, then down the road build a full plant with pressure oxidation, and process and smelt gold ore on site.

TGR: Any other companies you would like to mention?

KC: Fortune Minerals Ltd. (FT:TSX) continues to be in an interesting position. Management has built a strong team to support and advance permitting at NICO in Canada’s Northwest Territories. Right from the start, it identified key participants in the permitting process and the receipt of this permit is further proof of its due diligence. There’s still more work to complete before all necessary permits are granted but it’s a clear indication that the company should be successful. As discussions with foreign partners continue to advance, a fully derisked NICO project will ensure investors receive full value from any future partnerships.

TGR: Any parting thoughts?

KC: Investors need to remember that even if the gold price keeps going down there are still projects out there that could work. It’s not all doom and gloom. There are projects out there that show potential to provide a return—even at $1,000/oz.

Companies are rightfully stressed. Will they be able to finance? There are some perfectly reasonable questions being asked, but our report disproves that they aren’t going to work just because the gold price decreased. There are some projects out there that may struggle, but there are definitely projects that—short of capex increasing 50% or grade decreasing 50%—should do well in nearly all gold environments.

TGR: Thanks for giving us your insights.

KC: It’s always my pleasure.

Killian Charles joined Industrial Alliance Securities Inc. in February 2011 and covers small- and mid-cap exploration and producing companies. He graduated from McGill University with a Bachelor of Science degree in earth and planetary sciences. His technical training is an asset in the evaluation of companies in a sector that is changing rapidly. He previously worked with FNX Mining and QuadraFNX before joining the IAS team.

In this week’s issue:

• Weekly Commentary
• Strategy of the Week
• Stocks That Meet The Featured Strategy

WEEKLY COMMENTARY

Stockscores Market Minutes Video
This week, I highlight the Sentiment Stockscore indicator and why it is so important for the position trader. Plus, my regular weekly analysisView the video by clicking here.

The Stockscores
I developed the Stockscores indicators as a way to take the six important elements of chart patterns and put them into a pair of indicators. These indicators are available at Stockscores.com for almost all North American stocks and are very helpful for doing an assessment of whether a stock is worth considering.

Here’s how the Stockscores indicators are calculated. Every stock, index or ETF that Stockscores covers is given 50 points to start. Points are added for positive chart characteristics and deducted for negatives.

For example, a break through price resistance is an indication that buyers are stronger than sellers, so the algorithm awards points when this happens. A downward-sloping moving average is a sign that the sellers are in control, so points are deducted when this happens.

I created the algorithm with about 15 different metrics that can be measured from market activity, each awarding or deducting points based on whether that metric was a positive or negative signal of future price direction.

This algorithm defines the Signal Stockscore, which tends to bounce around quite a bit. To smooth out the line, the system then calculates a seven-day exponential moving average of the Signal Stockscore to produce the Sentiment Stockscore. This is the important number to watch.

A Sentiment Stockscore above 60 indicates that investors are generally optimistic about the stock, index or ETF. A score below 40 indicates the market is pessimistic. The sweet spot is to find Sentiment Stockscore lines, which can be seen on any Stockscores.com chart, sloping upward and crossing through 60. You should then look at the price chart to see a confirming price pattern where the stock price is moving up through resistance from low price volatility.

I don’t recommend buying a stock just because its Sentiment Stockscore is 60 or higher, but I do find that strong, market-beating stocks tend to have good Sentiment Stockscores early in their trend. The Stockscores indicators are a great way to provide a quick reference for the strength or weakness of a stock.

You can check the Stockscore for most North American stocks, ETFs and indexes by entering the symbol in the upper right corner of the Stockscores.com website. The Stockscore algorithm requires 200 days of data to calculate the Stockscores indicators, so newly listed companies will only display a chart and not the indicators.

You can review the charts of any North American stock and see the Sentiment Stockscore for free. Just enter the symbol in the box at the upper right of the site. Canadian symbols require a prefix: “T.” for the TSX and “V.” for the Venture. Members can use the Sector Watch to see what areas of the market are strong and the Market Scan to screen the market for stocks with good Sentiment Stockscores or perhaps those that are just crossing above 60 today.

It’s important to remember that the Stockscores indicators are applied to daily chart data and are not useful for a shorter time frame. A stock may give a good entry signal on the intraday chart suitable for day or swing trading despite having a weak Sentiment Stockscore.

What’s powerful about the Stockscores is that they allow you to use a computer to filter the market, seeking out stocks with optimistic chart patterns. Stockscores.com has a Market Scan tool for filtering a large universe of stocks in search of stocks that meet the filter criteria you establish. It’s hard for a computer to look for chart patterns the way a human can, but the Stockscore is helpful because it attaches points to the different elements of chart patterns.

STRATEGY OF THE WEEK

This week, I ran a simple Market Scan that looked for Canadian stocks with a Sentiment Stockscore of 60 or higher and which has risen at least 5% in the last 10 trading days. To focus in on stocks that are actively traded, I set a minimum number of trades of 500.

Based on Monday’s trading, the Market Scan found 73 candidates. I inspected their charts looking for stocks that have seen a recent move from below to above 60 for the Sentiment Stockscore and a predictive chart pattern. Here are a few stocks that stand out and are worth considering:

STOCKS THAT MEET THE FEATURED STRATEGY

1. T.BLD
T.BLD is breaking from a pull back after a strong run higher to start 2014. This is a good continuation pattern which should allow the stock to move up to new 52 week highs in the near term. Support at $2.20.

2. T.KGI
T.KGI is one of many gold mining stocks that are showing good signs of a turnaround after a lengthy bear market. The stock is breaking higher from a rising bottom and appears to be reversing the downward trend. Support at $3.20.

3. T.AUQ
T.AUQ is breaking the two year downward trend on the long term chart and through resistance from a cup and handle pattern on the daily chart. Support at $4.95.

References

• Get the Stockscore on any of over 20,000 North American stocks.
• Background on the theories used by Stockscores.
• Strategies that can help you find new opportunities.
• Scan the market using extensive filter criteria.
• Build a portfolio of stocks and view a slide show of their charts.

See which sectors are leading the market, and their components.

Disclaimer
This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Perspectives is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of Perspectives may have positions in the stocks discussed above and may trade in the stocks mentioned. Don’t consider buying or selling any stock without conducting your own due diligence.

 At the end of 2013 Wall Street appeared to be convinced that the markets were enjoying the best of all possible worlds. In an interview with CNBC on Dec. 31 famed finance professor Jeremy Siegel stated that stocks would build on the great gains of 2013 with an additional 27% increase this year. So far 2014 hasn’t gone according to script. In contrast to the prevailing optimism I maintain a high degree of skepticism regarding the current rally in U.S. stocks. But opinions are cheap. To back up my gut feeling, here are six very diverse indicators that suggest U.S. stocks are overvalued. (This article is taken from the Winter 2014 EPC Global Investor Newsletter.)

1) U.S. STOCK PRICES VS. LONG-TERM EARNINGS

Currently market bulls will tell you that price to earnings ratios are well within their historic range. But they fail to mention that this statement is based on projected 2014 those earnings that won’t be known exactly until 2015. More sophisticated investors tend to rely on the Shiller S&P 500 P/E Ratio which compares U.S. stock prices to average 10year inflation-adjusted earnings. This takes a lot of the guess work out of the equation. Today the Shiller S&P 500 PE Ratio is at 26.4. But going back 100+ years, the historic mean of the index is 16.5. This means the current ratio is 61% higher than its long term average.

Past performance does not guarantee future results.

There are only four occasions in the past 100+ years in which the Shiller S&P 500 PE Ratio was higher than it is now: 1929, 1999, 2002, and 2007. In 3 of these 4 instances, U.S. stock prices saw major declines over the ensuing two years.

But even if we were to agree with the bullish pundits who argue that today’s low interest rates have created a new plateau of valuations, (and therefore can’t be compared fairly to generations-old metrics) today’s short term P/E ratio is still high. Based on the most recent year’s trailing 12-month earnings, the S&P 500 PE Ratio is at 20.14.

At first glance, this does not appear to be extremely high. However, there is an important caveat. Currently, corporate profits as a percentage of GDP are the highest they have ever been since the World War II era. 

Currently profits are coming in at 11% of GDP, a level that is around 60% higher than the average of around 6% that has been seen since 1952. (It is even significantly higher than the average of the past 10 years – a period during which low interest rates pushed up financial ratios past their traditional levels). To return to a more normalized ratio either GDP would have to expand rapidly or profits would have to diminish. Given our view of the current economic prospects, we believe the latter outcome is more likely.

2) U.S. STOCK PRICES VS. CORPORATE ASSETS: TOBIN’S Q RATIO

Maybe earnings just aren’t as important as they used to be. Given all the cash that is on company balance sheets, maybe assets are more detreminative. Tobin’s Q Ratio is a popular measure that compares a company’s market value (which is a function of share price) to the amount it would cost to replace the company’s assets.

So if a company owned a factory, and the market capitalization of the company was $1 million, but the factory would cost $2 million to build today, Tobin’s Q Ratio would be 0.5. The lower the ratio, the less the investor is theoretically paying for the company’s assets.

At greater than 1, Tobin’s Q Ratio implies that stocks are overvalued. From the chart above, you can see that the Tobin’s Q Ratio for the U.S corporate sector was at 1.05 at the end of last year, which is approaching the level associated with past market declines. The historic mean over more than 100 years for the ratio is just .68 and there are only a few occasions over that time when the ratio passed 1.0. The late 1990’s was the only instance in which the ratio passed 1.1. At that time it shot up to 1.63, before eventually plunging. But should we really hold up the dotcom mania as a benchmark for sound valuations?

3) U.S. STOCK PRICES VS. GDP

The chart below compares the total market capitalization of all publicly traded U.S. companies with U.S. GDP.

Since 1950 the median figure of this ratio is .65, meaning that all public companies together were worth 65% of that year’s GDP. Currently, the ratio is nearly double that at 1.25. The only times U.S. stocks were valued higher relative to GDP were in 1999 and 2000.You know how that ended.

4) U.S. STOCK PRICES VS. MARGIN DEBT

Just as it’s possible to buy houses with debt (mortgages), people can buy stocks with debt (it’s called margin). As stocks go higher, an increased number of investors may become tempted to use credit to buy appreciating assets. This is particularly true when low interest rates push down the cost of borrowing. Not surprisingly, the chart below from the New York Times shows that stock margin debt as a percentage of GDP is approaching the higher end of its historic range:

New York Times (5/31/2014)

As we have seen in so many of the other metrics, the chart shows large spikes in 1999 and 2007. And while it’s certainly possible that margin debt could go higher from current levels of 2.27% (it reached 2.85% in 1999), it is also possible that margin debt will decrease sharply soon thereafter. When margin equity falls below a certain percentage, many investors are forced to sell stock to repay the loans, which brings downward pressure on share prices. We have seen this movie before, and it’s not a comedy.

5) U.S. STOCK PRICES VS. DIVIDEND YIELD

Of all the ways to measure stock valuations, dividend yield may be the most tangible. Dividends are what investors are paid directly to own stocks. By that metric, U.S. stocks are looking historically expensive.

Multpl.com (1/2/2014)

As you can see in the chart above, the dividend yield on the S&P 500 at the end of 2013 was the lowest it’s ever been (with the exception of the period around 1999 – there’s that year again).

6) U.S. STOCK PRICES VS. INTEREST RATES

Low interest rates have been the Holy Grail of stock market bulls. By definition, the present value of stocks is higher when interest rates are anticipated to be lower in the future (meaning that investors are willing to pay more for well-established income streams today in anticipation of lower rates).

As seen in the chart above, yields on the 10-year Treasury bond were cut in half between 1981 and 1989They were halved again by 2002, and again by 2011. From there they decline another 25% before bottoming in May 2013, at 1.5%. These historic declines helped fuel an historic rally in stocks.

Low interest rates also tend to keep corporate costs down and profits up (low rates are one of the main factors in the current profit boom), and make stocks more attractive relative to bonds. The Fed’s current open-ended commitment to zero interest rates has inspired many investors to  adopt a “Don’t Fight the Fed” rallying cry. (A new variant on this may be “As long as it’s Yellen, don’t think of sellin.”)

But here’s the problem…although interest rates remain in historically low territory they have been trending upward slowly for the past year and a half. It’s unreasonable to expect this trend to reverse and interest rates to fall once again into record low territory. If the Fed goes through with its tapering campaign and diminishes the amount of Treasury bonds it buys on a monthly basis (purchases that have helped keep rates low), they are much more likely to rise.

In the first weeks of 2014, yields on 10-year Treasuries flirted with three percent for the first time since July 2011, a time in which the Dow Jones Industrial Average was about 23% below current levels.

IN CONCLUSION

While our analysis at Euro Pacific Capital is in no way exhaustive, I believe that the above metrics make a fairly solid case that U.S. stocks are likely overvalued. I believe that the current optimism is based solely on confidence in monetary policy and the belief that the U.S. has embarked on a period of sustained expansion. However, as Peter Schiff has explained many times, the economy now shows many of the over-leveraged and delusional characteristics that existed before the recessions of 2000 and 2008. Perhaps that helps to explain why today’s markets so closely resemble those periods.

Neeraj Chaudhary is an Investment Consultant in the Los Angeles branch of Euro Pacific Capital. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital, or its CEO, Peter Schiff.