Kevin Bambrough: Fiat Currencies Are Worthless
Source: George Mack of The Energy Report 02/08/2011
February 11th, 2011
Kevin Bambrough founded Sprott Resource Corp. in 2007 to take advantage of a future in which he believes trust in paper currencies will diminish. The idea is to invest in natural resources, including precious metals, energy and agriculture, which represent tangible value from which investors will benefit as necessities become more precious. Unlike closed- or open-end mutual funds, the business is a corporation that can buy private equity to ultimately sell, spin out or even take an active investor approach through majority ownership in publicly traded companies. The company also looks for distressed deals. In this exclusive interview with The Energy Report, Kevin and Sprott COO Paul Dimitriadis share their investment philosophy and ideas on how to protect wealth.
The Energy Report: Kevin or Paul, Sprott Resource Corp. (TSX:SCP) bought $74 million of physical gold in 2008 and 2009, which is held in vaults at Scotiabank. How much is that holding worth today?
Paul Dimitriadis: It's worth roughly $105 million, I believe.
TER: It sounds like you're still bullish on gold. Do you think of it as a hedge, a store of value, insurance against catastrophe or all of the above? What is your investment theory here?
Kevin Bambrough: I believe that it's all of the above; but, more so, it's that I place no value in paper money. Fiat currency is worth exactly zero. Right now, we're in a unique time in history in which the populace, as a whole, perceives currency to have value; so, therefore, it does. But I believe that faith is going to continue to dwindle. Ultimately, investments like gold are a much better store of value.
TER: Do you believe that Sprott's stock price will typically underperform its internal rate of return (IRR) until there is some catalyst that causes dramatic inflation or something similar?
KB: In terms of market volatility, I think the market will overvalue our assets at times. Other times, it will have a very negative view and undervalue our assets. The greatest example is to look at the history of Sprott Resource Corp. When we first started the company, we had basically $1.50 per share in cash—that was it. But sometimes the market traded us above $3/share, so we were trading at 2x cash—having done absolutely nothing.
Then, after making significant gains and during the pessimism of late 2008 and early 2009, the stock traded down to about half cash. We had $3.55 in cash and gold per share and we traded down to the $1.80 range, which made no sense. Our goal is not really to trade in line with our asset value at any given point, but rather to be given some value for management's ability to source transactions, create companies and take them public, which we have already done repeatedly. SCP should get a premium value for our ability to involve the right people, including investors and directors, and marry business plans with high-quality assets so our companies outperform their peer group.
KB: Paul, did you want to add to that?
PD: In the oil and gas (O&G) sector, people have no trouble trading companies above their net asset value (NAV) due to their strong management teams. Investors are willing to pay a premium for that. Our hope is that, over time, they'll also be willing to pay a premium for our stock.
KB: With that in mind, we want to make sure we maintain at least a reasonable valuation relative to our assets. Management has committed and demonstrated that we will buy back our stock when it trades at what we believe is an unreasonable discount to the market. So, that really helps to mitigate the risk. We're very aware of the fact that closed-end type vehicles typically trade at a discount because what they do could be replicated fairly easily. You can look at the contents of a mutual fund or a closed-end fund and say, "Well, I could go buy those stocks." But the difference here is that we create businesses in unique sectors with unique opportunities well ahead of when they're properly valued.
TER: Give me an example of that.
KB: We've gotten some significant gains that have come from what initially appear to be very minor investments or very little capital being committed. For example, Stonegate Agricom Ltd. (TSX:ST). In that case, we started with an option agreement totaling $53,000 that turned into a mark-to-market gain of nearly $100 million over a couple of years. And we have made much larger investments, buying things like PBS Coals Limited (LSE:SVST) or Orion Oil & Gas Corporation (TSX:OIP) that were very cheap relative to the public market comparables.
TER: You wanted to get into the fertilizer business with Stonegate because it's a play on agriculture (Ag), a sector on which you're bullish. But doesn't a mining operation add risk to what you already believe is a relatively safe way of playing agriculture?
KB: Let me first say I agree that resource exploration has got to be one of the riskiest sectors in which to be involved. Typically, the odds are insurmountable but Stonegate is not a grassroots exploration. Both of Stonegate's properties had proven historical merit; and our agreement was structured in very low-risk terms, which would minimize any material damage to our assets or the NAV of our company. We approached the transaction, got involved and advanced the asset to the point of going public.
We started with a small investment of $53,000, which was an option agreement that we rolled into a private company, and we ended up with 80% of that company. We were in a very, very comfortable position as far as the money that we had to put in. Stonegate went public with a $50 million offering and, post-IPO, we retained about 54% of the company. We put $12 million into that IPO, which basically gave us a claim on 54% of $50M through our shareholdings. So, there was very little risk.
TER: You've said you're bullish on uranium. Could you tell me your investment thesis there?
KB: The investment thesis on uranium really stems first from the fact that I'm a believer in peak oil. The major oil discoveries were made in the 1960s and 1970s, and the world's major oil fields on most continents have already peaked in terms of production. Now, the discoveries are getting smaller and those that get headlines from time to time are really irrelevant compared to the scale of global consumption. We still get something like 50% of our energy from oil. That statistic—and the fact that the U.S. is a massive importer of oil and runs a substantial trade deficit—has led me to the view that energy prices in the U.S. will go up dramatically. Also, in looking at the cost of coal production, we don't properly account for the environmental costs. I don't think we've begun to come close to accounting for greenhouse gases or general pollution.
So, I think nuclear fuel and nuclear power will grow out of necessity. There's really no other choice than to see significantly higher uranium prices to spur production to meet what I believe is going to be burgeoning demand. In the U.S. in particular, where 90% of uranium is imported, I believe that it'll become an issue of national security that the government will get behind; it'll advocate increasing production in order to protect our energy security.
TER: How are you playing uranium?
KB: We own approximately 20% of the Coles Hill uranium project in Virginia mostly through a private company, of which Virginia Energy Resources Inc. (TSX.V:VAE) owns roughly 30%.
TER: The stock is up more than 300% over the past six months. Back in mid-October, the company announced an NI 43-101 preliminary assessment that stated the net present value (NPV) of the Coles Hill uranium project was more than $400M. Do you see more upside to this stock?
KB: Well, if you look back on that study, you'll see that with higher-priced uranium, the NPV rises dramatically. That's what we've seen recently, as the price of uranium has moved up. And I think you need to see uranium in the $75/lb. area on a sustained basis to encourage supply. Then I think the NPV will be in the $600 million area. But I don't think that study really optimizes uranium's value because, if you were to increase production rates, you would potentially get a higher NPV; and I think that ultimately is what should happen. The reason it's still trading at such a discount to that NPV is purely due to the lack of a uranium mining law in the state of Virginia. We're hopeful that, eventually, it will be resolved in a positive way so the project can go forward.
TER: Sticking with your peak-oil view, you mentioned Orion Oil & Gas a moment ago. Tell me about that.
PD: We completed the transaction in September of 2009. It was a private company that had been distressed. The banks were closing in on some of its lines. The company was looking for recapitalization. We co-invested with Gary Guidry, who, as CEO of Tanganyika Oil Company Ltd., sold his company to Chinese refiner Sinopec Shanghai Petrochemical Company Ltd. (NYSE:SHI) for CAD$2.2 billion. We purchased 80% interest in Orion for $107 million with a mixture of cash and stock; the total purchase price of the deal was $130 million. We just announced that Orion had released updated reserve numbers demonstrating an NPV of $440M on a 10% pre-tax basis—an increase of $106M over the prior year and a 34% increase in reserves from the prior year. Those results stem principally from the large capital program that was put in place this year. The assets are 50% oil and natural gas liquids (NGLs) and 50% natural gas.
TER: You invested $107M. How much have you made on this?
KB: Mark-to-market, it's more than double today.
TER: Orion is 50% gas weighted. Kevin, you've said cheap gas is a myth.
Source: George Mack of The Energy Report 02/08/2011
February 11th, 2011
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1.) George Mack of The Energy Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2.) The following companies mentioned in the interview are sponsors of The Energy Report: Virginia Energy Resources.
3.) Kevin Bambrough: I personally and/or my family own shares of the following companies mentioned in this interview: Sprott Resource Corp. I personally and/or my family am paid by the following companies mentioned in this interview: None.
4.) Paul Dimitriadis: I personally and/or my family own shares of the following companies mentioned in this interview: Sprott Resource Corp. I personally and/or my family am paid by the following companies mentioned in this interview: None.