“Kill the bill, don’t kill us”.
This was the chant of protesters outside the Senate chamber on December 20, one of the most significant days in American tax history. Against the wishes of protesters – who believe the bill threatens their access to health care – the bill passed. Donald Trump secured a major victory in tax reform, one of the most important parts of his election platform. The historic $1.5 trillion tax reduction package will affect every American taxpayer and corporation.
In last month’s issue, I wrote about how the bill will benefit corporations. The centerpiece of the bill is a reduction in the U.S. corporate tax rate to 21% from 35%. Also, corporations holding huge amounts of cash overseas will get a tax break so they can “repatriate” the money and bring it to the U.S. Companies from Apple (which has over $250 billion overseas) to Oracle ($48 billion stashed internationally) could bring enormous amounts of capital back into the U.S. The chart below shows a list of U.S. companies and the amount of capital they hold outside of the country.
The theory is that all this tax relief will spur companies to build factories, invest in research and development, expand, hire American workers, boost dividends, and buy back stock.
As I detailed last month, I believe the tax relief could result in a historic amount of capital flowing into the U.S., which would boost the U.S. dollar. Since commodities are priced in dollars, I stated that a rising dollar would be a headwind for commodity prices. However, that doesn’t mean all commodities will struggle in 2018 and beyond. A dollar headwind can be overcome by strong fundamentals. I believe some commodities will still do very well. Another Donald Trump “win” will see to that…
Sometime in mid-January, the Trump Administration is set to announce a $1 trillion infrastructure program proposal. A version of this bill passing in 2018 could kick off a higher demand for base metals. All those roads, bridges, power facilities, and broadband networks will require huge amounts of base metals like copper and zinc.
Plus, you know I believe the mass adoption of Electric Vehicles is very bullish for copper. And despite its critics’ dire forecasts, the Chinese economy is still growing… and still consuming huge amounts of base metals.
This trend of robust demand is manifesting itself in the charts of base metals. As I write, copper is near a three-year high…
The cobalt market has tripled in the past two years…
And nickel prices have strengthened considerably over the past 12 months.
We already have exposure to copper with Nevsun Resources and Equinox Gold. Now, I want to get exposure to all of the industrial metals. In a few moments, I’ll detail the way I’m going to do it.
Also in this month’s issue, I will veer from the main focus of this newsletter (the resource and commodities markets) and into something with massive momentum and capital flooding into it. We’ll get deep into Bitcoin, altcoins and the specifics of cryptocurrency mining.
How to Get a Piece of Everything
Over the coming years, I expect to buy and sell many commodity firms that employ a “targeted” approach and focus on single commodity markets like copper, zinc, and cobalt. However, I believe there is a lot of money to be made with the “shotgun” approach. This approach is to own one single world-class company that owns a broad and diversified portfolio of incredible base metal assets.
While this company isn’t well-known in the United States, the mention of its name in commodity markets around the world commands respect. This company is so dominant, so shrewd, and so powerful that its name can even instill fear in competitors.
Its name is Glencore… and it aims to put a stranglehold on the base metal market as one of the top copper, cobalt, and zinc producers. And to add a cherry to the top of this ice cream sundae, this company boasts a sophisticated and successful commodities trading business that creates large profits for shareholders…
In 1974, an American named Marc Rich created a company called Marc Rich & Co. The business-focused on trading base and precious metals along with crude oil. Marc was one of the savviest and most opportunistic traders of his time. He didn’t care who he was buying from or who he was selling to. All he cared about was making money. Whether it was deals with the Cuban dictator Fidel Castro, corrupt African governments, or Middle Eastern and African rebel groups, Marc was always happy to strike a deal if it could make him money. This way of doing business allowed Marc to build one of the most powerful commodities trading firms in the world… and earned him a huge fortune.
Opportunistically, Marc acquired millions of barrels of Iranian oil during the 1979-1981 hostage crisis. The U.S. government deemed these actions as “trading with the enemy,” which forced Marc to flee to Switzerland – or serve serious jail time. Because of these deals with the Iranians, Marc rapidly ascended the ranks of the FBI’s Most Wanted list. He would remain on the Most Wanted list for two decades before eventually being pardoned by Bill Clinton.
In 1993, Marc famously attempted to buy up a large portion of the zinc market. This is known in the industry as “cornering”. By controlling a large portion of the supply, a single trader can dictate prices around the world. The plan failed epically, and Marc lost nearly $200 million. The move ended up costing Marc more than just money. His business partners also forced him to give up his majority stake in the company. Following a management buyout of Marc’s stake in Marc Rich & Co., a new CEO named Ivan Glasenberg was put in his place, and the company was renamed Glencore.
Under Glasenberg’s command, Glencore continued to dominate the commodity trading business while expanding its mining operations and metal smelting business. In May 2011, the company went public, raising $11 billion. In 2013, the company merged with Xstrata, a Swiss mining behemoth. The combined business created a $65 billion commodity powerhouse.
The commodity bear market that started shortly after the merger spared no company. Not even the great Glencore was immune to decline. The company lost nearly 80% of its value, bottoming out at a little over £1 per share in 2015. In an effort to bolster its balance sheet, Glencore sold or spun-off many of its high-cost and non-core assets. The move worked. Today, Glencore is one of the most powerful commodities trading houses in the world and is one of the world’s largest producers of base metals.
Glencore stands to benefit from a commodities supercycle like few other companies do. The reason is because few, if any, companies are as vertically integrated as Glencore. Glencore has the unique ability to mine the metals, ship them to its own smelters for processing, and then sell the refined products to downstream users. This integration allows Glencore to capture the entire commodity value chain. The ability to opportunistically move commodities all over the world is very rare and exceptionally powerful.
Management Strength
The upper brass at Glencore are some of the smartest investors and traders on the planet. Long-time CEO Ivan Glasenberg has run the company since taking over for Marc Rich in 2002. Ivan is a shrewd dealmaker, and as Glencore’s CEO, he played a crucial role in the merger with Xstrata. Ivan’s right-hand man is Chief Financial Officer Steven Kalmin. Steve started out in Glencore’s coal division in 1999 and was promoted to the CFO role in 2005.
In a company this size, management’s common share ownership is normally diluted to only a few percent. But at Glencore, these managers have lots of skin in the game. Ivan Glasenberg is the company’s second-largest shareholder. He owns just over 8.4% of Glencore or 1.2 billion shares. The rest of the management team is strongly aligned with common shareholders, owning another 7% of the company. In total, Glencore’s upper management owns over 15% of the common stock. Again, this is a huge stake for management and quite unusual for a large company.
Projects and Assets
Glencore’s operations are comprised of 150 mining and metallurgical sites, oil production assets, and agricultural facilities.
The company derives a significant portion of its annual cash flow from the production and trading of copper, zinc, nickel, and coal. In each of these major commodity divisions, the company is a top five global producer. Additionally, each division has enough reserves and resources to last at least another 20 years.
Based on 2016 production figures, Glencore ranks third in global copper production, behind the private Chilean miner Codelco and Freeport-McMoRan. Glencore owns a 44% stake in the Collahuasi copper mine, which is the world’s second-largest producing copper mine. Glencore also owns 100% of three other world-class copper mines which rank in the top 25 in terms of annual production.
Glencore is the world’s largest producer of zinc. It owns 69% of the world’s third-largest zinc mine, and 100% of the fourth- and sixth-largest zinc producing mines in the world. In total, Glencore accounts for 8.6% of the world’s annual zinc production.
Glencore’s Canadian nickel operations in Sudbury have been a cornerstone asset of the company for over 20 years. The mine generates nearly 100,000 tonnes per year, which is 5% of annual global nickel production. Based on Glencore’s 2016 production, it is the world’s third-largest nickel producer. The company owns 100% of three of the world’s top 20 nickel producing mines.
In today’s world, it’s nearly impossible to not read a headline about electric vehicles. Inside each electric vehicle is a rechargeable battery, and a crucial ingredient in each of these batteries is cobalt (our August 2017 issue covered this topic… read it here). This is a niche market which Glencore virtually has a monopoly on. As a by-product of its copper and nickel operations, Glencore currently produces over 20% of the world’s cobalt. Glencore is also restarting what will soon be the world’s largest cobalt mine. Glencore’s annual cobalt production will be over 50,000 tonnes by 2019, or just under 50% of global supply.
For years, Glencore’s commodity trading division has been a stable cash flow generating business. It’s said that Glencore owns more ships then the British Navy. Glencore conducts business in every corner of the world and is not shy to go into AK-47 nations to strike opportunist deals. The trading division will continue to be a cornerstone asset of Glencore for the foreseeable future.
Between 2017 and 2020, Glencore expects to aggressively ramp up production of all its major commodities. The chart below shows the growth rates between 2017 and 2020 for each major division.
Valuation
Glencore has the unique ability to generate revenue and cash flow via its mining and smelting operations along with its commodities trading business. The trading business provides stable annual cash flow, while the mining business supplies the upside leverage to a rising commodity price environment.
Below is a chart that shows estimated cash flow generated by each division of the company and its percentage contribution to total cash flow in 2018.
The commodities trading business is the most stable of the businesses. The trading business capitalizes on the company’s ability to opportunistically move commodities from areas of low demand to areas of high demand. It’s the ultimate buy low, sell high business. Glencore collects fees on moving the commodities from point A to point B. In 2018, we estimate Glencore will generate over $2.5 billion in cash flow from its commodity trading business.
The mining business is driven primarily by copper, zinc, nickel, ferroalloys, and coal production. Based on current commodity prices, Glencore is going to generate significant free cash flow. As discussed above, Glencore operates some of the world’s largest and most profitable mines.
Management has indicated that increasing the dividend is a top priority. My models are telling me that within the next two years, the dividend should double… and that a dividend yield of 4% is sustainable over the long term.
One of my favourite metrics for identifying high dividend growth potential and undervalued share prices is the Free Cash Flow Yieldmetric. This metric is the ratio of free cash flow to the company’s market capitalization. The higher this percentage, the more attractive the company is.
Right now, Glencore trades at a Free Cash Flow Yield of 4.58%. For comparison, its peer group average is 10.66%. This makes Glencore look very bad. However, by my math – even using conservative metal prices – Glencore’s Free Cash Flow Yield could reach 11.28% by 2019. The reason for the rise is increased production at many of its large, low-cost mines. Furthermore, Glencore will be capitalizing on the massive bull market in cobalt.
Below is a chart of Glencore’s historical free cash flow and the Katusa Research estimates for free cash flow through 2020. These forecasted estimates use metal prices which are conservatively priced below today’s levels.
I believe that in a solid commodity pricing environment, Glencore will be able to meet or exceed pre-2015 free cash flow levels.
Balance Sheet and Capital Structure
Glencore is an actively traded company with a primary listing on the London Stock Exchange. It is also traded in the U.S. over-the-counter market.
Since the bottom of the commodities cycle in 2015, the company has repaired its balance sheet significantly. At the bottom of the market, Glencore had over $50 billion in debt. Since then, asset sales of non-core and high-cost assets have bolstered the balance sheet, lowering company debt by $20 billion.
Base metal prices have risen significantly over the past 12 months. Even if they were to stay at current levels moving forward, Glencore would generate nearly $8 billion in annual free cash flow. If base metal prices continue to rise, which I suspect they will, then Glencore’s free cash flow will continue to increase. This free cash flow can be used to pay down debt, increase dividends, and spur additional long-term growth.
Political Environment
Glencore operates in every corner of the world, from safe jurisdictions like Canada and Australia to dangerous countries like the Congo and Kazakhstan. The company is extremely well connected, especially in AK-47 nations. As powerful as Glencore is, the company has had its issues with operations being nationalized. In the past, the Bolivian government did nationalize several of Glencore’s assets, but recently the company has not been at war with any governments.
Glencore has significant infrastructure in the Democratic Republic of the Congo. Many consider this one of the worst countries in the world in terms of stability and political risk. However, Glencore generates enormous tax revenues for the country and has very close ties to top officials. While I see Glencore having to pay out its fair share of bribes, it will also get its fair share of lucrative deals.
Company Catalysts
The biggest catalyst for Glencore is base metal prices. Glencore is highly leveraged on a rising commodity price environment. A 10% rise in base prices can add nearly 20% to the Net Asset Value of Glencore.
Furthermore, one could make the case that Glencore is the most well-positioned company to take advantage of the electric vehicle revolution. Given Glencore’s massive copper, cobalt, and nickel mining operations on top of its premium smelting division, the company is extremely well-positioned to sell metals to electric vehicle and battery manufacturers. Many companies currently in the space can only mine one of these metals. Glencore can mine all three in huge quantities. This gives it a massive competitive advantage.
The focus for Glencore over the next 12 months will be to execute on generating free cash flow. I expect management to hit their cost and production targets and to increase the company dividend.
Investment Recommendation:
If you choose to follow the investment recommendation, I highly suggest you utilize my tranche buying strategy that I have outlined in past editions. The resource market is extremely volatile, and even a powerful company like Glencore can see its share price decline by 25% in the span of a few weeks. For new subscribers, do not rush off and buy a position at market prices. Let the price come to you. This is an investment strategy that I detail and remind readers extensively about in my educational essay, The Way of the Alligator. This plan of attack – waiting patiently for the time to strike – has served me very well in my career, and it will serve you well too.
Here’s how I’m looking to build a position: My suggestion is to buy Glencore using a 4-tranche strategy.
The table below shows the buy under guidance for the London Stock Exchange listing (LSE: GLEN) and the U.S. listing (OTC-BB: GLCNF). I’d rather see you buy the stock on the London exchange. It has more liquidity. However, if you don’t have access to the London exchange, you can buy the U.S. OTC listing.
Hypothetical Example:
Let’s say you wanted to buy $10,000 worth of Glencore. You would split your four purchases into four even dollar amounts. In this case, $2,500 for each tranche ($10,000 divided by four tranches).
Tranche #1: Buy an initial 25% of your total position below £3.30 per share on the London exchange or $4.50 per share on the U.S. OTC-BB.
Tranche #2: Buy a second 25% tranche below £2.75 per share on the London exchange or $3.75 per share on the U.S. OTC-BB.
Tranche #3 & #4: Keep 50% of your Glencore investable cash as “attack capital” to pounce on additional market weakness in the future.
The Greatest Mania in the History of the World?
At the recent San Francisco Gold and Silver Summit, I was amazed by the questions I fielded relating to cryptocurrencies and blockchain-related companies. Also, as I expected, Frank Holmes (chairman of Hive Blockchain and U.S. Global Investors) and Teeka Tiwari were big draws for the audience. The panel I moderated with Jim Rickards, Teeka Tiwari, Doug Casey, Frank Curzio, and Michael Gokturk has been a viral video hit. I’ve gotten requests from many publishing houses to run the video to their subscribers and readers.
Even with the recent price correction in cryptocurrencies, there is significant momentum in the sector. And where there is significant momentum, there is an influx of capital. And that leads to money being made.
I am not a gold bug. I’m not a uranium bug. I’m not a (insert any commodity here) bug.
I’m a profit bug.
If there’s money to be made, it’s on my radar. And when I’m serious about making money, everyone around me knows it. If I kept track of my steps in a day, it would number in the tens of thousands as I walk frantically from pitch to pitch and office to office hearing the latest financings, deals, and structures.
Much to the chagrin of my family, I’ve had an endless cast of characters come to my house in the last few months. Crypto miners, crypto exchanges, blockchain entrepreneurs, and other companies looking to create the next hot coin offerings. And an even larger cast of characters has been calling in, sending emails, and flying in to pitch their deals and ideas.
Vancouver is a hot spot for serial entrepreneurs. It’s also a hotbed for “also-ran” companies that are chasing the flavor of the day. I’ve seen the cycles. Ten years ago, it was uranium. Two years ago, it was marijuana. Now it’s crypto and blockchain.
The Wild West Lottery Tickets on the TSX Venture Exchange
Entrepreneurs are drawn to the TSX Venture Exchange because of the ability to get into a public listing through the “back door” – that is, with a Reverse Take Over (RTO). One day, I’ll go into detail on the many tricks of the trade of how these deals are structured, but that’s outside the scope of this month’s issue.
Because of the simplicity of getting a listing, there will be an explosion of blockchain and cryptocurrency listings on the TSX Venture Exchange in 2018. Currently, there are about 18 companies in the space (many of which came to light in the latter half of 2017) and upwards of 50 are expected to launch this year. It all reminds me of the hundreds of uranium “also-ran” companies in the uranium bull market of 2006 that used to be dot-coms and involved in other industries that were near death at the time.
Here’s how my experience with Bitcoin and cryptocurrency came to be…
Act 1:
In early 2010, while I was working with Casey Research, I sent my colleagues an email about this digital currency called Bitcoin, which at the time was mainly used in the underworld.
I was not introduced to Bitcoin by any analyst, broker, or investment advisor, but rather by someone who I always thought had a shady past.
In high school and university, I played very high-level hockey and wrestling (provincial all-star, junior level, and was asked to represent Canada in the Commonwealth Games in wrestling). This meant I spent a lot of time in my teens in a weight room.
Not all of the characters I worked out with had the same ambitions in life I had at the time. And many of the characters preferred taking a faster route to strength: steroids.
Ten years after last seeing this one individual who I knew was a steroid monkey in the past, I ran into him on the street in Vancouver.
This individual told me that he was onto something huge and asked me to lend him $25,000. He was bigger than ever, so clearly the steroid lifestyle hadn’t ended. Obviously, I didn’t lend him the money. I had not heard of Bitcoin at the time but thought it was interesting and sent the email off to my colleagues.
We collectively decided that Bitcoin was too taboo and “underworld”.
Bitcoin was on my radar. But it was always “shady” characters that were pounding the table on Bitcoin in the early years, which made me view it negatively at the time.
Act 2:
About a year ago, successful fund manager Mark Hart III became convinced that cryptos would get very big. So he started a new fund – one of the first funds I knew of in the sector.
I was intrigued, and I was one of his first investors.
Now, I had skin in the game, and now you are seeing how I slowly progress into a sector. I find the smartest and brightest in the sector, and back them in a small way to see how the speculation develops. If it’s real, there will be lots of time for me to get involved in a bigger way.
Act 3:
Fifteen years ago, before I started doing what I do now, I taught calculus at a university (and before that at a high school). Most of the students I taught were of Chinese/Taiwanese descent, and their parents had extremely high expectations for their kids to get the best results.
One of those students worked with me in my very early days at Casey Research. Together with Joe Hung, I formed an analytics team that could rival any hotshot team at Goldman Sachs. Long before expensive data terminals became the norm, we built incredible databases that tracked everything from resource price forecasts to supply and demand figures to key company metrics. Our proprietary system allowed us to spot and capture outstanding gains time and time again.
Fast forward 10 years and the other half of my superstar analytics team is back in the Katusa fold. He’s made serious money in the markets and even franchised successful restaurants in Canada. And he’s always hungry for the next challenge. He’s a math prodigy, and I’ve now hired Mike Chang full-time to head my new crypto and blockchain analysis division that I’ve nicknamed “Special Situations”.
Below, Mike and I break down the essentials behind cryptocurrencies you might not know from reading hastily assembled articles written by non-experts.
The Case for Cryptocurrency
Those of you who have been following the news in any capacity have no doubt found yourselves awash in reports heralding The Next Big Thing: Bitcoin. Bitcoin’s meteoric rise this past year has made it the jewel in the eye of journalists everywhere, and with good reason – the blockchain technology underlying Bitcoin could bring about significant changes on a global scale.
Though many have been quick to call Bitcoin a bubble and say its growth is unsustainable – sentiments that I don’t disagree with – Bitcoin has also made many nerds and investors alike very rich. And perhaps most importantly, I believe that it still has the potential, even at this price point, to achieve sizeable gains for those of us who are late to the party.
How will we do that, you ask?
More Than Just the Coin
As always, you should seek to understand anything you’re looking to invest your money in. With Bitcoin, the story is no different, even if the technological aspects of Bitcoin are somewhat removed from our usual haunt, the resource industry. I will be glossing over the basics and skipping straight to the juicy stuff in this issue.
There are currently two vectors for us to approach from when it comes to investing in cryptocurrency. There are the coins themselves, whether it be Bitcoin or Bitcoin alternatives like Ethereum, and there are blockchain companies, which seek to integrate blockchain technology with pre-existing sectors such as financial services and retail.
Much as with metals like gold and silver, investing directly in coins is the most direct exposure one can have to the actual performance of Bitcoin itself. However, buying coins can be a bit of a hassle – setting up your wallet, registering with a coin exchange, and actually making your transactions, which can take up to hours to confirm. Storage is also an important concern – the cautionary tale of Mt. Gox, the once-premier Bitcoin exchange that was hacked back in 2014, resulting in the loss of 850,000 bitcoins (USD$12 billion at today’s prices), is one that should not be forgotten anytime soon.
Perhaps most important, though, is the fact that Bitcoin is already rather expensive, trading around the USD$14,000 mark as of time of writing. And while many are calling for Bitcoin to go even higher – to the $50,000 or even the $100,000 mark – the fact remains that it will only become harder for Bitcoin itself to deliver the multiples I typically look for.
Bitcoin alternatives (“altcoins”) are worth considering, as even though the price of Bitcoin obviously heavily influences the price of all other coins, the actual exchange rate from each altcoin to Bitcoin itself can also vary based on the specific altcoin’s own merits as well as its perceived intrinsic value. Below is a chart that tracks the exchange rate of Ethereum (the current leading altcoin) to Bitcoin over the past year:
Ethereum’s performance has been stellar as well, rising from a mere $8.25 at the beginning of this year to its current $875 at the time of writing. You can see from the chart that the Ethereum/Bitcoin exchange rate actually peaked in late June, meaning that in the first half of the year Ethereum actually outperformed Bitcoin on a relative return basis. In the second half of the year, however, this trend reversed, and Bitcoin proved itself to be the more attractive investment of the two.
As you can see, opportunities in altcoin investments like this exist but require an extra layer of diligence. On top of taking Bitcoin’s future performance into consideration, one must also accurately determine how the market perceives a given altcoin’s relative worth compared to Bitcoin. This greatly complicates things, so we’ll set this aside and move on for now.
Our other consideration here is to invest in blockchain technologies. As previously mentioned, blockchains can be applied to all sorts of different sectors, but its specific implementation in each sector is unique and can be handled in different ways. Blockchain companies are the ones developing these implementations, with the end goal of being able to package and sell software and hardware solutions to companies in their target sector much as a “conventional” tech company would.
The diversity of blockchain technology’s applications allows for all sorts of companies to be able to brand themselves as blockchain companies – which, unfortunately, also makes it much harder to separate the wheat from the chaff. I find the blockchain space to be quite similar to the pharmaceutical space for this reason. In pharmaceuticals, where the success or failure of a company rides almost entirely on how well its flagship drug does in trials, the success or failure of a blockchain company would rely on how well its blockchain implementation can meet the needs of, and be marketed to, its target sector.
With pharmaceuticals, one needs to have intimate knowledge of both the underlying science as well as the product in question in order to properly value the company. This remains the case for blockchain companies, but those details are beyond the scope of this publication.
There are a number of listed blockchain companies already, and many of them are already seeing high valuations – though this is generally due more to the marketing push and momentum currently surrounding the Bitcoin and blockchain space than the actual fundamentals of the companies in question. That said, while it may be tempting to invest based on hype alone, it would be smarter to invest in a company that has both the hype as well as the fundamentals so that when the bubble eventually pops like the dotcom bubble popped in 2000, you aren’t left holding worthless shares.
Where does that leave us then?
Well, there is in fact one more vehicle for investing in Bitcoin – one that allows us to retain exposure to the price and success of Bitcoin, while still giving us fundamental metrics to use in our valuation models.
Mining for Electronic Gold
This alternative vehicle I’m talking about is one that should be at once both strange yet comfortably familiar to readers.
Bitcoin mining is not unlike mining for traditional metals, much as resource companies have long been doing. Though the underlying asset and the extraction methods are a little different from what we’re used to, the process is the same: companies invest capital in setting up the infrastructure and equipment for an operation that generates enough cash flow to pay back the initial investment, and then some. The only difference is that we’ve traded excavators and dump trucks for computers, mining licenses and mines for air-conditioned warehouses, and gold for its digital equivalent.
The first question, then: How exactly do you go about mining Bitcoin?
Setting aside the specifics of block generation and rewards, the simple answer is: with a lot of dedicated computing power. While it’s still entirely possible to mine Bitcoin on your own computer, companies looking to get into the mining scene these days will instead choose to purchase special hardware dedicated to mining Bitcoin. Called Application Specific Integrated Circuits, or ASICs, these pieces of dedicated mining hardware form the backbone of any crypto mining operation.
So, that’s the first step. The next step is to secure a space for all your hardware. Ideally, this space is dry, well-ventilated, and perhaps most importantly – cold. Bitcoin mining hardware generates quite a bit of heat, much like using a laptop on your lap would so imagine the kind of heat that a warehouse stacked high with these ASICs would produce. The higher the ambient air temperature, the less efficiently these electronics run, so being able to maintain temperatures at a comfortable level for electronics is a key part of the site selection process. And of course, a fast internet connection is quite important too, so we wouldn’t want to locate our warehouse in the middle of nowhere.
Finally, we need a source of power for our operation. ASICs are very power-hungry, and a warehouse full of them will require a cheap, steady source of electricity to ensure that downtime is minimized and costs are kept low. In fact, beyond the capital expenditure of acquiring the ASICs in the first place, the next most significant cost would be that of the power required to keep the hardware running. Selecting a jurisdiction with cheap electricity costs and/or being able to negotiate a good contract from the utility will help immensely in the long run.
With all that said, the next question is: How do we go about figuring out which companies are doing it right?
Let’s go back and start at the top of the list again, with hardware. What separates one Bitcoin mining ASIC from another? Well, actual processing power, known as the hash rate in this case, is a key indicator. Power efficiency is another, as different ASICs may expend differing amounts of power in order to produce the same results. Form factor is also a consideration, as the smaller the hardware, the more of it you can pack into the same space.
With all of these factors in mind, the throne of the Bitcoin mining ASIC market is currently occupied by BitMain’s Antminer S9. Available for purchase by commercial and retail miners alike, the S9 is the momentary king of the fast-paced tech race to produce ever more powerful, ever more efficient hardware. While the S9, released last year, maybe unseated in another year or two, at the current point, it is the go-to ASIC for all Bitcoin miners. Being able to secure a large number of these is the goal of any mining startup.
The next issue that needs to be addressed is how to house all of our mining ASICs. Keeping all of them in a nice air-conditioned warehouse would do the trick, but it would be easier if the ambient temperature was already low to begin with. That makes countries with low average annual temperatures more appealing since this would enable us to save on some of the costs of maintaining an ideal temperature for our mining machines.
The other important aspect of selecting the right locale for our mining operation is the cost of electricity there. Not all countries are equal when it comes to power generation. Australia currently “leads the way” with some of the highest electricity prices in the world, thanks to a decade of political mismanagement. Below is a chart of average electricity costs in a select group of countries, contrasted against their average annual temperatures:
The Nordic countries stand out here. They boast both cheap electricity prices as well as cold annual temperatures, on top of being highly developed nations that have well-developed infrastructure and easy access to high-speed internet. For the same reasons, Canada is also a winner here.
The current leader of the pack, however, is China, whose low costs, in general, have made it the most attractive destination for Bitcoin mining. As a matter of fact, nearly half of the world’s cryptocurrency mining capacity by megawatt (MW), is located in China!
As Bitcoin mining continues to grow in scale and more companies enter the space, I expect China to lose some market share to the U.S., Canada, and the Nordic countries, as they all boast ideal conditions for Bitcoin mining operations and are much more familiar to investors looking to enter the space.
Putting It All Together
Now that we have all the ingredients we need to set up our own Bitcoin mining operation, the last question we need to ask ourselves before we pull the trigger is this: Just how much money does Bitcoin mining make, anyway?
To answer this question requires us to once again touch upon some of the more technical aspects of Bitcoin – this time specifically with regards to difficulty. Mining for Bitcoin is quite similar to mining for a tangible resource in the sense that Bitcoin will eventually, “run out”. You may already be aware of the fact that when Bitcoin was designed, it was implemented in such a way that there would never be more than exactly 21 million bitcoins in existence. In a sense, this is the original Bitcoin “mineral reserve”. And again, just like with mining for a tangible resource, the closer we get to that 21 million mark, the harder it gets to mine for new coins, but for different reasons.
Where mining for Bitcoins differs from traditional mining is that for the former, you don’t have a mining license that allows you to mine your own property for bitcoins. Instead, there is only one giant mine for everybody, and you are constantly fighting everybody else trying to mine bitcoins to be the one who gets to it first.
The natural response, of course, would be to increase the number of ASICs you have mining, in an effort to ensure that you have a greater chance of being the one who finds the bitcoin (discovers the block). But since everybody has the same idea, the total numbers of miners in the Bitcoin pit (the hash rate) continues to grow. In order to prevent the supply of coins from running out too quickly, Bitcoin’s algorithm is devised in such a way that on average, a new block (12.5 bitcoins) is discovered only once every 10 minutes.
Long story short, the net consequence of all this is that no matter how many companies jump into the Bitcoin mining space, there will only ever be a constant 1,800 Bitcoins mined every day (until about mid-2020, when the next halving will occur, dropping this number to 900).
While this may sound bad for would-be Bitcoin miners, drilling down into the numbers reveals quite a different story:
Even with polynomial projected growth in network hash rate and difficulty, the profitability (net of electricity costs but less lease and administrative expenses) of Bitcoin mining remains quite excellent, with payback periods remaining shorter than a year well into 2019. Note that these numbers are based off of 4¢/kWh electricity and Bitcoin staying at USD$14,000 – but even if Bitcoin drops back down to $10,000, companies entering this space early (within 2018) will still see initial capital costs recouped in well under a year. In other words, companies that are entering this space now, situated in high-grade locales with low ambient temperatures and cheap electricity, will stand to make solid profits.
So What’s the Catch?
I know what you’re thinking. “This sounds great, Marin! Which company do I invest in?”
Well, you see… there’s a problem.
Thanks to all of the hype generated by Bitcoin’s rush to the near-$20,000 mark, Bitcoin is now the word on the street… and not just Wall Street. Just a few days ago, I left my office to grab some coffee, and on the way, I overheard three separate conversations concerning Bitcoin and the blockchain space. One of my analysts even had his barista bring up Bitcoin as she was making his order!
What this hype has done to blockchain and Bitcoin stocks has been phenomenal, for all the wrong reasons. Much as with the dotcom bubble of the late ‘90s, people are now willing to throw money blindly at any company with “blockchain” or “Bitcoin” in its name without any regard as to the company’s actual operating plan or revenue strategy. As you know, this is unsustainable madness.
On December 21, Long Island Iced Tea Corp., trading as LTEA on the NASDAQ, announced that it was switching from the bottled soft drink industry to the blockchain industry and changing its name from Long Island Iced Tea Corp. to Long Blockchain Corp. The company announced no tentative agreements, no deals underway, just vague mentions of possible entities looking for potential partnerships…
The stock tripled that day on huge trading volume.
Long Island Iced Tea Corp. was not worth any more at the end of the day than it was at the start of it. There were no material changes to its business. It did not magically acquire USD$45 million in cash on its balance sheet.
Yet for no reason other than the fact that it now had “blockchain” in its name, investors decided to give Long Island Iced Tea an extra $45 million in valuation. And as of the New Year, Long Island Iced Tea is still trading at three times its previous, pre-blockchain valuation, with no further news.
This has been the case for all companies in the cryptocurrency sector in the past few months. Even Bitcoin miners, who present the closest thing we have to a fundamental-centric play on Bitcoin, are not exempt:
An S9 ASIC currently costs approximately CAD$3,000 per unit. Yet for these companies, at the low end you are looking at an acquisition cost of upwards of $20,000 per S9 equivalent of mining capacity. Obviously, these companies are saving you the hassle of having to buy and set up your own S9 ASICs to mine with, but the premium involved is astronomical.
I have always been strongly against investing in a stock based solely on its momentum, and Bitcoin/blockchain companies are (right now) valued almost exclusively based on hype. Without strong fundamentals backing the company up, there’s a good chance that when the bubble pops and the dust settles, all you’re left with as a shareholder is the short end of the stick.
I like bringing up the dotcom bubble as an analogy for many reasons. Another one of those reasons is the little-known fact that by 2004, four years after the peak of the bubble and well after it had burst, 48% of dotcom start-ups were still in business. This half of the companies were the ones that kept their eye on the bottom line despite all the hysteria, tagging along for the ride while never losing sight of their fundamentals. Almost two decades later, here in the Bitcoin bubble, those are the same companies we are looking for.
I haven’t found anything convincing yet. But you know I’ve got my eyes peeled and ears to the ground, and rest assured, you’ll be the first to know when I find something.
Company Updates
Below are the company updates for each company in the Katusa Resource Opportunities portfolio. December is always a quiet month in the markets, so do not be too concerned with the minimal news flow this month.
Liberty Gold
Liberty Gold has completed its drill program at its past producing gold deposit Goldstrike. I believe the company was successful in delineating an initial economic gold resource. Gold grade continuously averaged near or above 1 gram per ton, which is economic for an open pit heap leach mine. I expect a compliant resource estimate this year.
The big key for the company is whether it can divest its Turkish assets. If the company cannot divest the assets, then the company will need to do a financing. The company reported a cash balance of $5 million in September 2017. I believe by now it will be down to the last few million in the treasury.
Current Guidance: Look to buy under CAD$0.35 per share (under US$0.30 on US-OTCBB. The company will need to raise money unless it sells off its Turkish assets. Also, Liberty Gold is currently a takeout candidate.
Nevsun Resources
Nevsun released significant assay results at its development stage copper-gold asset Timok. The latest drill program expanded the lower zone resource 350 meters by 750 meters. Copper grades averaged over 1% copper, demonstrating economic mineralization.
Nevsun’s zinc producing mine in Eritrea will be generating significant cash flow with zinc prices above $1.30 per pound. Nevsun’s new CEO Peter Kukielski made it clear the company’s focus is Timok, not Bisha. I expect the company to either sell this asset to a Chinese group or use the current mine plan to generate enough free cash flow to fund the Timok exploration program. I am okay with either option.
Current Guidance: Buy Nevsun on the NYSE under $1.90 per share or on the Canadian exchange below CAD$2.50 per share.
Silver Run Acquisition Corp
Nothing new to report, the company is still finalizing the merger.
Current Guidance: Hold
Wheaton Precious Metals
The management team at Wheaton Precious Metals has kept good on their word and has executed on a new transaction.
The company has provided an initial CAD$20 million in convertible debt and acquired 6.1 million shares of Desert Star Holdings. Desert Star Holdings has acquired the Kutcho copper-gold-silver asset in northwest British Columbia. Kutcho is an early stage deposit, so it will not contribute cash flow to Wheaton Precious Metals for a number of years.
Current Guidance: Hold
Maple Gold Mines
It was a quiet month for Maple Gold Mines. The company is finalizing its exploration program for 2018.Current Guidance: With tax loss selling out of the way in Maple Gold Mines, we are increasing our buy under price to CAD$0.20 per share on the TSX-Venture listing. Guidance for Maple Gold’s US listing is increased to $0.16 per share.
Sprott Resource Holdings
Nothing new to report this month.
Current Guidance: Hold
Equinox Gold (formerly Trek Mining)
Equinox Gold has successfully completed its three-way merger with Anfield Gold and Newcastle Gold.
I am very excited by the prospects of Equinox Gold moving forward. Equinox is one of my largest personal investments and is my largest investment in the gold sector.
By the end of this year, Equinox Gold will have reached commercial gold production at its Aurizona gold project in Brazil.
Current Guidance: Buy under guidance for Equinox Gold has increased to CAD$1.00 per share on the TSX-Venture. Buy under guidance for the company’s US OTC-BB listing has increased to $0.78 per share
Northern Dynasty
Northern Dynasty has signed an agreement with major copper producer First Quantum. First Quantum has the option to spend $150 million to earn the option to joint-venture 50% of the Pebble Project. For those looking for additional information on the deal, please watch my interview with Northern Dynasty CEO Ron Thiessen.
The company has hit every milestone we had hoped for this year. We will look to sell our position above CAD$2.50 per share in 2018.
Blackbird Energy
Blackbird released its first quarter financial results last week. The results met my expectations. The company has over $30 million in cash which should be able to fund the upcoming drill program.
From January through March, the company plans to release additional production results from two recompleted wells and three newly drilled wells, including the well site we visited in December. These well results should continue to prove up the company’s western liquids rich acreage.
I will be consistently monitoring the well results as they are released and will update all subscribers with my findings.
Current Guidance: Guidance remains unchanged. Buy under CAD$0.30 per share on the TSX-Venture or $0.20 per share via the US OTC-BB listing.
Alterra Power
Alterra Power shareholders have successfully voted in favour of the merger with Innergex Renewable Energy.
Completion of the transaction remains subject to court and certain regulatory approvals in Canada and the United States, key third-party consents, and other customary closing conditions. The transaction is not subject to approval by Innergex shareholders. Closing of the transaction is expected to occur in the first quarter of 2018.
Uranium Energy Corp.
No news this month from Uranium Energy Corp.
Current Guidance: Hold
Skyharbour Resources
No news this month from Skyharbour Resources.
Current Guidance: Hold
In the Room, in the Deal… in Vancouver
On January 21 and 22, I will be co-producing the Vancouver Resource Investment Conference with Cambridge House. Every year, I personally pick the speakers and goSurvival-Guide-Cover-ipad.jpgiustra, Jim Rickards, Rick Rule, Frank Holmes, Teeka Tiwari, Nolan Watson, Amir Adnani, and many more.
My team and I will have our boots on the ground on the conference floor and on the stage, interviewing companies and meeting with key management behind the scenes. I’ve spent many years in this gauntlet and know exactly what to look for in a great opportunity and speculation.
I encourage all Katusa Research subscribers to attend if they’re in the area and to come say hello.
For more information on the companies and agenda, click here.
To get complimentary tickets, click here.
With 250+ companies in attendance, how do you possibly distinguish between a company you need to look further into and one that you should pass on and use the brochure as a fire-starter? Well, you’re in luck. As an added bonus to your membership in Katusa’s Resource Opportunities, we’ve put together a comprehensive report to help you at this and other resource conferences.
We call it the “Katusa Research Natural Resource Conference Survival Guide”, and it’s yours free.In it you’ll find quick ways to discern between companies, questions to ask and red flags to look for. You don’t have to be intimidated by the investor relation folks or management at the booth now that you have straightforward questions to ask. Everything is summarized neatly on the last page, where you’ll find a 22-point checklist to help you shortlist quality companies.
Click here to get your copy, or find it in the Special Reports section of the Members Area.
PORTFOLIO SUMMARY TABLE
Regards,
Marin
Disclosures and Disclaimers
Marin Katusa, Katusa Research Inc. (“Katusa Research”), New Era Publishing Inc. (“New Era”) and/or the other principals, partners, directors and officers of Katusa Research or New Era (the “Katusa Research Team”) own securities positions in, and are long on, the following companies mentioned above: NSU, WPM, MGM, SRHI, SYH, UEC, AKG, TREK, BBI, NDM, AXY, LGD
Additionally, members of the Katusa Research Team currently intend to acquire securities in the following companies mentioned above: NSU, SRUN, WPM, MGM, SRHI, SYH, UEC, AKG, TREK, BBI, NDM, AXY, KAT, LGD, GLEN
No members of the Katusa Research Team have received any commission or other compensation to feature any company mentioned in this newsletter nor are they party to any financial arrangement regarding the securities of such companies or any person who has any interest in such securities. The information contained in this publication is not intended and does not constitute individual investment advice and is not designed to meet your personal financial or investment situation or needs. Neither Marin Katusa nor Katusa Research are registered broker-dealers or financial advisors. Never make an investment based solely on what you read in an online newsletter, including this newsletter, especially if the investment involves a small, thinly-traded company that is not well known. Past performance is not indicative of future results. You should independently investigate and fully understand all risks before investing. When investing in speculative stocks, it is possible to lose your entire investment. Information contained in such publications is obtained from public sources believed to be reliable, but its accuracy cannot be guaranteed. Further, the views expressed herein are of Katusa Research as of the date hereof, are subject to change and the Katusa Research Team does not undertake any obligation to update such information or views. None of the members of the Katusa Research Team shall be liable for any damages, losses, or costs of any kind or type arising out of or in any way connected with the use of this newsletter. The information in this publication reflects the current opinion of the publisher, is subject to change, and may become outdated. The publisher undertakes no obligation to update any such information.
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