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Kevin Bambrough: Fiat Currencies Are Worthless
Source: George Mack of
The Energy Report
02/08/2011
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. (
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. (
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.
KB:
Gas is cheap today, obviously; I think it's very cheap. But I
think it's too cheap compared to the level at which it should be
trading. I believe the average gas company is engaging in
production despite the fact that it can't make money at current
prices; and, ultimately, we may find that reserves are overstated
and companies can't produce at these prices.
TER:
Then why produce gas?
PD:
They're doing it for a variety of reasons. First, they have
commitments on leases that they must maintain, so they are forced
into drilling those properties even though it may not be
economic. Secondly, we've seen some alternative forms of
financing emerge in the form of joint ventures (JVs) and other
creative-financing techniques that are enabling these companies
to continue their drilling programs. But I think, slowly, you'll
start to see the switch to more liquids-rich deposits by some of
these producers. In order to sustain the production needed to
meet demand, we're going to need higher prices than those
currently in the market.
TER:
What are you doing in private equity?
KB:.
TER:
How will you exit this company in the end?
KB:.
KB:
Paul, would you touch on One Earth Oil & Gas?
PD:
The One Earth Oil & Gas concept is related to that of One
Earth Farms in that it's in partnership with First Nations of
Canada. On One Earth Farms' management team, we have former Grand
Chief of Saskatchewan Blaine Favel. He was instrumental in
creating One Earth Farms. Through his relationships and knowledge
of the First Nations sector, we've been able to sign agreements
with a number of First Nations with the hope of developing some
of the O&G prospects on their lands that have thus far
remained undeveloped for a variety of reasons. We've managed to
tie up a significant amount of acreage to date, both in Canada
and in Montana. This year, we're in the process of drilling some
of those prospects and further defining some of their resources,
and then we'll bring on production through various plays.
KB:
Just to clarify, when Paul says a "significant land package,"
we're talking about more than 300,000 acres and growing. We're
optimistic that we're going to increase our optioned acreage.
This is a very, very significant land package, which, in my mind,
gives us an eventual opportunity to have real upside to oil and
gas prices as we prove up the plays.
PD:
Again, we've invested only about $10 million to date in this
business. It's another example of us starting a business for a
very small amount of capital that could potentially be worth
significant sums of money. The risk/reward, in my opinion, is
exceptional.
TER:
Kevin, you don't have much faith in paper currencies. Do you
foresee a time when people will be holding gold, silver or other
metals in bank vaults and writing checks based on their value, or
using a debit card based on the value of the resources they are
holding?
KB:.
TER:
I enjoyed meeting you both. Thank you.
KB:
Thank you., general
counsel and corporate secretary for Sprott Resource Corp., a
position he has held since 2008. He evaluates and structures
transactions; coordinates and conducts due diligence; and is
involved in the oversight of the operating subsidiaries. He
serves on the board of directors of Orion Oil & Gas
Corporation, Waseca Energy Inc. and Stonegate Agricom Ltd.
Prior to joining Sprott, he practiced law at Blake, Cassels
& Graydon LLP. Mr. Dimitriadis holds an LLB from the
University of British Columbia and a BA from Concordia
University. He is a member of the Law Society of Upper
Canada.:
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.?