Investing

When you find a good source, it’s hard to leave it alone. That’s why I return to my friend Sam Parks when I have questions about gold and oil stocks. Mark Twain once defined a gold mine as "A hole in the ground with a liar at the mouth." Neither human nature nor mining promotion have changed much since then. Unless you are very careful resource stocks of all kinds can become a very deep hole into which you throw away money forever.

Why bother with them? Because well-chosen gold or oil stocks also offer exceptional profits. Sam’s research is impeccable, he has the experience necessary to make good judgements, and he is a man of integrity..

Sam entered the brokerage business on January 2, 1959, working for a little firm in Spokane that handled mining stocks. Two brokers took him under their wing and taught him why gold (then fixed at $35 an ounce) was valuable.

After working with gold stocks for years, in 1990 Sam took off a year and a half to study oil stocks. In the past year crude oil has roughly tripled in price. I called Sam to find out if the big rise in oil was over, or if there was still some way to profit from oil (and from gold stocks). You’ll find his answers in this interview, which he kindly gave me on March 9, 2000.

Sam Parks works with National Securities, 1001 Fourth Avenue # 2200, Seattle, Washington 98154. You can call his office at (800) 426-9993 or (206) 622-7200, but don’t expect to speak to Sam directly. He spends almost all his time researching and selecting stocks. However, the helpful brokers who work with him will be glad to answer your questions.
 
 
 
 

MONEYCHANGER The price of oil has tripled in the last year. A few days ago it reached $34.50, then backed off sharply. Will it drop farther, or is this just the beginning?

PARKS I think it will ease up some, to $22 – 25 a barrel. Oil prices are difficult to forecast, only somewhat easier than gold & silver prices. [Chuckling] What’s important is that at $22-25 a barrel West Texas, the oil business is fabulous for independent explorers. Integrated companies have problems because oil prices can work against their refinery profits. But for exploration & production companies these prices are excellent.

MONEYCHANGER Are oil stocks still a good buy?

PARKS Yes, I think so. With oil at $22-25, even $20 a barrel. you have a robust, healthy industry loaded with opportunities to make money.

There is also natural gas, and oil producers can get both out of the same project. Natural gas is just under $3 per thousand cubic feet and that price is good. As a matter of fact, the natural gas story is better than the oil story.

MONEYCHANGER So we’re not too late to hop on the oil bandwagon?

PARKS Nooo, I don’t think so. If you were just betting on the commodity run, you should have bought it at $11 a barrel, when nobody in the world wanted it, but the stocks have lagged behind the oil price.

The stockholders know that oil won’t stay here. A look at the futures explains that. When April oil was $34.13, December was $26.04

MONEYCHANGER A big backwardation.

PARKS Out another year it’s even lower, $21.87. So the market is saying, "Oil will drop back to the low $20s."

Now maybe it won’t, but my guess is it will. OPEC has a little bit of room to increase production, maybe a million or two barrels a day. Keep in mind the world uses 78 million barrels a day. A million more barrels a day might soften that price a little bit, and that’s good for everybody.

MONEYCHANGER But you don’t see the price of oil dropping back to $11 any time soon?

PARKS No. The price of oil went to $11 because everybody, including the Arabs, missed the depth of the Asian crisis. That left an oil glut, floating around the oceans on ships, but that has now been worked off.

MONEYCHANGER Why haven’t oil stocks caught up to the price of oil?

PARKS "Caught up" doesn’t mean they haven’t gone up at all, but that they haven’t gone up proportionately. There are two reasons. Number 1, fear that oil would drop right back down again. The higher it rises, the more that fear kicks in. Right now there’s a mixed attitude. Some people say we ought to buy these, and some say, let’s wait until the OPEC meeting March 27^th and see what happens. We might buy them a little cheaper.

MONEYCHANGER But doesn’t that fear just fit the old proverb, "A bull market always climbs a wall of worry"?

PARKS Yes. There’s another reason oil stocks haven’t risen. Keep in mind there are more publicly trading producing oil companies within a 500 mile radius of Seattle than there are within a 500 mile radius of Houston, Texas. They’re all in Calgary. The entrepreneurial oil business in Calgary is much more developed than it is in the US, believe it or not. Calgary-based oil and gas companies produce more dollars of revenue than the entire world’s gold mining industry.

Canadian stock players who would invest in oil or mining stocks are basically speculators. You can’t play in that game and not have some speculative blood in your veins. These Canadian players have put all their money in tech stocks. Let me tell you a crazy story. We bought a little bit of Vengold around C$1 – 1.50 (US$0.69 –1.04) . They had an interest in a big gold mining project in Papua New Guinea. They got in trouble and the stock collapsed to six cents. I was convinced that Vengold was going under. They sold their mine for nothing, paid their debt, and got involved in some internet stocks. Today the stock is $4.40 (US$3.04)!

This story could be told a few other times, too. There’s a game going on in Canada, as well as the US on these Internet things. It’s crazy. It’s nuts.

MONEYCHANGER But it is sucking the investment capital …

PARKS . . . out of both mining and oil. Mining shares probably wouldn’t be much higher because of the commodity price, but with the oil stocks, that’s the reason. That tells me that on sector rotation alone these stocks ought to rise 50 to 100%.

MONEYCHANGER Technology stocks riding on a wave of technology optimism are not immune to a crash. Bob Chapman recently wrote, "In 1929-32 RCA fell 98%, IBM and Sperry Rand 80%, Honeywell 90%, NCR 85%, and Central Data 95%. Four hundred Internet-related companies have a market value of $1 trillion. Their total revenue for the past 12 months was only $29.5 billion, and next year they are expected to lose $9 billion."

Technology makes no difference A bubble is a bubble. When those stocks do crash, will that help the oils?

PARKS It should, but you never know. A couple of weeks ago there was a great article in Barron’s, "The Two Markets." You have the "old economy" stocks like GM and the "new economy" tech stocks. You can buy GM for seven times earnings. That’s good, too, because it will prevent a market-wide wipe out. These high tech stocks are sucking money out of all the markets, not just oil.

Unfortunately, you don’t know when it’s going to pop. It’s like watching a stampeding herd of cattle – nobody knows when they’re going to stop, but they’ll all stop at exactly the same time.

MONEYCHANGER Exploratory gold stocks usually don’t pay any dividend. What about these exploratory oil companies?

PARKS They don’t pay dividends, but not because they don’t make any money. They build value by adding reserves. You bring reserves into production and then use that cash flow to develop more reserves. One measure of these stocks is the "re-cycle ratio". With the net proceeds from every barrel you sell, how many new barrels of reserves can you find? If all you get is one, you’re staying even, and so you want to get two.

A little oil company starts out with production, and a good operator will keep on building it. Small oil companies are true growth stocks, i.e., they increase earnings by 15% a year. Oil stocks don’t even want earnings. You’d rather write it off, take that cash flow, spend it in the ground, and not show any earnings. Why pay taxes? The entire industry watches cash flow, not earnings. Cash flow is earnings plus depreciation, depletion, and amortisation. It’s your cash, not your revenue.

The mining explorers, on the other hand, are money users. The oil explorers are money producers, a very big difference. Very seldom do these oil stocks go under. Generally they have producing assets and thus value, too.

View it as a circle. It takes dollars of drilling to find oil reserves, which in turn produce cash flow. The cash flow then goes back into the ground to produce more reserves. Reserves are the ultimate measure of a company’s value. Building those reserves makes a good company, not necessarily earnings.

MONEYCHANGER Can you name some of those good companies?

PARKS I can name a couple that I like, but first I want to tell you another story: natural gas. It doesn’t fear a commodity price dropping, like oil does. Natural gas is a regionalized market. North America’s natural gas market does not depend on gas in Russia, because the gas is not fungible like oil.

In the US & Canada natural gas is obviously the fuel of choice. The more infrastructure that is built and the more houses that install gas heat, the more long term consumption is built. Natural gas producers can hardly find enough gas to meet demand. It’s not dramatically out of kilter, but they’re really chasing it. Without the 15% of our gas that comes from Canada, US markets are really short at the margin.

Two things interest me about the Canadian plays. No. 1, they have recently installed a lot more pipeline capacity from Canada into the United States. In the past few years lack of pipeline capacity left a glut of gas in Canada, even while the US needed it. Now that pipeline capacity is being opened up, which really helps these Canadian producers.

No. 2, Canada has been drilled much less than Texas, maybe only 25% as much. That gives them much more upside potential. I personally think that Canadian natural gas is the best resource story in the world. The business end of oil and gas companies is really good. They’re great little companies and the Canadians are tremendous entrepreneurs in oil and mining. Canada is a resource country. Kids there go to school to become geologists and geophysicists, while in the US they go into high tech something or other.

MONEYCHANGER What about specific companies?

PARKS I’m going to give you three oils.

First is Maxx Petroleum (MXP.Toronto). The stock traded last at C$4.00 (C$1 = US$0.69, so C$4.00 = US$2.76).

Maxx is mostly oil, with all of its operations in the Canadian basin. Maxx’s hot button is its cash. It is selling at 1.9 times cash flow, with projected 2000 cash flow at $2.03 per share. That’s a lot. The industry norm is four times. I think it’s 50% too cheap, even before you account for any possible growth.

They had some management trouble a couple of years ago, then brought in a new team who’ve just done a tremendous job turning it around. It has even become popular with a lot of Canadian institutional houses, even though it’s a small company (market cap of C$65 million or US$44.85 million).

On the natural gas side I like Canadian 88 (EEE.Toronto), presently priced at C$1.63 (US$1.13). Its volume of production is about twice as big as Maxx. (10,000 cubic feet of gas equals one barrel of oil.) Revenues are twice as big.

EEE was absolutely the darling gas play in Canada until last year. I’ve been watching it for a long time, but never bought it until recently. In April ’98 it traded at C$7.55 (US$5.21). In April ’99 it was C$6.00 (US$4.14), so it has really been hammered.

The company has drilled some high risk big wells, and a lot of them struck gas. Then they fell behind getting that gas on stream. They missed all of their projected deadlines.

For oil companies, that is a disaster. Unlike gold where all the return lies in the future, production for oil stocks are treated just like earnings reports. EEE missed their production and the market has just been merciless. However, they’ve still got the gas, and my guess is they will get it producing. It’s not that they drilled a lot of dry holes, they’ve just been slow. (One of the plants had a fire.) I think it’s a great story, I’m just thankful I didn’t buy it at C$5.00 (US$3.45).

It’s riskier than Maxx because its debt levels are a little higher. They’re about C$300 (US$207) million in debt, but the banking industry in Calgary understands the oil business backwards and forwards. They finance them with a line of credit collateralized by production. The banks almost never get hurt.

That’s one of the things that makes the oil business so good in Canada. If somebody does go under, the bank just sells that oil to some other company. It’s immediately saleable, not like a big unique mining project.

Canadian oil stock analysts like to see debt not more than two times cash flow; for every million dollars of cash flow, you can carry two million dollars in debt. EEE has about three million dollars in debt for every million in cash flow. Down in the states it’s not unusual to find a company with debt ten or twenty times cash flow. (That’s why so many companies in the States go under.) EEE is a little heavy on debt, which is the one negative I see, but one good year and they’re fixed.

MONEYCHANGER What about any other oil or gas stocks?

PARKS I’ve got one other, Centurion (CUX.Toronto), last trade C$0.49 (US$0.338). Centurion is operating in North Africa, so it has a risk factor above and beyond Alberta. But the difference is that North Africa is way less explored and has far better geological opportunity. It’s just riskier.

Said Arata runs Centurion. He’s an Egyptian, born and educated in Egypt. Twenty years ago he moved to Calgary 20 years ago and has been very successful there.

Centurion has an oil project in Tunisia and natural gas in Egypt. In Egypt they’re involved in one big concession with two known fields. Both have large gas discoveries (12 million cubic feet a day and 20 million cubic feet a day). Years ago people found this gas while drilling for oil, but they never produced it in because they couldn’t get it to market. Oil you can always put on a truck or boat, but without the infrastructure (pipeline) for gas, it’s not worth much.

The regional infrastructure has now been built. Centurion will build two small gas plants and hook up to these pipelines. They’ll also drill two more wells. Production will begin in 2001 and should be pretty healthy.

On the Tunisian side they’ve made some good oil discoveries. Centurion is a smaller than Maxx with about a third the production, but the leverage is much greater.

MONEYCHANGER Tunisia has less political risk than any of the neighbours?

PARKS Less than its neighbours on either side, Algeria & Libya. From a political risk standpoint, Egypt is good.

MONEYCHANGER Since the collapse of Bre-X three years ago, gold stocks have entered a terrible eclipse. Are there any good ones left?

PARKS Oh, yes. There’s Aurizon (ARZ.Toronto), C$0.88 (US$0.607) last. From TVX and Golden Knight (owned by Teck Corporation), Aurizon bought a mine that was having trouble. Nobody in the world thought Aurizon could do anything with it. It was a stumbling mine, and they bought it as an exploration play, so for two years they drilled it. Since then they have found more than two million ounces, and the mill is already there. It’s a great mine and a great story.

The mine is so big that it also offers a take-over play. All things considered, it is clearly my favourite gold play.

MONEYCHANGER Are there any others?

PARKS I still like Cumberland (CBD.Toronto), painfully languishing at C$1.75 (US$1.21). Cumberland owns one deposit in the early stages with two million ounces of gold, a great deposit in Canada. They’re in the process now of developing their pre-feasibility study (one step before the feasibility study).

They also own a 22% interest in another deposit nearby. That’s controlled by Western Mining Company out of Australia. It will be the largest annual producing gold mine in Canada – and nobody knows it. They haven’t done a very good job telling their story. It’ll be a 500,000 - 600,000 ounce a year producer, bigger than any now in Canada.

MONEYCHANGER Is it too early in the gold cycle to buy these mines?

PARKS I really believe that Cumberland is the greatest gold story in Canada. They have at least 3 million ounces to their credit. It’s a beauty, and when the day comes, it will work.

Cumberland will be slower than Aurizon. Aurizon could be quick because any big company that operates underground gold mines in Eastern Canada could step up tomorrow morning and say, We’ll pay you two bucks a share, and they should.

MONEYCHANGER Let’s discuss silver stocks. Very few so-called silver stocks actually offer leverage to the silver price. Basically there is Pan American Silver (PAAS.NASDAQ, US$3-7/8), Silver Standard (SSO.Vancouver, C$1.82 or US$1.26), and I understand Minefinders (MFL.Toronto, C$0.95, US$0.656) now actually has a silver mine.

PARKS Minefinders deposit contains both silver and gold.

MONEYCHANGER Do you like any of those three right now?

PARKS Minefinders is one of our six core gold stocks. I think it’s a buy.

MONEYCHANGER What about Pan American and Silver Standard?

PARKS I just don’t know about Silver Standard.

MONEYCHANGER What about Pan American?

PARKS Pan American set out to become the really exciting silver play, but the chart doesn’t look very good. The management is great, but they have an inherent weakness. They’ve called themselves a silver mining company, and they’ve cut off their ability to do anything else. That works in gold mining because it’s a broader industry, but silver mining is not a good business. It is metallurgically difficult, recoveries are tough, and it’s hard to find all by itself.

Pan American (is also having trouble with its big deal in Russia, the Dukat mine. If I wanted to buy something that the market would go after when silver rises, I’d probably buy Hecla (HL.NYSE, US$1-7/16).

MONEYCHANGER Even though so little of its revenues come from silver? Last time I checked it was less than 15%.

PARKS But the public perceives it as a silver stock. It’s also a little healthier. Coeur d’Alene Mines (CDE.NYSE, US$3-5/8) could go under. It’s very vulnerable. Sunshine (SSC.NYSE, US$1.00) also looks very bad. If I were going to get serious about silver stocks, I’d take a look at a little silver stock in Mexico, Corner Bay (BAY.Toronto, C$2.20 or US$1.52). I don’t know much about it, but if I were going to get serious about silver stocks I’d take a look at that. There’s not much else out there. Maybe Apex Silver Mines (SIL.NYSE, US$9-1/16).

MONEYCHANGER That’s the one George Soros put together.

PARKS They’ve got a lot of properties, but silver’s a tough deal.

MONEYCHANGER It’s tough to find a company that has strong leverage to silver. A lot of companies produce it, but only as an infinitesimal part of their total revenue stream so that you can’t get any leverage to it. The ones we’ve named are just about it.

PARKS If you’re betting on silver you can do it two ways. Look for a little company with a silver mine (and they tend to be small), or you can look for companies that the public will buy because they think they are silver stocks. Hecla, Coeur d’Alene, Pan American, they’ll all be in there.

But if somebody is going to speculate on silver, I’m not sure stocks are the best way to do it. I think you buy the metal. Put it on leverage. Buy $100 worth of silver and put up 50 bucks. Or, better yet, buy silver bags.

MONEYCHANGER They’re very cheap now. You can buy them about melt. Thanks very much, Sam. 

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