Mike Kachanovsky: Navigating the Discount

By Gold Report Mar 25 2011 4:40PM www.theaureport.com

Source: Brian Sylvester of The Gold Report 03/25/2011
http://www.theaureport.com/pub/na/9041

The terrible tragedy in Japan is shifting markets worldwide. Mike Kachanovsky, a consultant to both resource companies and institutional investors, believes the volatility has created a finite opportunity to scoop up resource stocks on the cheap. In this exclusive interview with The Gold Report, Mike explains what impact the devastation could play to the performance of rare earth companies, as well as how to navigate discounted stocks to avoid the duds.

The Gold Report: Japan recently experienced one of the strongest earthquakes in recorded history and suffered a devastating tsunami. It's certainly a terrible tragedy. In a recent commentary, you said the disasters could result in a buying opportunity for rare earth element (REE) plays, which seems counterintuitive. Can you explain that investment thesis?

Mike Kachanovsky: The rare earth metals sector is a very tiny sector, but Japan accounts for about 25% to 30% of all the rare earth metals consumption in the world. China recently said it would restrict its REE exports, which puts pressure on a lot of Japanese industries.

The market is now discounting rare earth producers because the catastrophic disaster in Japan could translate into a reduced demand from the country. This created some significant discounts in rare earth share prices. However, it is my opinion that the area affected by the earthquake only accounts for a very small percentage of the Japanese economy and the disruption will be fairly short term. As tragic as it is, I expect the economy to recover and overall consumption of REEs in Japan to stay steady. So, the discount will probably be a very short-term event.

Also, even though China exports roughly 97% of the world's total rare earth production, some estimates predict that China will have no additional export capacity as soon as 2015. It will consume all of its production domestically. This is a more serious consequence in the long term that would more than offset any decline from Japan.

TGR: Are there impacts from Japan's crisis that have caused you to change the way you invest?

MK: The initial market reaction to the disaster in Japan was extreme, and stock markets around the world are sold off. Commodities, in particular, were getting hit very hard. The market seems to be pricing in almost a recessionary-type scenario. Some market watchers would have investors believe that a disaster of this magnitude is actually bullish for commodities because it's going to stimulate demand through the rebuilding process. But my investment philosophy has always been to buy aggressively at the dips and to be a contrarian. During any strong selloff, I am active as a buyer in a lot of stocks. This disaster hasn't changed my investment philosophy. I think you have to be prepared to take advantage of market weakness when investors are selling—if there's no real fundamental weakness and the market reaction has been overdone. It's a good time to be a buyer.

TGR: How do you believe the disruption in the Japanese economy will impact the gold price?

MK: Gold also went through a mild selloff immediately after the disaster. Gold was just recently at its all-time high and perhaps needed an opportunity to consolidate. The drop in the gold price was relatively modest. Also, if you step back from what's just happened in the last week and look at the dollar over a yearlong period, it isn't showing much strength. It's still sitting at the lower end of its range. Investors aren't fleeing to the dollar as much as the media has been projecting. Asian investors traditionally have been very gold-friendly and tend to move some of their money into gold in times of crisis. The drop in gold prices is a short-term blip. The price will recover as things start to settle down. The market is more likely to see a flight of capital into, rather than out of, gold based on the aftermath of a crisis like this.

TGR: Many of our readers know you as 'Mexico Mike' from your website, smartinvestment.ca, which covers investment opportunities and other news in Mexico. What sort of things are you looking for from companies operating in Mexico?

MK: One of the great things about Mexico is that a company can take a project from initial discovery and advance it through to production in a very short timeframe. It's also a relatively low-cost operating jurisdiction.

Juniors and producers in Mexico have had a fantastic run during the last six months because as metal prices ran higher quickly, the profit margins at a lot of these companies spiraled higher. Even if there is some consolidation in metals going forward, these companies are still making a lot of money currently. The exploration upside for these companies is also very strong because they have funding from operations and profitability. They can divert much of that money back into enhancing the value of their resources in the ground and building mineral inventory.

Obviously, I'm still very excited about Mexico juniors; however, when we spoke about them last year, they were all priced at a discount. It was the right time to be a buyer. Now, some of that discount has been corrected by the market and they're more fully valued based on their future potential.

As an investor in today's market, I'm focusing my attention on finding companies that are at the lower end of their price range and undiscovered by the market. Some of the early stage explorers, for example, that are holding great property areas and are actively drilling, but haven't yet achieved significant discoveries. Those companies are trading near their bear market lows from two years ago.

TGR: Do you have any forecasts on the macro picture of the market?

MK: We are early in the curve, in terms of where I believe the ultimate long-term price trend is going for both gold and silver. It's going to become much more volatile. Down days of significant magnitude are going to be part of the story that investors will have to deal with if they're going to venture into this sector. Investors need to stick with a strategic approach and look for value in companies with proven management that are able to withstand the high degree of volatility that will be part of the story. There's a lot of money to be made for investors who can get involved now and stay invested for years to come.

TGR: Thanks for speaking with us, Mike.

Mike Kachanovsky is an independent consultant providing analysis on resource companies for institutional investors. He has visited more than 100 mining projects worldwide. Mike's writing is presented in numerous investment publications and he also contributes to several resource newsletters.