Shelter from the storm

Purple Lightning

Looks a bit like the TSX Venture lately …

“In a world of steel-eyed death and men
Who are fighting to be warm,
Come in, she said, I’ll give ya
Shelter from the storm.”

Bob Dylan, Blood on the Tracks (1975)

by James Kwantes

Steel-eyed death? Not quite, but speculative investors are bruised and bloodied.

And Venture investors are certainly fighting to keep their portfolios warm – ie. retaining a pulse – after a near-nuclear winter that has seen the TSX Venture Exchange drop about 27% from this year’s high-water mark and plunge more than 63% from 2007 highs.

Gold, meanwhile, has bounced around between $1550 and $1650 an ounce, confounding both goptics (gold skeptics) and gogs (gold bugs).

It’s a hell of a time to be running a company with the words “storm” and “gold” in its name, but Nolan Watson is doing just fine. Shares of Sandstorm Gold (SSL), the Venture-listed gold streaming company where he is president and CEO, are up about 65% year-to-date and began trading today on the New York Stock Exchange (SAND).

Sandstorm funds small gold mining or advanced-stage gold exploration companies in exchange for a share of future production, a la Silver Wheaton. In fact, Watson was chief financial officer at Silver Wheaton and one of its early employees. He was a director of Gold Wheaton, acquired by Franco-Nevada early last year for $830 million. Watson also runs a base metals/energy streaming company, Sandstorm Metals and Energy (SND).

There are critical differences between Sandstorm Gold and the thousands of other mining-related juniors – let’s face it, many of them junk – listed on the Venture. These attributes make Sandstorm Gold an interesting investment idea for those who don’t want to sacrifice capital protection on the altar of capital gains.

Here’s what I like about Sandstorm Gold:

1)      Little geopolitical risk – purchase agreements are with companies operating in Canada, the United States, Mexico and Brazil. Mexico has its moments, but generally speaking, these are safe mining jurisdictions that operate under the rule of law. With the rise of resource nationalism, the importance of this factor can’t be overstated.
Bottom line: Hedged against nasty geopolitical surprises.

2)      When cash is king, financiers rule. And Sandstorm has cash flow, in spades. In the second quarter, Sandstorm produced a record 9,259 ounces of gold at an average cash cost of $298 an ounce. Yes, you read that correctly. The company now generates about $3 million in monthly cash flow. Its Q2 operating cash flow was $11.3 million and it finished the quarter with $25 million in cash and a $50-million revolving line of credit. The dismal financing climate makes juniors with quality projects and depleting funds vulnerable, creating a golden opportunity for Sandstorm. Expect more deals, on favourable terms.
Bottom line: Cash-rich and positioned for deals with companies that aren’t.

3)      Upside leverage to gold AND downside protection. In this market, many juniors are pinning their hopes on $2,000, $5,000 or (pick your number) gold. Sandstorm’s purchase agreements include minimum cash flow levels and the option to purchase the yellow metal at lower prices if the gold price melts down, ensuring Sandstorm makes money on every ounce. Gold is sold at spot. So gold could plummet and Sandstorm would still be profitable. Sandstorm’s Q2 margin of $1,300 per ounce looks particularly good in light of smaller margins and rising costs among the miners, both large or small.
Bottom line: Impressive margin of safety and leverage to rising gold price.

If you’re looking for a ten-bagger or to get rich quick, Sandstorm likely isn’t your lottery ticket. At $10 a share, SSL has a lofty market cap of $700 million – far higher than most companies on the Venture.

But if you believe in the management team, a look at larger royalty plays such as Franco-Nevada (FNV, $7-billion market cap) and Silver Wheaton (SLW, $11.3-billion market cap) shows the kind of upside that is possible for those with a long investing horizon.

Besides FNV and SLW, competitors include Royal Gold (RGL) and Bridgeport Ventures (BPV), which bought a gold royalty spinoff from Premier Gold Mines (PG) on Aug. 8. SLW’s latest agreement, with Hudbay (HBM), also includes a gold streaming deal at $400 an ounce.

Catalysts:

While the stock is already liquid, the NYSE listing will expose Sandstorm Gold shares to a much wider retail audience – investors like the gentleman who flew up from Texas for Sandstorm’s May 4 AGM in Vancouver, which I attended.

Another catalyst is production upside from the conservative guidance issued by Sandstorm on its gold streams. In a presentation after the AGM, a bullish Watson gave a detailed description of each stream and potential upside. Most deals give Sandstorm a right to a percentage of life-of-mine gold production, effectively giving shareholders a call option on more cheap ounces.

In December, for example, partner Luna Gold (LGC) announced a 250% increase in its measured and indicated gold resource at its Aurizona mine in Brazil. Sandstorm has the right to purchase 17% of life-of-mine gold for $400/oz.
More recently, partner Metanor Resources (MTO) got environmental approval for its Bachelor Lake gold mine in Quebec (20% at $500/oz). And partner Silvercrest (SVL) is targeting a 100% increase in metal production at its Santa Elena operation in Sonora, Mexico (20% at prices ranging from $350 to $450).

Watson has been selling some shares lately, something he addressed in the Q&A of the Q2 conference call. According to the Seeking Alpha transcript, he said he plans to boost his stake in SSL’s energy/metals streaming brother, Sandstorm Metals & Energy, and finance SND share purchases with some SSL sales.

Watson has sold $684,365 worth of Sandstorm Gold shares in the past 3 months and $1.3 million in the past year, according to INK Research (subscription required). He still owns about 1.84% of outstanding shares, a stake worth more than $12.8 million.

Existing shareholders who have profited from SSL’s rise may want to take a page from Watson’s book and consider moving some capital over to SND, which is an earlier-stage, riskier play in the same streaming business. Sandstorm Gold shares are trading at 52-week highs, but the stock’s chart shows that pullbacks typically follow price spikes.

Disclosure: I own shares in both SSL and SND. This blog does not constitute investment advice, and World of Mining is not responsible for the personal investment decisions of readers. Please read my disclosure.

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