Rodney Stevens, portfolio manager at Wolverton Securities, believes investors speculating in precious metals must be disciplined to avoid gambler's ruin. While "disciplined speculation" may seem like a contradiction, it is key to Stevens' approach. Through both technical analysis and fundamental analysis, and a careful read of intermediate trends, Stevens has developed a concentrated portfolio of precious metal companies held both long and short. In this Gold Report interview, he shares where the sweet spot in the mining space is and advises how to limit portfolio risk.
The Gold Report: Rodney, in July 2007, StarMine rated you a top analyst for the metals and mining space based on stock recommendations and market analysis that generated a return of about 8% over the industry benchmark. The metals and mining space has changed a lot since 2007. What are some key ways your approach has changed in the five years since that rating?
Rodney Stevens: Since being an analyst at Salman Partners, my strategy has developed into a more disciplined approach to speculating, which now includes the use of technical analysis in security analysis overall and short selling. The disciplined approach involves having a concentrated portfolio of securities both long and short in conjunction with progressive stop-losses.
"Dow Theory is saying that we are still in a bull market but with the caveat that it might be turning."
The concentrated portfolio, while adhering to progressive stop-losses, helps control company-specific risks. Being both long and short provides a natural hedge to protect the gains from extraordinary market risk such as a market collapse—collapses when stop-losses are breached. This disciplined approach allows us not to fall into gambler's ruin even though we still are looking for stocks with great potential.
TGR: What do you look for in stocks to short?
RS: We look primarily for ideally topping formations, so we can benefit from the downward trend when it begins. The ideal shorting scenario is picking a company that goes bankrupt. That may be rare, but we also look for certain catalysts that may be divergent from what management is saying.
TGR: What would a chart look like on a stock that you would consider shorting?
RS: There' s a classic head-and-shoulders formation that looks like a head with two shoulders on the top of a chart, which breaks through a neckline. In general, you're looking at topping formations, downward trends and even some consolidation formations. A right angle triangle of the descending formation could lead to a continued drop in share price. We look for cues for timing, but then also look for the fundamentals to get an idea of how much downside there might be and for catalysts.
TGR: What's your typical weighting of shorts to longs?
RS: It depends on the degree of bullishness. We could be 50/50, 80/20, 20/80, depending on where we think we are in the intermediate trend. Right now we're about 80% bullish on gold and silver stocks.
We are interested in capturing as many intermediate trends on the upside and the downside. The problem with the intermediate trend, however, is often there is little notice as to when the trend changes direction.
Despite being 80% bullish, there's still a risk that the intermediate trend can drop, so we want to be partially hedged, perhaps having a 20% allocation of stocks that we are shorting. Then if the intermediate trend halts and goes down sharply, we'd be cutting our longs short through stop-losses, but allowing our shorts to ride, which could make up for some of the loss from the unexpected change in trend.
Of course, we also look for stocks with homerun potential and are happy to ride out the gains as long as we don't get stopped out of our positions.
TGR: Is it fair to say that the intermediate trends are where you really make your money?
RS: We look at the intermediate trends because if we could capture a fair share of these intermediate trends, we might be able to do better than just playing the long-term trend alone. We use Dow Theory to put the long-term Primary Trend into perspective. The tools we use to identify the intermediate trends are other technical indicators, such as important reversal patterns, trend lines, trend channels and support, and resistance levels. All those help assess the intermediate trend. We really make money on our stock picks, but we have to gear our portfolio in the general direction of the market.
TGR: Please explain what Dow Theory is.
RS: Dow Theory was originally developed by Charles Dow to gauge the overall health of the global economy. It is based on technical analysis. It identifies a bull market and bear market depending on if one sees higher highs, or lower lows in the Averages. It uses the Dow Jones Industrial Average and the Dow Jones Transportation Average. If both averages are confirming that we are in a bull market by higher highs, then we can be confident that we're still in a bull market. If the indexes contradict each other, then we may be heading for a bear market and the onset of lower lows in the Averages.
TGR: What is it currently indicating?
RS: Basically Dow Theory is saying that we are still in a bull market but with the caveat that it might be turning. There's been a divergence between the Dow and the Transport Average; we may be on the cusp of a change in direction over the long term from a bull market to a bear market. That tells us to be a little more cautious. There are no time limits as to when the Transports and the Dow have to confirm each other.
TGR: You recently launched a weekly newsletter called The Disciplined Speculator, and the investment strategy says, "The portfolio is speculative, suitable for those investors who can afford the substantial risk associated with seeking capital growth through trading a concentrated portfolio of speculative securities. Volatility of 50% or greater may be experienced." What's your read on investor appetite for that type of risk right now?
RS: It may sound somewhat contradictory to be a "disciplined speculator." I would argue that being disciplined is the most important thing about speculating so that it doesn't lead to gambler's ruin. For example, if the average stop-loss were 10% on a rolling 10-stock portfolio, one would have to get stopped out of many losing trades in a row before losing 50% of one's principal.
"I would argue that being disciplined is the most important thing about speculating so that it doesn't lead to gambler's ruin."
We only note the extreme volatility because we don't want people to believe that our disciplined approach is not speculative. It is designed so that investors shouldn't fall into gambler's ruin, but it is speculative.
Investors should always have an appetite for some level of risk, the degree of which should depend on personal circumstances. For example, investors who rely on their investments primarily for income, then only a small portion of their portfolio should be allocated to this type of strategy.
TGR: A lot of what you do involves the junior resource space. Are these typically good stocks to be long on?
RS: It depends on the market. If we're in a bear market, resource juniors are the worst, and when we are in a bull market uptrend, they can be the best. We look for stocks that are volatile enough that they make trading worthwhile, but hold them both long and short. For the smaller-cap issues that are below $5/share, we might only venture into that category when we're in a bullish trend. Right now we're in a bullish trend; we feel that there is sufficient liquidity and the tides are going in our favor so that we can venture into this market.
TGR: Given the current intermediate trend and the long-term trend, what's the sweet spot in the junior mining space? Is it the precious metals explorers, the precious metals development stories, or are the junior producers the place to be at the moment?
RS: The sweet spot is new high-grade gold discoveries or near-term production opportunities in the mining space, but only when the market is in a bullish trend. These opportunities are some of the riskiest, so it's also good to round out your portfolio with some established producers with good growth prospects. Another reason to add the larger-cap stocks is for liquidity because you want to be able to reverse your position if necessary.
TGR: What' s your top pick in the junior precious metals space now?
RS: Right now my top pick is Roxgold Inc. (ROG:TSX.V). It's still in the early stages of a new high-grade gold discovery in Burkina Faso. There's a lot of potential to drill off a large high-grade ore body of sufficient size to be attractive to the majors. Successful drilling could garner takeover speculation.
From a technical perspective, the shares of Roxgold have just actually broken out of a nice upside-down head-and-shoulders bottoming formation and in a breakout. So that's also very bullish.
Upside-down head-and-shoulders formation chart for Roxgold. NL: Neckline, LS: Left Shoulder, H: Head, RS: Right Shoulder
TGR: What's the upside in ounces at Yaramoko?
RS: The mineralization can extend for kilometers at depth for these types of systems. Right now Roxgold is about 250 meters (m) at depth and is going to test down to 700m. The current roughly 500,000 ounce resource has potential to triple from the current drilling program; it still could extend below 700m at depth as well. There is large potential and the key takeaway is that if the company can expand the resource maybe to the 3 million ounce (Moz) range—the sweet spot that makes it attractive to the majors—then we could look for it to be a potential takeover target.
TGR: Does Roxgold have sufficient cash to continue that drill program to find more ounces through the drill bit?
RS: It has enough cash for its current drill program, but after that it would need to raise more money to continue expanding the resource.
TGR: Is Roxgold getting any value for its other projects at Bissa West or Solna?
RS: No, but it is not working those properties and it shouldn't really because to get the best bang for its buck, it should be targeting the expansion of the high-grade area, which is what it is doing.
TGR: Is Roxgold going to joint venture (JV) those properties?
RS: Roxgold could but I don't think it would receive much value unless it did a number of drill passes that resulted in a great discovery. Burkina Faso typically has low-grade 1 gram per ton deposits and Roxgold's Yaramoko property is somewhat of a freak of nature in that area. Roxgold may not find a similar resource in its other properties, so it wouldn't be the optimal use of its money.
TGR: What are some other gold and precious metals explorers you have positions in?
RS: We have a position in Tirex Resources Ltd. (TXX:TSX.V), which has a volcanogenic massive sulphide (VMS) deposit in Albania, and this is a near-term production play. The company recently received its mining permit to commence commercial production on Mirdita, its JV property with the Turkish company Ekin Maden, which is actually mining its deposit underground up to the border of Mirdita.
"Right now we're in a bullish trend; we feel that there is sufficient liquidity and the tides are going in our favor so that we can venture into the small-cap market."
The joint venture could announce a production decision imminently, and within a week or so, we could have a little more clarity on the production guidance. But, in theory, it could start at 500 tons per day (tpd) initially and have potential to grow to 2,000 tpd within the next two years. There's near-tem production and Tirex won't have to spend anything on capital expenditures. The mine is already in operation so it's a good risk-reward play.
TGR: Ekin Maden is a private Turkish company and how important is that relationship to Tirex shareholders?
RS: It's extremely important. The first question is does Ekin Maden's mill have extra capacity and the answer is it does. Does it want to bring the JV property into production or would it mine other deposits where it doesn't have a JV and doesn't have to split the profits? Ekin Maden recently finished a $40 million development plant expansion and it has more than enough excess capacity and wants to feed its hungry mill. In theory, Ekin Maden's motivation to mine this ore is presumably equal or stronger than Tirex's alone because Ekin Maden actually makes more money on the mining than the milling.
TGR: Will Tirex effectively be toll milling? Would it be feeding the mill and getting a percentage of the value of the metals recovered?
RS: Yes. The other thing is that Tirex is not responsible for any of the maintenance capital or expansion capital that may be required. It's somewhat like a royalty agreement but Tirex is exposed to operating costs. It's my understanding that Ekin Maden has been operating for a number of years and Tirex has been able to thoroughly analyze Ekin Maden's operations and costs so Tirex has a good indication of what those costs are and what the profits might be. While Tirex has exposure to operating costs, the flipside is it has a proficient operator that has been achieving cost controls.
TGR: Any other precious metals explorers that you would like to talk about?
RS: Dalradian Resources Inc. (DNA:TSX) is one that we actually don't own but it's been on our radar and we're looking for an entry point. It has a high-grade 2.7 Moz deposit in Northern Ireland and it has a lot of cash and a significant drilling program, which might expand the resources by 50%. Dalradian has good management and a good property with good resource growth potential. Its management has a track record of drilling up properties and selling them, so there's potential for takeover speculation.
TGR: Dalradian is certainly in a very safe jurisdiction and quite close to infrastructure, being about 150 kilometers outside of Belfast.
RS: The other thing is the grade. If we are heading toward a bear market, companies are going to look for this type of grade and size potential because it could sustain their cash flows in any market; that's what's going to be desirable for a takeover.
TGR: What are some producers in your portfolio?
RS: The producers provide a little more liquidity. We have some producers right now: Fortuna Silver Mines Inc. (FSM:NYSE; FVI:TSX; FVI:BVL; F4S:FSE), Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) andSilver Standard Resources Inc. (SSO:TSX; SSRI:NASDAQ). Both Fortuna and Eldorado have relatively high growth potential compared to their peers, so I like that in the near-term. They also have good management to be able to achieve those production targets.
Silver Standard doesn't really have much production growth over the next 12 months, but the initial production hiccups have for the most part been resolved and the worst of the Argentina currency controls have already been factored into the company's share price. A near-term catalyst for Silver Standard might be the potential for a weakening peso, which would lower its operating costs. The charts of these companies have all gone through a consolidation phase from an uptrend and appear to be positioning to outperform the general market in the continuation of this uptrend as well.
TGR: For Fortuna, where's the growth going to come from?
RS: Right now its San Jose project in Mexico is ramping up production to the 5 Moz/year range by the middle of next year. That's part of the near-term potential.
TGR: Are you generally more bullish right now on silver than gold?
RS: It's hard to actually time the performance of gold and silver over an intermediate trend. They tend to track each other. Without trying to be too cute on timing, I'm weighted toward silver but I think they will both rally nicely and outperform the general market.
TGR: You hold Silver Standard, which is one of the biggest silver names out there. Why do you choose that over a company like Pan American Silver Corp. (PAA:TSX; PAAS:NASDAQ)? How do you choose between those two?
RS: I look for catalysts and I look at the charts and at the time Silver Standard's chart looked to be stronger than Pan American's, although they both tend to trend together when nothing is going wrong. They both have good management and good growth. When I am looking at two good companies that both have good fundamentals, I look for catalysts and which chart appears to be stronger than the other. Catalyst-wise, if the Argentine peso can't be held up by the Argentine government, which we are not sure whether it will happen, that could be a good catalyst in Silver Standard's favor in the near-term.
TGR: What's your advice to investors playing this space?
RS: Investors face some tough decisions in this market. If we are toward the end of a long-term bull market, then investors can be completely out of the market because buy-and-hold may be over. Another thing investors could do is to trust someone to actively manage their money if they can't do so for themselves. They have to take a wise, disciplined approach and it is a little more dangerous market to be in. My newsletter gives advice on avoiding a single stock commitment that could wipe an investor out, avoiding being frozen in a market that has turned against the investor and also informing the investor on how to take profits while limiting losses. Learning how to maneuver through the risks that there are in the market would be a first step.
TGR: Is there one thing that made you more disciplined as an investor?
RS: It's been the losses that I've sustained. I'm known for some good stock picks such as Silvercorp Metals Inc. (SVM:TSX; SVM:NYSE) when it was under $1/share and rallied to $30/share and more recently Canaco Resources Inc. (CAN:TSX.V) at $0.30/share rallying to $6/share. As part of a group we've helped finance Ventana Gold Corp. at $0.30/share and we got taken out at $12/share, so I do look for these great opportunities, but I have had a tendency to be a less disciplined gambler. I've learned from hard knocks of the risks that are involved to develop a belief in this more disciplined approach.
The typical gambler's ruin, which we try to avoid, is if investors are taking a 40–50% risk in any commitment, it doesn't take many wrong calls before the capital is wiped out. In our disciplined speculator approach, we're limiting risk to a more reasonable level so that investors have ample time to turn it around and make good calls.
TGR: Thanks for your insights, Rodney.
Rodney Stevens, CFA, is a registered representative and portfolio manager at Wolverton Securities Ltd. Since 2001, Stevens has worked in the mining securities industry, initially as an investment analyst with Salman Partners Inc. Stevens became a top-rated analyst by StarMine on July 17, 2007, for the metals and mining industry based on the profitability of stock recommendations and the accuracy of earnings estimates, generating an excess return of 7.9% over the corresponding industry benchmark. To subscribe to The Disciplined Speculator, please contact Rodney Stevens firstname.lastname@example.org.
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1) Brian Sylvester of The Gold Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Gold Report: Roxgold Inc. and Fortuna Silver Mines Inc. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Rodney Stevens: I personally and/or my family own shares of the following companies mentioned in this interview: Roxgold Inc., Tirex Resources Ltd., Fortuna Silver Mines Inc., Eldorado Gold Corp. and Silver Standard Resources Inc. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
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