Today Bill Fleckenstein discussed a huge story unfolding in the gold sector this week.
Nonsense
By Bill Fleckenstein President Of Fleckenstein Capital
September 7 (King World News) – Today’s market action discussion will be extra brief due to my lengthy Pretium comments below. The market opened weak, perhaps thanks to the NFP report and weakness in Tesla (which appears to be unraveling). It then promptly rallied, pushing the Nasdaq to a gain of 0.5%, but the ramp job failed pretty quickly (for once) and by day’s end the indices finished slightly lower.
Away from stocks fixed income was very weak, oil was a nonevent, the dollar was stronger, and the metals were slightly weaker. (The CFTC data was even more constructive today. More about that Monday.)
Well, Let’s Dig In
On the topic of Pretium, Thursday an activist short-selling group, Viceroy Research, put out a 47-page scathing report on the company. For the most part, it was a rehash of a negative story that has been around for a while which first began in late 2013, when Pretium had an engineering firm (Strathcona) that resigned because it didn’t believe the other engineering firm or Pretium’s management. That sent the stock price to about $3.
Coincidentally, several people with whom I had been on the board of Pan American were very constructive in their analysis of the ore body, which was why I got involved to begin with. But the fact that an engineering firm that had helped trip up a company in the late 1990s called Bre-X (which was a fraud from day one, as it was basically “salting” the mine), caused people to believe that there was really no “there” there at Pretium (which is wrong)…
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The main reason for the controversy is the nature of the ore body. If you think of it as a loaf of raisin bread, with the raisins as the gold and the rest as waste rock, you would understand that it was never going to be possible to know exactly what they had until they mined it for multiple quarters. Thus, I had always expected that it would take some time before we would be sure what exactly was there and what Pretium had to do to manage the mine and the ore body. (For what it is worth, the ore grades at roughly 15 grams per tonne are some of the highest I have ever seen for a large project.)
When Pretium reported its first quarter of production it was OK, considering the early stage. That was 4Q17. But in 1Q18 Pretium stumbled, because the grade reconciliation equipment that it needed to manage the stopes wasn’t working properly. Management also realized that it needed to do more drilling to create the right mix to send to the mill. Thus, the stock was in the penalty box.
After the second quarter of 2018 was reported, which sent the stock briefly to almost $10, I assumed that would alleviate many concerns, because the results showed the sort of grade that was expected and generated $86 million in cash during the quarter. I believed that with another couple of similar quarters, that would demonstrate that this was a fabulous (if lumpy) ore body being run by people who knew what they were doing.
This “Crime” Doesn’t Pay
I was wrong. The folks who doubt this still believe that it is a fraud. Originally, it was supposed to be a fraud because there wasn’t any ore there. Now the story is there isn’t enough, or Pretium is high-grading the mine and therefore the mine life will shrink. If the latter really were true and they really were scumbags, that brings up the question, why not do that in the first place? I mean, they could have produced several good quarters with 20 to 25 grams per tonne, the stock would have gone to the moon, insiders could have sold, and it would have been a successful fraud — assuming that means the “bad” guys win.
In fact, all the decisions Pretium has made indicate just the opposite. There has been no insider selling, and in fact there’s been insider buying, which is no way to run a fraud, nor would you consider buying back the royalty stream that Pretium has stated it wants to do. Why worry about the next 5 to 10 years and what the royalty stream holder would cost if it’s all phony in the first place? That makes no sense whatsoever.
On the subject of the royalty stream, this is what Sean Roosen, CEO of the company holding the stream, had to say on his conference call in May: “Pretium, it’s always been a question of the stability of the resource. We think that Pretium is going to have quarter-by-quarter sort of up and down because of the way the ore body works, but in the overall basis, this is a world-class asset. It’s going to perform.”
Now, I expect the bears will say Pretium won’t really buy that stream back, but we will know by Oct. 1 because that’s when it must notify the holder if it wishes to reacquire it. However, if that is just something for them to say to paint a good picture, as bears might contend, then if they don’t buy it back for a couple of hundred million dollars at the end of this year, Pretium’s net debt will shrink and it will be able to pay nearly all of it off next year. Thus, while not an outcome I want to see, eliminating the debt makes it pretty hard to go broke.
It’s the Old, “Going to a Lot of Trouble for Nothing” Trick
To simplify the bear case a bit, it is essentially this: there will be nowhere near enough gold, the mine life expectations will collapse, so it won’t be able to pay the debt or refinance it, and therefore it will go to zero. That scenario has no chance to be correct in my opinion.
On the other hand, what I think is more likely is that the quarter we are in will show good grades and the company will have strong cashflow generation. I expect that will happen in the following quarter, too. Pretium has explained in a way that is understandable what it needed to do differently than it did in Q1 to make the mine work. (Their special equipment designed to help monitor the ore in real time kept breaking, but they got it fixed.) And as I stated earlier, it was always going to be a tricky management issue to deal with an ore body that is as lumpy as this one is.
One issue that is a little bit unique is that Pretium can only produce so much ore from the mill because of the area they are in. If the mine were located in a different environment, it would be the world’s greatest open pit mine, because the grades are so stunning, but they can’t do it that way.
Near as I can tell, Pretium has done everything within its control correctly. Most of the short “story” is a rehash of older allegations (some five years old), most of which have already been disproven. The current negative thesis seems to be that it doesn’t even matter if Pretium reports strong cashflow and good results, because they are high-grading it, and by doing that it will shorten the mine life, so it won’t turn out to be what the bulls thought it would.
Of course, all that would do is limit the upside, it wouldn’t make it go to zero. In fact, Pretium is doing plenty of drilling and the most recent results looked promising in terms of more gold being to the east of where they are now. So it is quite likely that, rather than see the mine life shrink, as the bears imagine, it could grow. So even if Pretium were to high-grade to a modest degree for a couple of quarters, that wouldn’t change anything in the grand scheme of things, although arguably it could impact the upside.
The Truth Should Be Here Shortly
The bottom line is, I thought the controversy with this company would have been put to rest with the last quarter, but I guess in the current environment, where metals and mining are hated, those who hate this particular company just refuse to give up and have really thrown down the gauntlet.
The good news for those of us who are involved is we will know a lot more in the next four to six weeks. As noted, if the company is going to redeem the royalty stream (sort of amazing that we’re talking about a company that is supposed to go broke but can generate $250 million or so in three quarters), we will know by Oct. 1. Then shortly thereafter we will get Q3 production figures, so this chapter of the saga should be over with soon. (I also expect by year’s end Pretium will restructure its debt, which comes due a year from now, to push the maturity out a few years.)
In short, if the ore body plays out anything like I think it will, Pretium will be able to repurchase the royalty stream, it will have no problem restructuring and paying down its debt, it will generate enormous cash, and it could find more gold and easily extend the mine life rather than shrink it. I personally still believe this is one of the more compelling ideas I have seen in mining, in part because of the controversy. That makes it volatile, and a little bit scary to those who are already worn out by mining stocks being crushed, but it has created a tremendous opportunity.
If it turns out that my view is correct, the short position (which was at 16 million shares, or roughly eight days of normal trading volume), combined with the new position, could create some real fireworks. I never got into PVG to capitalize on a short squeeze, because I think attempting to squeeze shorts is just plain stupid, and that is not my goal here. I believe the bears are fundamentally wrong on a variety of topics, not the least of which is all the innuendo about what a bunch of bad guys the people running Pretium are. I know for a fact that is false.
There is no point in going into all the cashflow projections that show how cheap PVG is, but you can look at the financials and see that at around $1,250 for gold they generated $71.9 million in free cashflow last quarter. So you can do the math as far as what they might generate at higher prices. And, in addition, Pretium has an application for a permit that is due to be decided on in the fourth quarter that would allow it to expand its mill capacity by 40% for very little money, which means the upside of higher gold prices could be even bigger.
As I have noted many times, it was always going to be difficult to have a high degree of certainty as to what Pretium could deliver until it operated for many quarters. I am still nowhere close to certain, but I strongly believe that they can deliver. The only people who are 100 percent certain about something that is nowhere near crystal clear are the guys who are short PVG.
Truth Ore Consequences
Now that is a lot of macro and background data. As for numbers: next year at $1,250 gold, with no mill throughput increase, PVG could earn about $1 per share and see cashflow per share of about $1.50 on revenues of about $700 million. The current market cap is $1.3 billion and they have $600 million in debt. In the long term, drill results, the mill expansion, and the ultimate mine life expectations will have a lot to do with its valuation, but to me the risk reward is as compelling as any idea I have ever seen in mining. Given the data on tap for the coming month, October options might be an especially good way to try to capture this opportunity. I know I plan to use them. For more details, visit the company web site, be sure to look at what I (and Fred Hickey) have shared on Twitter, and see Ask Fleck.
Hopefully, this will help people who are already involved with, or considering, Pretium, to understand where we are and what they wish to do about it.
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