Published May 08, 2012

Two Out of Three Ain’t Bad

By Marin Katusa, Chief Energy Investment Strategist

I want you
I need you
But there ain't no way I'm ever gonna love you
Now don't be sad
Cause 2 out of 3 ain't bad
Now don't be sad
Cause 2 out of 3 ain't bad
Meat Loaf, from his 1977 album
Bat Out Of Hell (song written by Jim Steinman)

Before I get into why I'm using what is arguably Meatloaf's best song as an introduction, there are two things I want to get off the plate. First, you can now track me daily on twitter @marinkatusa. Second, on a flight from Florida to Georgia, Doug Casey and I flew with Porter Stansberry, and the bet is on. One hundred ounces of silver will go to the winner, and in addition we are having a radio debate next week – more information to come.

Now on to this week's article. I spent the last few days of April at the Casey Research Recovery Reality Check Summit in Florida. The event was packed with interesting, thought-provoking speakers and panel discussions debating the health of the world's economic recovery, the meaning behind the recent correction in commodity prices, and the best path forward from here. It was a fantastic event, and for those who were unable to attend an audio collection is being produced, in CD as well as instantly available MP3 format, that will have every presentation and every chart, graphic, and slide each speaker used. I recommend ordering your own copy, as it will be well worth it.

I came away with lots of food for thought. I also came away with renewed enthusiasm for one of my guiding investment principles: follow the right people.

The renewed enthusiasm came from a cool survey that ran alongside the show. Attendees were invited to vote for the three companies at the Summit that had the best upside potential. Now, companies gain upside potential from a number of factors; but without one fundamental component – the right people – even a company with all kinds of interesting projects and plans is a lost cause. Company management is the ingredient that turns upside potential into reality. That's why I would have cast my votes based on the people involved in each company.

I know hundreds of good people in this industry, but you can't follow and invest in the movements of hundreds of people. You can only track the movements of a few, which is why I created the Casey NexTen. The NexTen is a list of the top ten up-and-coming titans of the resource industry. These are the movers and shakers who I think will make resource-industry history time and again over the coming years.

Two of the guys on my NexTen list were at the Recovery Reality Check Summit, presenting their companies. We must have done a good job selecting the members of the NexTen, because of the three companies at the show voted to have the best upside potential, two were NexTen companies.

Two out of three ain't bad.

Since we can't go back, we have to look forward

Imagine investing in Silver Wheaton seven years ago. The brainchild of resource legend Ian Telfer, Silver Wheaton is a metals streaming company, which means it provides upfront payments to mine developers to secure the right to buy all or part of the future mine's production at a low fixed cost.

Telfer founded Silver Wheaton (T.SLW) in 2004. In its first 18 months the company's share price ranged between $2 and $5. Today, Silver Wheaton shares are worth $28 to $35, depending on current precious metals prices. That means a $1,000 investment in 2005 at $3.50 per share would today be worth no less than $8,500. When the price of silver peaked in late February, pushing SLW's share price to almost $40, the savvy investor who bought SLW in 2005 could have sold his shares for $11,285. That would be what we call a ten-bagger.

Here's another multi-ten-bagger. In 1993 geologists from a company called Diamond Fields Resources were prospecting in northern Canada – northern Labrador to be specific. Instead of diamonds, they found nickel. A lot of nickel. The Voisey's Bay deposit remains one of the world's richest nickel-copper-cobalt discoveries in the world; and by 1996 it earned Diamond Fields a $4.6-billion takeover offer from Inco.

The man who led Diamond Fields through this discovery and deal is the now world-renowned Robert Friedland, who is also a Casey Explorers' League honoree. As Diamond Fields' stock shot from a few dollars to almost $27, Friedland's personal net worth grew by $500 million. And he hasn't slowed down since: He most recently led Ivanhoe Mines through the discovery and development of a massive copper-gold-silver deposit in Mongolia called Oyu Tolgoi, adding another item to a long list of laudable accomplishments.

Telfer and Friedland are part of a small group of resource titans who proved their successes were more than just luck by repeating their resource feats several times over. As mentioned, Friedland's list of successes is too long to list. Ross Beaty earned the nickname "the broken slot machine" for the repeated payouts he generated for shareholders who followed him from one landmark deal to the next. Lukas and his late father Adolf Lundin are legends in the resource sector, each with a long list of hugely profitable companies.

How fantastic it would be to have an investment time machine, to travel back in time and invest in Diamond Fields in 1994, or in Silver Wheaton in 2004, or in any of Beaty's or Lundin's companies before they made it big. Ten-baggers all around! Unfortunately, time travel isn't an option, so since we can't go back, we have to look forward: We have to figure out who will comprise the next group of resource titans and follow their moves in anticipation of the next big win.

The NexTen

The NexTen is that next generation of titans. The NexTen are all young, driven, and successful beyond their years. By hitching your cart to their horses now, you can follow them through several more decades of discoveries and deals.

The characters on the NexTen list are very impressive. Take Amir Adnani. Many people spend their entire careers trying to find a deposit and build a mine. Amir Adnani built an operating, revenue-generating uranium mine by the time he was 33.

Amir is the president and CEO of Uranium Energy (NYSE.UEC). Founded in 2005 and taken public a year later, UEC is focused on the 300-mile long South Texas uranium belt. It's an area long known to host uranium, and in particular it hosts uranium that can be leached out of the ground using a technique called in-situ recovery (ISR). Compared to conventional mining, ISR is a much less damaging and more cost-effective way to extract uranium.

Amir honed in on South Texas because it offered the perfect opportunity: to develop a set of low-impact uranium mines arranged around a central processing facility and start producing uranium just before the United States loses its biggest uranium supplier – the Megatons deal. Through this agreement, Russia has provided the US with half of its nuclear fuel for the last 17 years by decommissioning Soviet warheads – but the deal is set to end next year. To transform that dream into a reality, Amir has led UEC team through an impressive list of accomplishments since 2007. They acquired uranium-exploration databases covering the entire region. They bought the old Hobson ISR processing facility and completely refurbished it. They drilled off resources at three sites near Hobson. The company permitted one for development and started producing uranium in late 2010. They also permitted and are currently building a second mine. They have raised money and spent it wisely.

Building a mine is never easy. Building a uranium mine in the middle of Texas is very challenging. Amir handled every hurdle with aplomb and has never taken his eye off the prize: to transform UEC into a significant American uranium producer just as global uranium supplies start to tighten and prices start to climb. And remember – Amir managed to do all this before his 34th birthday. The guy has decades of mine building, project buying, and deposit discovering ahead of him. That's a trajectory I want to track.

Another NexTen honoree who continuously achieves feats beyond his years is Nolan Watson. Ian Telfer may have founded Silver Wheaton, but Nolan was the company's first employee and was instrumental in its success. As CFO, Nolan worked alongside Telfer for four years; together they grew SLW from a startup to a company with a market capitalization of $3 billion.

To date, those four years developing SLW remain the best way anyone could have ever learned the streaming and royalties business – there is now no one who knows the business better than Nolan. At the age of 30 Nolan decided to apply that knowledge to a new venture: he founded Sandstorm Resources, a streaming company modeled on Silver Wheaton but not limited to silver. A year later he led the charge as Sandstorm raised $47 million from eager investors, and in its first four years Sandstorm's share price nearly quadrupled.

Nolan is exceptionally smart and extraordinarily driven. His list of successes by the age of 33 is phenomenal. Just imagine what the guy will have accomplished 20 years from now… and how much we could all profit by following his moves. I've done my portfolio a favor and have invested in both Nolan and Amir.

Trusting Pareto

There's a mathematical principle behind the concept of basing investment decisions on the actions of just a few exceptional individuals, known as the Pareto principle. In 1906 Vilfredo Pareto observed that 80% of Italy's land was owned by 20% of the population; 35 years later Joseph Juran noted that 20% of the pea pods in his garden contained 80% of the peas. Thus was born the Pareto principle, which states that 80% of the effects in a situation come from 20% of the causes.

It really does seem to hold up. For example, at present the richest 20% of the world's population earns just over 80% of its income. Many quality control regimes focus on fixing the top 20% of reported bugs to fix 80% of a system's errors. In the US, 20% of healthcare patients use 80% of the system's resources. And so on.

In investing, we take Pareto one step further. Trying to watch the movements of the top 20% of market movers would be very difficult and leave much room for error – too many people to ferret out and follow. So we apply the principle a second time: if 80% of market moves are sparked by 20% of investors, then 80% of those effects come from 20% of those 20%. Eighty percent of 80% is 64%; 20% of 20% is 4%. So Pareto derived, as it were, suggests that 64% of market movements come from 4% of the players.

Four percent we can work with. My Casey's NexTen list is an attempt to identify some of that 4%, specifically the most impressive industry actors under 40 years of age.

I must be on to something. At the Summit there were only two representatives from my NexTen list presenting at the event, and both made it into the top three voters' choice list. Like Meat Loaf said, two out of three ain't bad.

Additional Links and Reads

Oil Slumps to Three-Month Low After European Elections (Bloomberg)

Speculation that the new governments of France and Greece will derail austerity measures in the Eurozone pushed the price of oil down to a three-month low. Downward pressure on oil stemmed mostly from the falling value of the euro against the dollar, a shift that generally reduces oil's appeal as an investment. In France, new president François Hollande inherits an economy that is barely growing, with jobless claims at their highest level in 12 years. Hollande's platform calls for higher taxes, increased spending, and delayed deficit reduction – policies German Chancellor Angela Merkel opposes. In Greece voters also flocked to anti-austerity, anti-bailout parties. West Texas Intermediate crude for June delivery slid to US$97.94 a barrel, its lowest settlement since February 6, while Brent oil for June settled at US$113.16 a barrel.

China's Steel Mills Too Big to Fail – Or Succeed (Reuters)

Trying to serve the "twin masters of the state and the market" has pushed China's steel sector to the brink. Chairman Mao Zedong turned China's steel sector into a key symbol of the country's economic and political prowess, but now margins are plummeting and debts are piling up at lumbering state-owned mills that have never needed to compete for survival. Ferocious expansion since 1978 has produced a massive steel sector in China, one that sates 45% of global demand, but an obsession with size and technological advances means costs have risen out of control just as demand slows.

Coal Fights Obama with NASCAR, YouTube Campaigns (Bloomberg)

Coal supporters are embracing an all-of-the-above strategy to defend their industry against what they consider regulatory overreach in Washington. Coal backers are slighted that President Obama regularly fails to mention coal in his comments about the US's energy future; worse still for industry proponents are a series of regulations related to air pollution and mountaintop mining. More generally, coal is losing its position as the fuel of choice for US electricity generation – coal is now responsible for just 40% of electricity generation in the US, down from more than 50% only a decade ago. To fight back, the American Coalition for Clean Coal Electricity is sponsoring Dale Earnhardt Jr.'s JR Motorsports team and have produced and promoted a YouTube video on the economic impact of the new coal regulations, while coal political action committees and industry executives have spent more than $5 million on political donations.

Higher Bills Likely as LNG Heads to Asia (Financial Times)

Gas prices and energy bills are set to climb in the United Kingdom as cargoes of liquefied natural gas (LNG) are diverted to Asia. UK imports of LNG have plummeted 30% this year as prices climbed, largely in response to increased demand from post-Fukushima Japan, where there are now no operational nuclear reactors. The drop in imports shows how the UK is losing out in the competition for energy supplies to fast-growing economies in Asia and South America, a problem that could get more acute as Britain's own indigenous gas production declines. Britain bears the brunt of any disruption in the LNG market because it has fewer long-term LNG supply deals than others in the EU.

Japan Counts Down to End of Nuclear Power (Financial Times)

For weeks only one of Japan's 54 commercial nuclear reactors had been operational, and now there are none: on May 5 the No. 3 reactor in the northern coastal village of Tomari went offline, leaving Japan without nuclear power for the first time since 1970. Japan's nuclear future is very unclear. The national government has yet to set a clear direction for the power sector but did green-light several reactors for restart. Those reactors remain offline, however, because local authorities still oppose any restarts. Many wonder whether Japan can get by without nuclear energy, which until last year accounted for about a third of the country's electricity supply.