Willem Middelkoop: Commodity Investors Are Facing a Once-In-A-Lifetime Opportunity to Profit

Willem Middelkoop believes we are staring down the beginnings of a generational bull market in commodities. In this interview, Willem shares how he plans to profit from the expected commodity bull market by focusing on investing in mineral discoveries.  He discusses how the Commodity Discovery Fund identifies and invests in potential world-class discoveries.

Willem Middelkoop is the chairman of the Commodity Discovery Fund’s management team and is ultimately responsible for the fund’s investment policy. Willem is one of the pioneers of discovery investing and is the author of seven books on economics and financial markets.

0:05 Introduction

1:30 How Willem came to focus on discovery investing

4:58 Why natural resource speculation versus over other discovery-focused sectors?

6:07 How often do you buy your initial position after the discovery hole announcement?

7:31 Due diligence in first 24-48 hours after discovery announcement

10:57 Role of fundamental and technical analysis in monitoring discovery plays

12:25 Exit strategy for discovery plays

15:24 Managing a discovery fund in a commodity bear market

18:55 Stock exchanges Willem’s fund buys positions through

22:28 Investing in pre-production stories

24:58 Must you be bullish on the underlying commodity to invest in a discovery play?

26:10 Ideal time for new investors to invest in the mining sector

TRANSCRIPT:

Bill Powers: Willem, welcome to Mining Stock Education and could you begin by sharing with us why your fund focuses on investing in the discovery phase of the mining life-cycle?

Willem Middelkoop: Thanks for the invite. Well, as many investors know, this is the most exciting and often the most profitable phase during a mining cycle when a small exploration company strikes gold or silver or copper or zinc. We often see a very sharp increase in the market capitalization of the explorer company. Which is, pre-discovery, often valued at 10, 20, 30 million dollars. And after a discovery hole indicating this could be a world class discovery we see a sharp rise in value often leading to a valuation of over 100 million, 200 million, 300 million dollars.

Bill: True discovery and invention creates wealth, but that doesn’t only occur in the mining sector. We see it in biotech and other sectors. Why did you decide to focus on finding discoveries within the mining sector?

Willem: Yeah, it all started for me in the 1990s. I was an investor in Amsterdam real estate. It was all mortgage, so I was quite a bit in debt and I was studying the economic cycles. I became convinced we’re in bubble territory with all the tech stocks. And I decided for myself that when a market crash would start to happen I would start to take profit on my real estate because I learned from my studies of monetary cycles that often real estate lacks a few years on the stock market. So when the NASDAQ bubble burst, I started to take profits on the real estate, 2002, 2003, 2004. And I started to hedge myself by buying gold and silver positions: first physical and then some mining shares, the bigger names like the Newmont’s and the Barrick’s. But I soon learned that the smaller companies doing discovery were doing much better.

So around 2005 I started to specialize on the discovery cycle. I started to study it more and more. I started to even write a small newsletter called Middelkoop Discovery Alerts, sending out alerts about discovery holes. I was very fortunate to be very early investor in Aurelian Resources. I bought 10,000 stocks for 30 cents six weeks before they made the discovery of Fruta del Norte, that was beginner’s luck. And then I rode it all the way to over $40. Not with all of my shares, but I always had some shares left. And that made a huge impression on me. And then I decided, well, I like this so much, this is so interesting, let’s really study it in detail. I was working as a journalist at that time, as a market commentator for Dutch TV. But I soon decided to quit as journalist and to focus on discovery investing full-time and this occurred just before Lehman crashed.

Bill: As a speculator do you feel as though the mining exploration sector and pursuing discoveries there, that you have a higher probability of success versus other comparative sectors that focus on discovery?

Willem: I’m also an angel investor in some start ups. And in the start up scene you have the same dynamics, one could say, you see the same in biotech. But I think as an investor, as a speculator, as a fund manager you should focus on one thing and one thing only. And because it started for me with Aurelian Resources I decided to stick to natural resources. Of course the worst decision in my life was to start a commodity fund in 2008 at the top of the commodity cycle. I should have started the commodity fund now, at the bottom of the commodity cycle. But we are very fortunate because we have some 50 million Canada assets under management. So if you’re 50 million at the bottom of the market, nice things can happen to you and your fund when the bull market returns and I think we’re on the verge of that to happen.

Bill: How often do you buy your initial position in your fund after that first discovery hole is announced, versus when you buy before the discovery?

Willem: We prefer to buy after a discovery hole and then very soon after. So often when there’s a discovery hole we will be buyers at market at the open. We buy all we can buy. When we think it’s a great discovery. When the great bear discovery was announced and it was halted and then we got a news of the private placement and as soon as they opened we bought shares in the open market. Buying pre-discovery is always risky so we only do that when we have a strong indication a discovery could be made on a short notice. But often you have to wait longer. We have a big position, a quite sizeable position in Sama Resources. They do have a nickel discovery in Ivory Coast. But it’s a complex system. They know the nickel is there, they don’t know how much nickel is there. And often you have to play the waiting game and when you’ve got too much money involved and you’re in the waiting game it’s not the best position for great returns.

Bill: Willem, after you see that initial discovery hole press release, can you talk about that first six hours. What do you and your team do within that six hours after that first hole is released?

Willem: Actually, it’s about the first 24 or 48 hours. Because if you really talk about the situation that a major discovery hole has been discovered then you need … Often there’s quite limited time before the market opens and you heard the news. Often there’s only half an hour or one half hour. So then you do the basic research, you look at the presentation, you look at the insider sales, but most important for me is to look at the graph. When the chart is showing an uptrend already, it often proves to me that there has been a leak and this is a serious discovery and insiders have been buying already. When I see a discovery hole and the chart doesn’t show an uptrend I’m always a little hesitant to buy a lot at the open. But the first 24 hours or 48 hours are most important because there’s a lot to study. And I visited the bulletin boards a lot, I visit CEO.ca.

There are always people who know more, there are always people who heard rumors and there’s a lot of advantage to be gained by looking at all these public boards because this is no insider information, it’s all public information. So we have to make sure we’re very well regulated, so we have to stay on the safe side and never can trade on insider information. And it takes a lot of time to read all previous press releases because a discovery hole doesn’t come out of nothing. So previous there has been channel sampling, chip samples, there have been previous drill holes. And you have to study it all, you have to read it all and most of the time there’s quite a bit of history to study. You have to study the location, the geology, you have to look at Google Maps and this can take one or two days. But then you have a real advantage, a real advantage compared to other investors if you’ve done your homework well.

Bill: After you take that initial position in a discovery play and let’s say it’s a couple months down the road and drilling progresses, what’s the role of fundamental analysis and technical analysis in how you monitor your positions?

Willem: That’s a great question. Because it all starts with a bang and then you get this very steep uptrend. So if it this is a world class discovery in the making what’s very important to notice that the stock will rise and stay above the 50-day moving average. Only once or twice in the discovery phase the stock will return to the 200-day moving average. And that’s most of the time a quite severe correction. So as long as the stock stays above the 50-day moving average we tend to stay long and long only. And only decide to take profits when we think the parabolic phase of the first stage of this discovery is going to end. Then we tend to sell quite a bit. With Great Bear Resources we sold half of our position between seven and nine and a half dollars. And then we feel comfortable to ride the correction to the 200-day moving average. And then often the fund starts again.

Bill: So you don’t always just wait for that exit strategy where the producer buys out the deposit?

Willem: Yeah, we always wait for that end game, but not with our full position. And we also, I told you we’re highly regulated and, for example, with Great Bear or SolGold often a position grows to over 10% of our portfolio, and when it’s over 10% of our portfolio we need to scale down. We’re not allowed to have one position being over 10% of our portfolio. So then we have to take profits, but we always keep a very large position, Great Bear Resources is still over five percent of our fund. And I expect much higher prices in the future. But we had to scale down because it was over 10% of our fund.

Bill: Willem, I talk to CEOs and fund managers who have been guests on this show, and from a CEO perspective sometimes when they’re an exploration company and their shares sell off they’re trying to figure out who’s doing the selling and often times it could be a recent investor that maybe took part in a private placement. I’ve also talked to fund managers who say that when they’re not happy with what’s occurring in the exploration company they don’t mind just blowing out the stock and getting their initial capital back. How do you approach things, when you invest in an exploration play and you’re not pleased with the progression or management decisions or how they’re spending their money? What is your exit strategy at that point?

Willem: Well it’s important to sell and it’s often difficult to sell, because especially when you have to sell at a loss. But often you better sell at a loss of 30% than wait for the loss to become 90% or even 95%, which happens in exploration stocks. But often for us it’s quite difficult, because if the stock is quite illiquid, because of our size and the very illiquid markets nowadays we tend to have a large position which is quite difficult to sell at open market. If we start selling aggressively you’ll bring down the price. So it can be difficult. So it’s always important to understand you made a mistake early or the situation changed and react early. I saw the press release or the first news about the terrorist attack in Burkina Faso a few weeks ago and we had a position in SEMAFO and they were down 10 to 12%. And I knew I had to sell right away but I waited, I thought well maybe it has an uptick. And then often you tend to sell when it’s down 20 or 30%. So often when you see the news, if it’s good news on the discovery hole, buy right away, if it’s bad news, sell right away.

Bill: You launched your fund in 2008, so you’ve already gone through a bear market. Because you focus on discovery you can actually still make money in a bear market, but throughout a bear market if you say to yourself, even though I’m bullish on the long-term for commodities and mining, but I realize I’m in a bear market, do you keep more cash rather than positions or how do you navigate your fund through a bear market?

Willem: It’s very, very hard. Because as a fund manager you’re almost obliged to put your money at work. You can’t attract new investors and say, we’ll keep it cash for the next few months or a year and wait till the uptrend starts again because investors they invest their money and they hope you’ll put that money at work. And often we’re into a few very good investments we show a real nice uptrend, but if you’re in a general bear market you have 10 discovery stocks going up in your portfolio but the other 90% is going down, so then it’s very difficult to make positive returns in a bear market. Especially since the exploration companies don’t have any cash flow and they have to dilute themselves and in a longer bear market the dilution is what kills you. It’s very hard to make good returns. But we ended, I think this bear market in commodities, devaluation of commodities against S&P 500 are at 50-year low. And I think this is a once in a lifetime opportunity to really buy at rock bottom prices, really pennies to the dollar.

Bill: Because your fund is such a high-risk, high-reward fund, how do you educate your investors in order to temper their expectations?

Willem: This is maybe the most important part during a bear market. We had net inflows every year since our inception. So we even had net inflows in 2014 and 2015 and 2016. I think we’re the only resource fund who has this track record. And this can only be done by being very open and very active on the information side. We do a lot of webinars, we send a lot of information out there. So we constantly show investors what we’re doing, where the market is. And this has worked very well for us. Of course there’s a lot of frustration in our team, but also with investors. And every month we have redemption but we always have a positive net inflow. It’s very rare for us to have a net outflow. And we’re very fortunate that we only have retail money, high net-worth money, and these investors tend to be much more loyal than the institutional investors. So I know a few funds who work from London or from Toronto and they were … All their clients was more or less institutional and they all left so these funds they had massive redemption and that’s what brought the market down that much.

Bill: Do you primarily purchase your companies via the Toronto Venture Exchange? Is that the primary exchange that you participate in?

Willem: It’s the primary exchange, it’s not the only exchange. In the first few years we ignored the Australian companies but there’s some very great situations in Australia, also discoveries. So I think 20% of our portfolio is Australian-listed now. Many Australian companies also listed in London, on the London stock exchange. And we don’t like to trade in London, it’s not a very efficient market, you still have to work with market makers and you get screwed sometimes. But we trade the London exchange, the Australian exchange, but mainly the Toronto stock exchange, the venture index, that’s right.

Bill: How does the Frankfurt exchange compare to the TSXV?

Willem: Oh, well we ignore it almost. Because if they have a listing in Frankfurt they also have a listing in Toronto. So it’s a German situation, it’s nice for the German investors. The German’s want to buy in their own country, they have an account for their own stock exchange. But it’s very, very rare we trade Frankfurt, although it’s very close to Holland, but we prefer to trade in Canada and have more liquidity.

Bill: Many investors feel that the Toronto Venture Exchange regulators have a louder bark than they do bite. Is there anything that you can share from an international perspective regarding your experience with the Toronto Venture Exchange and maybe some suggestion you might have?

Willem: Oh yeah, if you look at the level of front running and insider training, this would never be allowed to happen in Europe. Our regulators in Europe would really put people trading on inside information in jail or give them very high fines. So there’s a very serious crime if you do that here. And I think the watchdog in Canada is asleep at the wheel. But mining is such an important part of the economy, so I think there’s some pressure from high above, that, you know, if people like Willem bring money to Canada, let’s not spoil this game. But I think it’s a shame what happens. Look at what happened with the pot stocks and every hype is being developed and helped in a way. Wall Street could be jealous.

Bill: Do you focus at all on that sweet spot? The pre-production spot on the Lassonde life-cycle of a mining share right before companies go into production and there’s the expected increase in share price?

Willem: Yeah, that’s the second best spot. So we play the discovery cycle, discovery phase, and we play the start up of production. Currently there’s an interesting situation: Nevada Copper. They’re on the verge of starting production in the U.S. And I think their valuation is incredibly low. So we’ve been buying that stock and Lundin Gold starting their Fruta del Norte mine. That’s the discovery I described at the start of our talk.

Bill: It’s your second go around.

Willem: Yeah. 13 years later that’s amazing. So we invested there. But it’s tricky, we’ve seen a few new producers really collapse. If we look at the diamond space we saw a few disasters there in Australia, we’ve seen a few disasters with starting producers. Of course we have Victoria Gold in the Yukon, the first serious gold producer in the Yukon. Seems they’re doing everything right, but we need to see a few positive results on the quarterly basis. So it’s a risky part, but high risk, high reward.

Bill: And what percentage of your fund would be in that stage of the mining cycle?

Willem: 10% to 15%.

Bill: So you definitely are a discovery fund.

Willem: Oh yeah. On average, exploration and we just completed a new strategy, well, concept for 2020. And we discussed the 50% of our portfolio should always be the top 25 discoveries world wide. So maximum 25 different names will make out 50% of our portfolio. And then we have ETFs, we play the market also by ETFs. So if we’re going to go long copper stocks we prefer to go long the COPX instead of all the different copper names. And the ETF makes let’s say 20% of our portfolio and then we have some other pockets.

Bill: Do you have to be bullish from a fundamental and demand standpoint on the underlying commodity before you would invest in a discovery play?

Willem: No. The wealth creation from a world-class discovery is so strong that the market, the general market or the underlying metal could go down by 30 or 40% that year and that stock will rise 200% or 300%. And that’s what I love about discoveries. A great discovery can be made by a very bad management team. And the management team will be changed when it’s a world class discovery. We’ve seen that time and again. So there’s only one real criteria for us and that’s the quality of the discovery hole. And then the only thing that can go wrong is, we’ve seen that happening with Bre-X, that was before our time but if you really … If the results have been tampered with and if the gold dust is being salted in the samples, but these, of course, are very rare situations.

Bill: Willem, as we conclude do you have any parting advice to the investors that are listening to us in light of what we’ve spoken about today?

Willem: Well, people who are just starting to look at this business, they are the fortunate ones. If you can put money at work now and you haven’t experienced the losses we all experienced in the last few years, like I said, it’s really once-in-a-lifetime situation and there’s so much value out there and there are so few good projects. We’ve seen four M&A transactions in the gold space in the last few weeks, today a new one. And it shows that the producing companies are on the hunt for the last few real good deposits out there. So when a discovery has been made or will be made in the future you’re guaranteed that they will be bought out and there’s some very nice examples on our shortlist now. We expect a few buyouts. We had eight buyouts this year and we expect a few good ones next year.