Excellon Resources

By lottery ticket I’m talking about lowly priced, speculative stocks with great potential; rather than actually trying your luck at the latest Powerball or the Big Game, although I’ve been known to do that too! In the investing game my lottery ticket is (surprise, surprise) a junior silver exploration company, Excellon Resources. It trades in Canada under the symbol EXN.V and in the US on the pink sheets under the symbol EXLLF. [See here for a discussion on pink sheets.]

I won’t belabor the bull case for silver. Instead, this post will be a fairly in-depth (for me anyway) look at the fundamentals of this company with some technical considerations thrown in at the end.

Excellon’s claim to fame is its Platosa property in northeastern Durango State, Mexico. Mexico has one of the friendliest legal environment for mining companies. Given the victory of Felipe Calderón over the leftist López Obrador last year, this situation is expected to continue. Platosa is located down the Eastern slope of the Sierra Madres, along the famous Mexican CRD (carbonate replace deposits) belt where many massive silver/zinc/lead/copper mines have been found.

Extremely high ore grades
The Platosa property is characterized by its extremely high ore grade. The company presentation (PDF) shows mineralization of 50 oz/t for silver and around 10% for both lead and zinc. I just about fell off my chair when I first saw these numbers which are so high that a quarter to a tenth of them may make somebody else’s flagship property.

On the other hand, this highly concentrated ore body is not great in extent which I guess is nature’s way of evening things out. The NI43-101 (a Canadian standard for reporting reserves and recourse for mining companies) conforming report prepared in August 2006 shows only 184,500 tons of resource, although if more recent discoveries were included, the total would like be around 350,000 tons. This is miniscule compared with the 5-50 million tons that a large scale CRD could contain.

The high grade ore does allow even a small scale test mining to be profitable. This is precisely what the company has been doing for the past two quarters: generating positive cash flow from test mining to self-finance its exploration activities. For now, Excellon needs to deliver half of the silver it mines to satisfy a silver backed debenture. Its bottom line will improve significantly when the debenture matures this July.

The company currently has 146 million shares outstanding at approximately US$1.20 each which gives it a market cap of US$175 million. It also has 13 millions options outstanding.

Intrinsic value

The intrinsic mineral value can be calculated from the resource amount, mineralization level and valuation for metal-in-the-ground as outlined in the table below. My assumption of $5/oz for silver, $0.25/lb for lead and $0.40/lb for zinc was fairly conservative. A smaller silver concentration than the company currently claim was assumed. I arrived at an intrinsic value of US$114 million, or 65% of the current market cap.

Income model
The picture is rosier when one considers the potential income after retiring the silver debenture. Using the annual tonnage, ore grade and recovery rate contained in the most recent report, it’s reasonable to expect the company to generate US$26 million in the first year based on current metal prices.

If the company were to cease exploration altogether and concentrate on its small scale mine activities, there may be six years of mine life left. Using US$26 million as a baseline and a discount rate of 12% and growth rate of 15% (both are subject to debate of course) the DCF model gives a present value of US$163.5 million, which is close to the current market cap of US$175 million.

Latest quarterly report
Excellon’s stock price was temporarily depressed following the latest earnings announcement where the bottom line number was a measly $216k, a big let-down form the $7+ million in the prior quarter. However, over $2 million was an accounting artifact due to the re-valuation of the silver debenture. In addition, there was some operation problems at the mill that reduced the amount of ore processed in the quarter. The company further stated that they encountered an unexpected mineralized zone while constructing an access ramp. Rather than letting the ore going to waste it was processed and resulted in a drop in the overall ore grade for the quarter. It seems one can’t avoid hitting something when digging in this place!

The technical picture
The weekly chart shows that Excellon has consolidated along the top rail of a large triangle that it broke out from at the end of 2006. The daily chart shows a “W” formation off the strong support at C$1.25-1.27. Short term momentum indicators are pointing up.

Much of this article was written prior to Wednesday, April 11 when the stock jumped over 9% following a new drilling announcement, although I would have to say the content of the announcement was very much expected if one actually paid attention to the map of the property and previous drilling results. I believe my analysis above still stands.

In summary, Excellon is a profitable, exploration company – a combination that is exceedingly rare. Naturally, the stock is leveraged to metal prices, but the real jackpot potential lies in the possibility of discovering a large CRD in the vicinity of its Platosa mine. According to my DCF model, current valuation is largely supported by the test mining activities alone; therefore, investors are getting a near “free ride” on Excellon’s exploration potential.

Disclosure: I own this stock. My “lottery ticket” analogy was meant to highlight the speculative nature of this stock: just like any lottery game, the jackpot may be huge, but payout is far from guaranteed.

Quit Lag

Life changes rarely happen alone. I mentioned here the birth of my daughter in February. My mother-in-law has been staying with us since then. However, she’s leaving next week. After some long discussions, my wife and I decided that I’ll be the one staying at home to take care of our daughter for a couple of years.

There are many, many dimensions for this decision. Foremost on our minds is the well being of our daughter. I’m thrilled with the prospect of spending time with her and teaching her all I know. There are obvious financial implications in this decision given the loss of my income and associated benefits. Fortunately, my wife has a good job and supports my decision.

Looking at salaries alone, it would make more sense for my wife to stay at home instead if one of us has to. However, I’ve been mulling a career change and this is a great opportunity. As a research scientist I’ve built up expertise in a narrowly focused field that is, unfortunately, not very transferable. My wife, on the other hand, has a job that is in demand in most of US. Furthermore, my job demands a greater amount of time commitment than my wife’s. So we agree that it makes more sense for me to do this now and restructure our life for maximum flexibility down the line.

I’ve been writing mostly on concrete options in investing/personal finance, but big picture issues like where to live and what kind of job to take actually have far greater influence on the quality of life and overall well-being. Unfortunately, most of us are so bogged down by the pressures of daily living that we feel powerless in affecting our situation. For our working lives, my wife and I have been living beneath our means and investing diligently. We were not delaying the instant gratification of buying NOW in order to hoard, rather we were acutely aware of the freedom that a solid financial foundation can provide. It’s this freedom we’re cashing-in now.

Quit-lag mode
I’m leaving my company on very good terms. There is no sense burning the bridges even though it’s unlikely that I’ll go back. I gave more than a month of notice although my employment contract requires only two weeks. It’s also unusual that management let the news out over three weeks ago. I guess it was because I have a large number of tasks to hand over. Anyway, I have been in this quit-lag mode for a while now. This was a term that I first came across in this Business Week article. A quote:

When I went back to my desk, the piled-up papers looked like annoying debris. Now that I was leaving, my projects-in-process were meaningless to me. But I had two weeks to kill, so I went to work. I started creating a manual for the person who came after me. I wrote down procedures and lists of contacts and important events coming up in the future. That took about three days. Then I got to work cleaning house.

I threw out papers and cleaned out files. I reorganized employee records and made sure vendor contracts were current. I walked around the office and visited employees who had pending benefits issues or other matters that needed attention. Boy! they said. You are really on the ball this week! Heh, heh, I said to myself. What else do I have to work on?

I’m not sure if I was that much more efficient. But I’m certainly no longer sweating the things I can’t control. Several people commented on that I look relieved, and that’s on about six hours of discontinuous sleep per night!

Preparations for leaving
I’m not sure how common my experiences are, but I want to share my financial to-do list nonetheless.

  • I got supplemental disability insurance. The disability coverage (65% of income, to age 65) I receive through my employer will end shortly, so I work with an agent (my sister-in-law actually) to get some supplemental insurance. You may have to do this well ahead of the final date.
  • I re-read my employment contract so I’m clear on my rights and obligations.
  • I still have company stock options that I have 3 months to exercise after departure. I have been exercising them gradually this year. I will continue with cash-less exercises at certain price targets. I decided against exercise-and-hold because of the AMT implications and the high expense of put options I would need to purchase to guard my profits.
  • I set aside one year’s worth of cash needed to pay for living expenses (in addition to my wife’s income) and put it in our HSBC online savings account.
  • I started investigating income generating securities. [If you were wondering why I was writing about those high yielding closed-end funds, this is why.]
  • I started a self-employed 401(k) account at Fidelity in preparation for rolling over the 401(k) at work. [See why I’m not rolling it into an IRA here.]

Friday is my last day at work. This is going to be a whole new experience for me. Wish me luck!

DOW Near Record High But Japanese Nikkei Plunged

Just when I’m going to write for Friday’s post, reflecting on the market actions, international markets threw another curve ball. Nikkei plunged by 2.3%, down by almost 400 points, while other major Asian markets followed with some 1 to 3% loss.

Will US markets open tomorrow with a loss?

Will the Euro and UK Sterling keep beating up on $US, which just broke $1.36 (Euro) and $2 (UK) levels?

Will gold ascent continue, or be hammered again (for the fifth time on HUI) by the invisible (Fed) hands?

Will uranium spot price continue its parabolic ascent after breaking $100 barrier? Yup, my U.TO (tied directly to the spot price of uranium) has returned 70% in less than a year.

Where was the subprime panic after all? Countrywide (CFC) now is back up to $38. I really wonder who is that stupid to buy those billions of subprime TOXIC loans from Fremont (FMT) and Accredited Home Lenders (LEND)? The only news is that they were sold at a discount (without a doubt). How can there be not a single trace of the loan buyer at all?

In the meantime, my short positions are definitely hurting. I just closed more with a small loss. I still have outstanding 5 short positions in QQQQ, XHB, GM, etc. I was approved for naked short-selling calls, which is allowing me to short stocks that are already on the FTD (Failed-to-Deliver) list via option markets. The advantage of selling calls versus buying puts is obviously that you benefit from time premium. The disadvantage on the other hand is obviously that your profit is limited, while your loss is unlimited.

Despite my short-selling, my net worth on 4/18/07 is just 0.18% below the “all-time” high since I kept a record on this blog (the all-time high was the very first date 5/9/06 quite ironically). My own saving and investing have made up almost 11% shortfall from my company holdings.

Despite all the complacency in the stock market, I’m spending 3+ hours everyday watching the market now (and therefore less time for blogging). This is one of the most dangerous time and my eyes and ears are paying full attention. I fully expect the housing slowdown to hit stock market this calendar year, and I have no time nor mood to cheer the market advances.

I feel almost like I’m back in 1999, when I’m totally shocked by the P/E ratios of the stock markets, while everyone else keeps hooraying all the way into March 2000. NASDAQ however doubled in a single year from 1999 to 2000 during which I was totally abhorrent of the stocks.

From my own investing experiences, I tend to be right, but early (if not way too early). I will delay my own actions, but will make sure that my delayed action won’t turn into inaction.

If you have not gone partially into cash yet, I would say, watch out below. NASDAQ is under-performing SPY, and that is a sign of weakness in this market.

I am prepared to take some amount of haircut even with my shorts which cannot hedge all of my long exposure. What about you?

The Best Real Estate Mutual Fund Ever

For me to come out and recommend a real estate fund, you know this mutual fund needs to be more than truly outstanding. I’m very bearish on real estate as the regular readers know very well. But this real estate fund, plus its other fund offerings in other categories are simply outstanding. In fact, I should say that it is one of its kind, so outrageously probabilistically impossible.

I first noticed this mutual fund back in year 2002/2003, when I was studying various funds for asset allocation. Certainly, real estate must be an essential element to anyone’s portfolio, especially if you don’t own your home. At that time, I noticed that this fund had a very good performance record. Not only that, when I compared its major holdings with other real estate funds, its holdings are wildly different. Most real estate funds hold companies that hold residential or commercial rental properties, collecting rents to produce their yields. This fund however held mostly home builders. Well, from year 2003 to 2005, home builders had great returns, probably out-beating 80% of the stock selections that you can ever pick yourself. But today’s CGMRX holding has not even a home builder stock in its top ten holding, keeping its 20% annual return for the past ten years completely intact.

The fund manager Heebner of this fund company Capital Growth Management is no doubt a VERY smart investor. Here are some highlights of his recent words:

[On housing markets] It will be the biggest housing-price decline since the Great Depression,’’ Heebner, 66, said today in an interview in Boston. Prices may fall by a fifth in some markets….That would leave home prices at levels last seen in 2003 and 2004, the middle of boom that lifted prices to a record in 2005. The damage from high-risk mortgages will slow the U.S. economy, though not enough to send it into a recession….
[On financial brokerage stocks] The investment banks and brokerage firms that package and sell these products won’t get hurt because they have passed on the biggest risks to the investors, “They know the product is toxic; they’re not going to get caught,’’
[On mining, China, infrastructure plays] He is buying shares of mining companies that benefit from growing infrastructure needs in India, China and Russia. CGM Realty Funds also holds shares of Las Vegas Sands Corp., the casino operator that is developing real estate in Macau, China, and Mexican homebuilder Desarrolladora Homex SAB.

On very few occasions, you can witness such a smart investor. Keep him on your list to watch. Take his words and regurgitate during your contemplation. And if you really have to buy a real estate fund, CGMRX is probably one of the better choice. In this particular case, I would really say “FORGET about the low fee Vanguard”. Here is the comparison chart between VGSIX and CGMRX. Don’t use Yahoo to plot because Yahoo plotting doesn’t take into account the almost 20% capital distribution/dividends in the last couple of years by CGMRX. The following plot uses the price on 12/31/1996 as 1. CGMRX returned almost 7 times or 700% in the last 10 years. (I mispelled CGMRX as CMGRX in the chart.)

On the last note, CGMRX and its other offering are mostly concentrated bets and non-diversified. You will be taking higher than normal risk when you buy one of his funds due to its concentrated bets. But given its past record, although there is no guarantee for the future, I would probably still lean towards buying any CGM funds.

I currently have no holding, but I’m really going to seriously consider CGM funds (not necessarily CGMRX), especially after I’ve missed the entire ramp-up in the most recent real estate bull market (which has probably turned into a bear market already).

Its CGMFX Focus Fund returned 24.7% from 1/3/06 to 4/9/07, and 17.9% from 1/3/07 to 4/9/07, very good this year, but not so good last year. This uncorrelation to the general market is an excellent choice for asset allocation.

Hedging Strategies Through Options By Hussman

I have been contemplating how I can hedge my portfolio with less risk. I decided to take a look at how Hussman mutual fund managers do it. Using from their semi-annual report, I found out that they had the following outstanding option positions:
Effectivley Long: Call on 10000 S&P 500 index option, expiring 2/17/07 at $1420 strike price.

    Effectively Short:

  1. Put on 8000 Russell 2000 index option, expiring 03/17/07 at $780.
  2. Put on 10000 S&P 500 index option, expiring 03/17/07 at $1330.
  3. Put on 6000 S&P 500 index option, expiring 03/17/07 at $1400.
  4. Sold Call on 8000 Russel 2000 index option, expiring 03/17/07 at $700.
  5. Sold Call on 6000 S&P 500 index option, expiring 03/17/07 at $1250.
  6. Sold Call on 10000 S&P 500 index option, expiring 03/17/07 at $1330.

Whether Hussman had gains or losses from these trades, it really depends on how well he timed the market. First, I’m just going to study the hedging strategy these options provide to his portfolio.

His long position basically cancel out short position #2, without regard to the difference in the calendar dates. The rest of positions, only Put can provide full downside protection. Selling calls only allow your downside protection to the strike price. The thing to note here is that at the time when this report is out (12/31/06 I supposed), the price for S&P 500 was at 1418.30, and Russell 2000 was at 787.66. If you take a look at the calls that were sold, all of them were deep in the money. When deep-in-the-money calls are sold, it basically amounts to short-selling with less time premium (but more downside protection to the strike price). The puts that were purchased were mostly at-the-money. With this combination of calls & puts, Hussman is able to provide a downside protection from both of his calls & puts, assuming that S&P 500 stays above 1250/1330, and Russell 2000 stays above 700. The total hedging power assuming that S&P 500 stays above 1330 would be roughly (6000 + 6000 + 10000) * $100 per contract * S&P 500 value + (8000 + 8000) * $100 per contract * Russell 2000 value = 4.38 billion. (S&P 500 and Russell 2000 values are from 12/31/06). Or 2.96 billion if S&P 500 falls below 1330, but stays above 1250. Since the total NAV is 2.84 billion, and total common stock value is $2.89 billion, Hussman had his portfolio fully hedged.

Now if I look at the actual gain/loss from his positions, his effectively long position lost about $5.8 million, and his puts lost about $5.1 million, while his sold calls lost about $8.8 million. If he has not closed out his hedging positions since 12/31/06, his hedging positions would be losing more money by now since overall the market has moved higher. Obviously, his long stock positions are moving higher too to counter the losses from the hedges. But with a total loss of about $19.7 million, he is able to pretty much fully hedge a portfolio value of $2843 million or 2.843 billion. That’s a loss of about 0.7% (on 12/31/06).

Such hedging strategies definitely provide a very good protection when the market falls. However, because of the hedging, Hussman strategic growth fund has been underperforming the general market in the last 2 to 3 years. Such is the cost of being a market timer when the market does not cooperate with your actions.

In the next post “The price of a free(?) hedge”, I will look at my own hedging strategies using stock options of calls & puts in a similar fashion that Hussman has done. It’s certainly much easier to study what others do than putting everything in action. One can be so grandiose about the term hedging, but after all, what it really means is selling out in a certain way. Whether this “certain way” is smart or not, the performance will speak for itself.

P.S. By the way, the pricing/cost between options on futures market and options on stock market is similar (or else someone can arbitrate between the two). The only difference in cost may be simply the brokerage commissions.

Networth Review For March 2007

For the month of March from 3/1/07 to 4/1/07,

  1. Net worth is up by 3.28%.
  2. Value of my company holdings (stock options, ESPP, etc.) is down by 5.35% partially due to my liquidation.
  3. Everything else excluding my home and cash is up by 4.54%.
  4. If including cash in #3, it’s up by 3.46%.

My portfolio has not changed much since the end of February. I have liquidated majority of my holdings that correlate to the general stock market. Right now I only hold 0.2% of my net worth in such stocks/funds. I also still hold some short positions in QQQQ and housing stocks which only hedges against less than 7% of my own portfolio. I’ve closed out about half of my hedges, and some unsuccessful shorts.

Here is the current composition of my portfolio:
1. 55% in metals.
2. 35% in energy.
3. 10% in consumer staples, water, and agricultural stocks.

Here is the current composition of my net worth:
1. 62.6% in my portfolio+cash+misc.
2. 20% in my company holdings.
3. 17.4% in home equity.

Last month I commented:

I believe the secular bear market in stocks may have resumed. The unfolding of such secular bear market however does not necessarily mean a fall in the absolute price of the stock market this time around. Rather, the stock market will fall on an inflation-adjusted basis, and also against gold. There is also a chance that Fed stops the downward spiral in time, and create a bigger bubble in everything going forward. The most likely timeframe is in 2008/2009 for next (potentially higher) peak. In fact, the stock market can put in a higher high in 2009, but not necessarily beating the accumulated inflation since 2000. I do expect the stock market to go lower than the low on 3/5/07 this year. I also expect the general stock market to put in less than 3% gain for the entire 2007 year.

After much seesawing in March, this stock market really has some inexplicable strength, except in a few isolated mortgage stocks and financial sectors. Fundamentally speaking, the problems in subprime and Alt-A mortgages will create a huge problem for the market going forward. Yet technically, the market doesn’t seem to go down much at all. How much longer this market can hold up? I’m still waiting for a safer entry to short more. In the meantime, NEW century mortgage has filed bankrupt, and several other mortgage companies keep falling.

I’m not sure whether a higher high will come first before a lower low than the Feb/March low. Although my belief is that a lower low will materialize later this year, my conviction is wavered by the market strength. My current plan is still going short against financial/housing/general market and possibly adding some tiny long positions in energy or gold. But I will take my loss if the bull market runs away to the upside again.

Best luck navigating in the dangerous water.

Special note: returns were calculated by subtracting 3.00% APR return of my cash position.