Forty years a speculator, part II

—The following is the second of a two-part, edited excerpt from Forty Years a Speculator, an investing memoir by Fred Carach, a certified real-estate appraiser in Florida and 40-year subscriber to The Northern Miner. The 142-page book is available at www.lulu.comand www.amazon.com.

Another favourite penny mining stock that I am very keen on is Canadian Zinc (CZN-T). The saga of Canadian Zinc, and it truly is a saga, begins with the famous Hunt brothers and their attempt to corner the silver market in 1980. In the process, the price of silver was driven to US$50 an oz.

As this was going on, the Hunt brothers were building what is today’s Prairie Creek mine in Canada’s Northwest Territories. The Hunt brothers sank US$50 million into building the mining infrastructure, which was 90% complete when they declared bankruptcy and lost the mine.

Over the years, a total of US$100 million was spent to build the infrastructure that is now complete. The orebody is extraordinary: 11.8 million tonnes of lead, zinc and silver. If silver were a base metal, the deposit would probably rank as North America’s richest base metal deposit not in production. The deposit contains 70 million oz. silver, 3 billion lbs. zinc and 2.2 billion lbs. lead.

I know what you are thinking: “Fred, how much did you have to pay to buy into this treasure trove?” I made my initial buy in 2002 for 9 a share, but my average cost is now 20 a share. As this is being written, silver is selling for about US$10 an oz., zinc for US$1.02 per lb., and lead for US53 a lb.

Now if my figures are right, you come up with a total orebody value of about US$4.86 billion. Currently, Canadian Zinc has about 93.4 million shares issued. Therefore, each share represents about US$52 in ore value. As this is being written in 2006, Canadian Zinc is selling for about 80 a share. The best is yet to come. [Editor’s note: the stock subsequently rose above $1.50 per share and today trades at 45.]

Now the astute reader is going to point out that what is really important isn’t the value of the orebody, but whether it can be extracted at a profit. And this is of course true, but when you own 40-50 penny mining stocks and each position is considerably less than 1% of your investment capital, you need a quick and useful indicator of value, and this is one of the best.

For years I struggled with this problem. There are many mining claims for which no reliable ore estimates exist. How do you estimate value? For a real-estate appraiser, this was a serious matter that I couldn’t resolve.

One day, plus or minus two years from the time of my Koger Equity crisis, I was reading The Northern Miner. I was trying to make sense out of the core drilling samples that had just been reported to the press by a company that I was following, but of course I wasn’t having any luck. The only thing I know about geology I learned in a college course.

As I agonized over the data, the second great revelation of my stock market career occurred. In a flash I realized that penny mining companies weren’t mining companies at all unless they were producers, and this is very rare. They are in reality real-estate companies in drag. They are “location plays.” And I had always been too stupid to figure it out.

In real estate, the classic location play is raw acreage. You find out in what direction the city is growing and you drive out in that direction until you reach the point where the land is sold by the acre rather than by the lot, then you just buy and wait for the city’s growth to reach you.

A penny mining stock’s only asset is its mining claim, which is real estate. And the value of that mining claim is overwhelmingly determined by its location in a mining camp or proven mineral trend. When a mining camp reports a rich strike, all the mining stocks go up in value and the cheapest stocks go up the most. Armed with this knowledge, I was able to take bigger positions and bet with more confidence than had ever been possible before.

There is one last penny market play that I have to tell you about. The reason why is that it is the greatest profit maker I have ever had on a percentage basis. It started out in an unusual manner.

In 2001, I bought a little jewel called Pioneer Metals for 12 a share. I liked the stock because it had a nice package of properties and it was being run by the highly regarded mining promoter Stephen Sorensen.

A year later, the owners of Pioneer Metals received a most intriguing letter. We were informed that the company had decided to spin off its uranium properties into a new corporation to be called UEX.

I was only vaguely aware that it even had uranium properties. I had purchased the stock because it had an interesting stable of gold properties.

But what blew me away was their brilliant analysis of the coming boom in uranium. Until that time, uranium didn’t even appear on my radarscope. By the time I finished reading the report, I was a raging bull on uranium. At that time uranium was selling for about US$18 a lb.; today it is selling for US$45.50 a lb. The shortage is so acute that US$60 a lb. is in the bag in the next two years. [Editor’s note: at presstime, uranium oxide sells for US$64.50 per lb., having peaked above US$130 per lb. in mid-2007.]

At its birth in 2002, UEX was blessed with about 247,000 very strategic acres in Canada’s Athabasca basin in northern Saskatchewan. The Athabasca basin is the richest, but not the largest, uranium camp in the world and produces about 30% of the world’s uranium.

I was so impressed with UEX’s potential that after the spinoff, I increased my position by an additional 25%. Because the value of Pioneer Mines was worth more after the spinoff than when I purchased it, I decided that for accounting purposes I would regard the cost of the spinoff shares as zero.

Currently, Pioneer Metals is selling for about 57 a share. When I consolidated the free spinoff shares with my purchased shares of UEX, the average cost of my position was 7 a share.

I wasn’t the only one who was impressed with the potential of this new creation. From the moment it went public, its rise was relentless. UEX currently sells for $4.25 a share. [Ed.: $3.02 at presstime.] My investment has increased in value about 60 times and the sky is still the limit. As I have stated before, it is possible for an investment to be too good to be true if people are unaware of its existence.

The penny mining stock universe is the secret citadel of stocks that the investing public would regard as being too good to be true if they knew it existed. Where else can you routinely make micro-bets or chump change investments and get returns like this? I rest my case.