June 2011’s Penny Shares to Watch…

This month’s penny shares to watch:

• Have commodities peaked...

Regency Mines (RGM), Red Rock Resources (RRR), Zincox (ZOX)

• Can this audacious little inventor finally make millions...

Torotrak (TRK), Transense Technologies (TRT), Corac (CRA), Baker Hughes (NYSE: BHI)

Looking to invest in penny shares? Keep reading to discover my ideas for the coming month...

Have commodities peaked?

(This article first appeared in Penny Sleuth in May 2011. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)

“WANTED! Gold and Silver!”

That was the headline of a leaflet that dropped through my letter-box at the end of last week:

“Silverware Urgently Wanted! Diamond Jewellery Bought For Cash! Gold is at an almost record breaking price, so don’t delay. No article too small.”

When the housewives of north Oxford are being urged to raid their jewellery boxes and scurry down to the scrap dealer, it sounds like the bell that rings at the top of the market.

Stock market investors seem to have drawn the same conclusion. Share prices across the natural resources sector have been tumbling. The greed and excited anticipation that was so evident at the start of the year has turned to fear. Private investors have been running for their lives.

But there is an alternative argument here – one that suggests that this could present a decent buying opportunity…

China and India are still very hungry for metals

To get an insider’s view of the problem I headed down to London to meet Andrew Bell. This chairman and chief executive of Regency Mines (RGM) and Red Rock Resources (RRR) knows the sector better than most.

I started by suggesting to him that the recent pullback in mining stocks was nothing more than a knee jerk reaction to a perceived slowing of the Chinese economy. He agreed, pointing to the still high price of iron ore. This is the commodity most fundamental to China’s needs and its price is a good measure of how the economy is faring.

Demand for iron ore is not just a factor of the country’s growth rate, Bell explained. “Under Chairman Mao”, he said, “the Chinese had to live in their place of birth. Mainly that meant in the countryside. But now the process of urbanisation is under way. Every year over twenty million Chinese are quitting the countryside and heading for the city”.

In any case, he continued, India is ready to take up any slack. India’s ‘Hindu growth rate’ was traditionally about 3% per year, strangled by bureaucracy.

“You could not do anything without a permit”, said Andrew. But last year growth of the Indian economy surpassed that of China for the first time.

And here’s a figure for you: 45% of Indians still do not receive electricity. Since nobody has found a way of sending electricity wirelessly, this ensures a continuing demand for copper.

With 40% of the global population living in either China or India, the growth and urbanisation of these two countries will be the overriding factor for commodities for years to come.

A massive gold appetite meets a supply squeeze

Bell sees this growing demand as the key to the price of industrial metals. But for gold, other factors are at work.

On the supply side, South Africa produced over 900 tonnes of gold in the late 1970s. Today its production is below 300 tonnes per year. With world production of 2,450 tonnes last year, that leaves a huge gap.

Meanwhile, two other factors are driving demand. For the last two decades, central banks have been selling their gold reserves. Now though, the tide is turning. Mexico recently bought 100 tonnes of gold, and other countries may choose to diversify their reserves away from the dollar and follow suit.

To this we can add the appetite for gold from the nouveau riche. Demand for gold has always peaked during the Indian wedding season. This year, though, this demand was exceeded by Chinese gift-giving during Chinese New Year.

Commodities will keep rising in the long term

The long view is still surely positive for commodities. Supply simply cannot be cranked up fast enough to meet demand.

In the case of many commodities, oil for example, the obvious resources have already been exploited. A chart I spotted last week projected that output of the world’s operating zinc mines will fall from 12m tonnes to 8m tonnes by 2020, while demand is expected to soar from 12m tonnes to 16m tonnes. Even aggressive mine expansion is unlikely to close this gap.

To me, the current setback in mining stocks looks like a trader’s reaction to three factors. A slight slowing of Chinese growth; a generalised retreat from perceived risk consequent upon the travails of the Eurozone; and some heightening of political tensions between miners and host governments.

But as the chief executive of Zincox (ZOX) explained to me this week, if product prices stay anywhere close to today’s levels, most mining ventures are set to be very profitable indeed.

I agree with Andrew Bell. “If you take a short term view”, he says, “you are competing with everyone else. But if you take a long term view you are competing with far fewer people - and have a better chance of being right”. The long-term view surely favours the bulls.

Can this audacious little inventor finally make millions…

(This article first appeared in Penny Sleuth in May 2011. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)

Like Barry Manilow and celebrity cults, small companies with exciting technologies are hard to kill off altogether.

There are always some persistent believers – the kind that keep companies like Torotrak (TRK) and Transense Technologies (TRT) alive. Another to test the enduring faith of investors is Corac (CRA).

Corac’s best known invention is the Downhole Gas Compressor, a cleverly engineered device that can, in theory anyway, release much of the gas that is left in producing wells when the pressure ebbs and the gas ceases to flow.

This could have considerable value. In its recent results presentation, Corac explained that there are 500,000 active gas wells in North America alone. Its American partner, the giant oil services group Baker Hughes (NYSE: BHI), reckons that 8-10,000 of these could benefit from the Downhole Gas Compressor (DGC).

Even a 10% share of this market would reap 800-1,000 customers. With each DGC selling for around £1m, that amounts to considerable revenue of which a fair slice would accrue to Corac.

In a research note, Cenkos Securities spells out just how valuable this could be. Deals such as GE Energy’s £1.7bn acquisition of the Wood Group’s Electrical Submersible Pump division and its earlier purchase of Sondex, a specialist in downhole wireline logging and drill tools, are evidence that the industry’s big groups will snap up any proven technology.

“So it is reasonable to assume”, says Cenkos, “that one of the industry majors may well be prepared to invest in order to secure a long term source of growth… we conclude that the potential value of Corac’s technology is many times larger than the current value of the company”.

That much is indisputable. But the question remains…

Will the DGC ever pay off?

The DGC, essentially, is an air compressor that blows air into the gas well, increasing the pressure and driving the gas out. No operator has been able to replicate the effect of increasing the flow rates of gas in the same way that electronic submersible pumps do for oil wells, despite applying the same logic – that it is more efficient to place such a system within the well rather than on the surface.

The technical challenge cannot be underestimated. The rotational speed of the wellbore compressor is roughly 3000-7000 revs per minute in an oil well, but needs to be much higher in a gas well. The DGC needs to work up to four kilometres below ground, it must withstand temperatures of up to 150 degrees and cope with water, sand particles and corrosive chemicals.

Assuming it can survive such harsh conditions, it must then rotate at exceptionally high speed, generating maximum impact despite being enclosed in a seven-inch casing pipe.

To achieve this, Corac, which is based on work done at London’s Brunel University, has had to design a unique power electronics system. But the real key to the product is the use of gas bearings.

Rather than resting upon ball bearings and being lubricated by oil, the DGC is enclosed by a sleeve of gas, floating upon it like a bird on the wing. Having tested this under artificial conditions at a site in Cumbria, Corac now believes that the DGC, which is by far the smallest compressor of its kind relative to its power, can work in live conditions. But investors have been waiting a long time for proof.

The gas compressor moves towards commercial success

Last year former executive chairman Professor Gerry Musgrave was ousted in favour of Phil Cartmell. Cartmell has managed to sign a number of deals that could accelerate the commercialisation of the DGC.

In particular Corac has signed a deal with the Austrian oil major, OMV, which is to pay for an initial feasibility study with a view to using the DGC in one of its on-shore gas wells. This adds to an existing arrangement that should see Italy’s ENI trial the DGC later this year and a third with an unnamed partner in North America.

Progress, especially with ENI, has been painfully slow. But with £21m under its belt after a share issue last November, Cartmell has been given a fair run at the problem.

If Corac can commercialise the DGC, there is no shortage of other potential applications for oil-free compressors that can achieve 70,000rpm, such as in water treatment, cryogenic processing of shale gas, movement of bulk products and improving the efficiency of existing compressors.

But that is for the future. For the time being, the shares are a gamble on the trials in live gas wells. As Cenkos explains “valuing companies with disruptive technologies and high potential is difficult”. Well nigh impossible, I should say. But if the DGC can finally make a commercial breakthrough, its faithful shareholders should be well rewarded.

- If you give it a try, you'll get access to my definitive list of the 34 companies in our portfolio...

Good investing,
 

Tom Bulford Editor, Red Hot Penny Shares

Leo from Kintore, Scotland says… “I took the plunge and subscribed and, to be honest, have not looked back since. I have invested in a number of recommended companies and the result has been to see my portfolio rise 150% thus far (in about 18 months). I would simply say that if you are looking to invest in something a little different, have a little cash you can afford to lose and like to take risks in order to achieve greater returns, then this is for you.”

To see more feedback from our readers click here

(This article first appeared in Penny Sleuth in May 2011. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)