Joe Mazumdar, senior mining analyst at Vancouver’s Haywood Securities, adheres to certain fundamental metrics when reviewing the pedigree of a junior firm. In this exclusive interview with The Gold Report, Mazumdar explains why some juniors are positioned to do better than some majors in the current geopolitical climate and he counsels pragmatism: the key to unlocking golden opportunities is locating firms with experienced management and adequate cash flow that can qualify for mixed-source financing in the international context of uneven gold prices. He shares a few picks in that space.
The Gold Report: Let’s cut to the chase, Joe. With the stock prices of gold mining companies in free fall during the past year, why should gold investors stay the course?
Joe Mazumdar: One of the underlying fundamentals driving the gold equity market is what investors believe about the future supply and demand for gold. With respect to supply, global gold production has grown at a compound annual growth rate (CAGR) of 3% over the past four years despite a 15 –17% CAGR increase in the gold price over the same period. We note the risk of constraints on future production, which include the paucity of large deposits for majors to replete their reserve base, operating and capital cost escalation, skill set shortage and increasing geopolitical risk, not to mention the current financing environment.
Gold Juniors Poised to Rebound: Joe Mazumdar
We’ve seen the gold price in various currencies go up 5–18% since 2011. In the Brazilian real and Indian rupee it’s been up as high as 30%. Gold price appreciation has been problematic in countries such as India that traditionally support gold via physical demand due to high local prices. Consequently, a higher proportion of the physical gold demand has migrated to China, where the gold price appreciation has been more modest due to the strength of the currency. Overall, with gold fluctuating around US$1,550–1,600/ounce (oz), we’re seeing net speculative positions reduced to the point that if we do have positive news on the gold front, such as another round of quantitative easing, there is a lot of room for these positions to rise and provide a significant lift to the gold price.
Currently, long-term investment demand for gold is being supported by exchange-traded funds. For diversification purposes, gold is being purchased by central banks. In many emerging markets, the proportion allocated by central banks to gold is rather low compared to the Western countries. Therefore, the potential exists for sovereign nations to further diversify their reserve base into gold. Volatilities are down off of the highs of Q3/11 and closer to long-term levels. Lower volatility would increase gold’s appeal as a safe-haven asset.
TGR: What strategy should gold investors employ in an uncertain market?
JM: If you think gold prices will continue to move sideways, you should lean toward dividend-paying gold stocks, seniors to intermediate firms with low cash costs and a diversified asset base, predominantly in a low geopolitical risk jurisdiction, that are currently producing gold. If you think gold is headed up, then we advocate for leveraged plays, which come with a higher risk profile and include gold explorers, developers and junior producers. Notably, juniors are trading at betas to the gold price of 1.5–1.7, on an annualized basis, over the last quarter.
TGR: How do high interest rates affect the price of gold as compared to currencies?
JM: Interest rates vary globally as the global economy over the past few years has been running at two speeds. Western countries, which are combating anemic growth, have experienced protracted periods of low real interest rates; emerging markets are still battling inflationary pressures that have led them to maintain higher interest rates. Currently, risk averse investors seeking shelter from the sovereign debt crisis in Europe have sought out U.S. bonds, in particular, pushing yields down while driving the U.S. dollar higher. The higher U.S. dollar has driven commodity prices lower in U.S. dollar terms. Investor interest in low-yield, safe-haven assets lies in protecting their investments rather than seeking higher yields in riskier jurisdictions. Gold’s ability to compete for a slice of the demand pie for safe-haven assets will, I believe, be important over the near to medium term.
TGR: What are the key indicators of a gold mining company in trouble—the signs of a management that may not be able to weather the downturn in stock prices and restricted access to development capital?
JM: In a nutshell, developers and explorers that are not producing cash flow are in danger. Important indicators to look for include the company’s current cash position, the catalysts coming up and whether or not the firm has the cash to deliver the catalysts. Then we ask: Will the catalysts impact the stock positively? Where is the project located and what is the permitting environment? Are there social-license-to-operate issues? Is there a technically savvy management team? Can the team convince the debt market that it can deliver on its execution plan?
Management is the key to success for developers in the junior market. Possessing an in-situ resource alone in the current environment may not be attractive unless there is a competent management team that has the capacity to get the project permitted and is technically competent enough to execute the development and production plan. These management teams can provide access to alternative financing streams. If the skill set of the current management team seeking to progress a development project lacks development and/or operations experience, the stock is not going to go very far right now.
“Management is the key to success for developers in the junior market.”
Although we believe it’s a buyer’s market for development assets, we are seeing more acquisitions of producing assets. Well-priced producing assets present less risk of permitting or social-license-to-operate issues and capital-cost escalation than a development project.
TGR: When is it generally prudent to sell holdings in a troubled company?
JM: Many believe the market will turn, and we believe it will, but the time frame is uncertain and in the long run we’re all dead. Currently, we have noted the longer-term investors are willing to increase positions in equities within their current portfolio but less willing to take on new names. Short-term investors continue to pursue opportunities to reduce their position and sell into liquidity events such as a resource update or drill results.
TGR: How do you find companies to recommend?
JM: We lean toward companies with assets primarily in low geopolitical risk jurisdictions with infrastructure. Infrastructure is critical as it impacts capital (roads, power lines, transportation, remote camp, for example) and operating expenditures (diesel versus grid power, for example). The grade of a deposit may look great, but if it doesn’t have power from a reliable grid and requires diesel, for example, it may only deliver weak margins and require higher capital expenditures (capex). Processing one gram of ore only works with inexpensive and reliable power such as in areas of Ontario and Quebec. If, however, the company needs to build a 100-kilometer power line, the capex quickly becomes unreasonable and is at risk to escalation. Once we narrow the jurisdiction, we seek the higher-grade deposits with a similar mining method (open pit versus underground bulk versus underground selective) within the area, which provides ample cushion for potential cost over-runs. A metallurgically simple ore body that can deliver recoveries in the 90s is desirable. We either seek companies that can provide assets that can generate a good margin with a manageable capital expenditure requirement or one with an asset that would provide a merger and acquisition (M&A) target for a major to intermediate producer seeking to replete its reserve base.
TGR: Are there any junior companies that you specifically favor at this time?
JM: As mentioned, currently we are focused on the low geopolitical risk end of the spectrum. For the last two years, we have liked Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.A). The company has a joint venture option on a potential large open-pit heap-leach deposit known as Spring Valley in Nevada with Barrick Gold Corp. (ABX:TSX; ABX:NYSE). It provides the investor exposure to a series of heap-leach projects in Nevada, which the management team is seeking to develop. The capital expenditure is financeable and manageable. Midway’s CEO is an ex-Newmont Mining Corp. (NEM:NYSE) executive who has permitted and built many projects in the mining-friendly jurisdiction of Nevada.
“We lean toward companies with assets primarily in low geopolitical risk jurisdictions with infrastructure.”
Midway’s Nevada assets are low grade, open pit, heap leach with low capex requirements. Its Pan project, according to our estimates, has the potential to generate 70,000 oz per year (70 Koz) at cash costs of over $700/oz. In the current gold price environment, the project can generate decent margins with a quick return due to the low capex requirements [US$110 million (M), Haywood estimate]. It recently completed a financing, so its cash position [~US$16M] should enable it to deliver the next round of catalysts. Once it gets its first mine into production, more avenues for future financing are opened. The company has a few catalysts coming up and will be announcing a resource update on its next open-pit heap-leach project, Gold Rock, in Q3/12. Note the Spring Valley gold project is currently being funded by its joint-venture partner, Barrick Gold.
Another company that fits our risk profile is Atna Resources Ltd. (ATN:TSX). The company operates a steady-state ~40 Koz open pit, heap-leach project in southern California at cash costs of US$930/oz. It is currently developing a high grade (11.5 gram/ton gold, Haywood estimate) underground project known as Pinson, a former open-pit, heap-leach operation, in the Getchell Trend of Nevada. The company is only required to permit the underground mining operation as it has negotiated deals with third parties to process its oxide and sulphide ore. It’s a leveraged play with high cash costs (US$970/oz), low permitting risk and a management team with abundant development and production experience. Financing risk is low because Atna doesn’t need a lot of money to start the development at Pinson. We believe that the Pinson project will be capable of delivering an annual production profile of 60 Koz over a 14-year mine life beginning in 2013.
Atna also has a near-term open-pit heap-leach project, with the most significant permits in hand, known as Reward in southwestern Nevada. We estimate that the project can generate revenue from an annual production of about 30 Koz at cash costs of US$700–800/oz in Nevada. In summary, the company has a multiple-asset portfolio, a good management team, financeable projects, minimum permitting risk and lots of infrastructure; that’s what we want to find in a junior firm.
TGR: What about potentials for mergers and acquisitions among the juniors?
JM: From an M&A perspective, we like Midas Gold Corp. (MAX:TSX) in Idaho. We believe that majors should be seeking a critical mass, depending on existing infrastructure and proximity to current operations, of over 5 million ounces (Moz) in a low geopolitical risk jurisdiction, depending, of course, on their current geopolitical risk profiles. Midas has effectively consolidated the fractionated gold mining district of Stibnite-Yellow Pine in central Idaho. The Stibnite-Yellow Pine area that includes Midas’ Golden Meadows project was mined back in the late 1800s/early 1900s and up to the mid-1980s/mid-1990s as heap-leach projects. It’s not pristine forest. Midas’ Golden Meadows project is sitting on a global resource of more than 7 Moz concentrated in three deposits within a significant land package. There is, however, a protracted permitting timeline; this asset may not enter production until 2019–2020. The management team is top notch and very capable of executing the development plan. It has a significant treasury enabling it to deliver its near- to medium-term catalysts including a scoping study by Q3/12.
TGR: Let’s talk about geopolitical risk. Is it increasing worldwide?
JM: I believe that major gold corporations should be concerned, if they are not already, with their geopolitical risk profiles with respect to current and future production. They need to diversify—whether it’s the South African companies that need more assets outside of South Africa or other companies that have a bit too much of their production profiles based in high geopolitical risk jurisdictions. With all of the news about creeping nationalism, higher tax revenues, royalties, ownership and overall increasing geopolitical risk, firms need to mitigate the risk by investing more in increasing current production and reserves in lower geopolitical risk environments. The amount of global gold production in low geopolitical risk jurisdictions—such as the U.S., Canada, Australia, Chile and some Scandinavian countries—is just below 30%.
JM: Prodigy presents a low geopolitical risk play in northern Ontario. The company’s Magino project is currently an open-pit, bulk-tonnage target where we are modeling a mineable resource of 3.25 Moz. The project is located proximal to infrastructure that was created to some extent by a currently depressed logging industry that has left in its wake a lot of available labor.
TGR: Back to the majors: what cost-benefits do senior companies generally use to assess the merit of repleting gold reserves?
JM: In the end the acquirer should be convinced that the project is accretive on either a near-term cash flow (CFPS) or longer-term net asset value (NAVPS) per share basis. The recent trend in M&A has been for production over development projects as the latter carries the risk of capital escalation, execution and permitting risk, among others. Hence, what appears to be accretive on a NAVPS basis one day may not be the next day.
Previously there was a lot of pressure from the investment community to show growth. The problem is when you’re producing at levels of 4–8 Moz, it’s difficult to show 3–5% annual growth rates. Currently, the investing community has shifted its collective focus and reverted to production at steady-state levels with dividends over concerns of escalating capex and delays with project development either organically or via acquisitions. Nonetheless, for majors a lot of ounces must be repleted on an annual basis just to maintain production levels, let alone grow them. I don’t believe that any company wants to show a declining production profile to the market.
TGR: What is happening with Orvana Minerals Corp. (ORV:TSX)?
JM: Orvana Minerals is in production and needs to get its operations to steady-state levels. The company needs a few quarters to hit its targets and increase cash flow. It had technical issues with the startup at both of its operations and was punished in a downward-trending equity environment. Investors were concerned about its working capital position as Don Mario, its Bolivian operation, failed to generate meaningful positive cash flow due to a slow commissioning due to the processing plant. The problem at the Don Mario operation has been an issue of recovery rates from treating oxide and transitional ore with the leach precipitation flotation (LPF) circuit. Orvana has adjusted its process flowsheet to stabilize the recovery rates, so that Don Mario does not drain its cash reserves.
Also, the company had grade issues at its flagship project in northwestern Spain, El Valle-Boinás/Carlés (EVBC). Orvana needs to get the EVBC head grade up. This is a function of getting more road headers (mining instruments) into the high-grade zones. The throughput is increasing as Orvana slowly gets its shaft into place and de-bottlenecks the underground operation. Once the shaft is in place, the throughput should improve markedly and provide steady-state head grades. The plant has been running very well.
TGR: Do you have a target price for Orvana?
JM: Our target on Orvana right now is $2/share, and it’s trading just above $0.80/share.
TGR: Are there other firms that you are focused on?
JM: For Minera IRL Ltd. (IRL:TSX; MIRL:LSE; MIRL:BVL), we’re at a $1.90/share target. Minera is a greatly discounted company. It has a small, open-pit, heap-leach project in Peru called Corihuarmi that is at well over 5,000 meters, an inhospitable environment with no pre-existing infrastructure. In Peru, it’s not easy to permit a heap-leach project proximal to standing water but the management team has managed it. Since its commissioning, the Corihuarmi operation has exceeded expectations.
“We note the trend toward more debt financing and away from traditional equity financing. “
There are a lot of socio-political conflicts holding up mining ventures in Peru, such as at Newmont’s US$4.8 billion Minas Conga project, to name one. Minera’s management team is located in Peru and its CEO has a long history with majors like Newmont and Newcrest Mining Ltd. (NCM:ASX). The president of the company, Diego Benavides, is a member of the Benavides family—a very well-established local family with a rich mining history. At the Ollachea project, Minera spent months negotiating with the local community and a group of miners with divergent opinions on the project’s development. Minera negotiated a 5% free carry to the community, without the help of the government.
TGR: Given the geopolitical situation in Latin America and Haywood’s concentration on junior mining company fundamentals, such as cash flow and existing production, how does a company like Seafield Resources Ltd. (SFF:TSX.V) stack up either on its own or as a potential takeover? Do you have a target price for Seafield?
JM: We monitor Seafield Resources within our Exploration Quarterly with no formal coverage. The company has a significant land package within a highly prospective region, the Mid-Cauca Belt, for gold-rich copper porphyries in Colombia. Colombia is a Latin American nation that has managed to avoid some of the negative mining-related press emanating from others such as Bolivia, Venezuela, Argentina and Peru.
We consider gold-rich copper porphyries to be a sought after deposit type by majors due to the opportunity for scalable (+5 Moz) gold deposits with significant co-product copper revenues. Due to their size, these deposits would also require large capex upfront that would limit the number of potential developers.
TGR: Any final thoughts on the market situation?
JM: In the near term, financing constraints will continue to be an issue effectively restricting the volume of news flow from many junior mining equity plays. We anticipate that many will reduce their burn rates and push their catalysts back while re-benchmarking expectations.
But I still see opportunities for companies with well-managed assets in low geopolitical risk jurisdictions that can produce near-term cash flow to be financed. We note the trend toward more debt financing and away from traditional equity financing. If the capex is manageable, say, in the $100–200M range, other alternatives to finance the project may be available such as vendor financings, selling of royalty, streaming off byproducts, doing some debt and a smaller proportion of equity. We acknowledge that a junior developer with a large capex requirement (over $500M) may be difficult to finance in the current environment.
TGR: Thank you for your time, Joe.
JM: You are welcome.
Joe Mazumdar is a senior mining analyst with Haywood Securities in Vancouver. He served as director of strategic planning at Newmont Mining and was the senior market analyst for Phelps Dodge. He has held a variety of geologist positions with other mining companies working in South America, Australia and Canada, rounding out ~20 years of industry experience. Mazumdar holds a Bachelor of Science degree in geology from the University of Alberta, a Master of Science in exploration and mining from James Cook University and a Master of Science in mineral economics from the Colorado School of Mines.