Gold has been produced in Africa for thousands of years in places like Ghana and neighboring countries whose names have changed over the centuries. One thing that has not changed is that there’s still a huge amount of gold to be found and mined in West Africa. That’s what Mark Lackey likes about the area and in this interview with The Gold Report, he talks about companies that are or will be producing significant amounts of the world’s prized metal.
The Gold Report: When you last spoke with The Gold Report this past March, gold had just dropped from its first peak of the year, from $1,781/ounce (oz) at the end of February to $1,660/oz in a matter of three weeks. Now it’s looking for support at $1,700/oz. The trading range you predicted for 2012 looks good in retrospect. What are you projecting from here?
Mark Lackey: I’m looking at a range from $1,680/oz to $1,850/oz, and moving up over the year so that by December I am expecting to see the gold price at $1,850/oz.
TGR: But you don’t see a big breakout past $2,000/oz that some people are predicting?
ML: It’s possible, but for the gold price to go much higher than $1,850/oz there needs to be a good reason, such as a big decline in the value of the U.S. dollar or major gold buying by central banks. While I expect the dollar will weaken somewhat in 2013, I don’t expect a huge decline. Over the next few years we’ll get above $2,000/oz, but probably not in 2013.
TGR: What do you see as the market drivers for gold at this time?
ML: Significant trade and fiscal deficits remain in the United States and the country is continuing to use quantitative easing, which tends to lower the value of the U.S. dollar. Investors are going to look at the U.S. dollar and the euro and decide that there are other financial options they would rather own. Some investors will buy gold as an investment alternative to paper currencies.
“I believe that jewelry demand will continue to increase as a result of the growing middle class in Indonesia, China and India.”
In addition, I believe that jewelry demand will continue to increase as a result of the growing middle class in Indonesia, China and India. Those are the demand factors that will move the price of gold higher in the short run. We also anticipate that some of the gold projects that are expected to begin production in 2013 will be delayed due to regulatory and permitting issues and this will lower the supply of gold on the world market and therefore push up the price of gold.
TGR: What’s the next concern that might become the focus for precious metals investors?
ML: I don’t think Europe’s problems have gone away after allocating over $300 billion to Greece. We cannot count on Europe to have the kind of economic growth it once did, but as long as it doesn’t crater dramatically, there’s still going to be demand for gold and other commodities. I’m looking at a modest recession in Europe in 2013. I do think the Spanish banking system will be bailed out but as long as Spain’s sovereign debt doesn’t have to be bailed out, Europe will muddle through.
TGR: Despite the relative strength of gold over the past year, the performance of gold stocks has been pretty disappointing. When and how is the turnaround coming?
ML: If you look at the performance of the gold markets, the one area where we’ve actually made some good returns was in the mid-cap gold producers and near-term producers that did rally with the price of gold. The problem for many of the larger producers was that they didn’t reach the production numbers that they had forecast and their production costs were also above what they had planned. Thus their earnings and cash flows were below expectations and this resulted in share prices that did not follow the rising gold price.
“We expect that with gold prices going higher in 2013, investors will be buying the well-run junior companies.”
There are a number of smaller gold companies that do not have much cash left on the balance sheet and found it difficult to raise money in this past year so this prevents these companies from moving their projects forward. The Toronto Venture market has declined from a level of 2,450 in April 2011 to 1,200 at end of 2012, so it is not surprising that many junior mining companies have had a difficult time trying to attract new financing. Many of those companies saw significant declines in their share prices especially at the end of 2012 as they were hit by tax-loss selling.
We believe that there will be share price appreciation in 2013 for those junior gold companies that still have money (or can raise it) and have good projects. We expect that with gold prices going higher in 2013, investors will be buying the well-run junior companies, especially those that may have declined or lagged behind in 2012 due to the overall market conditions.
TGR: Where do you see the best opportunities for investors in gold stocks these days?
ML: We look at three or four factors when we try to make a decision on a gold company. We like to see an experienced management team with a project or projects in a jurisdiction that does not have significant political risk. We also look for companies that have a mining-friendly terrain and have access to transportation, power and water. We prefer the companies to be producers or near-term gold producers. We are concentrating, as we mentioned earlier, on mid-cap and junior companies that have cash in the treasury and are also looking for those companies that are potential takeover candidates. My company, CHF Investor Relations, has several clients in gold.
TGR: Last time you talked mainly about companies active in Africa. We know there is lots of potential there, but it seems that there’s also been some unrest lately that might cause concerns for some investors. How does the current picture look to you?
ML: The gold opportunities tend to concentrate in West Africa, where three of the four countries, Senegal, Ghana and Burkina Faso, are quite stable by anybody’s standards and have had no problems with political unrest or indigenization of resources. In Mali, the problem is with the Tuareg rebels and Islamists in northern Mali. The mining companies are in southern Mali, hundreds of miles away.
“West Africa has a lot of advantages compared to some of the more traditional mining areas.”
Last month the UN Security Council voted to have 3,300 African troops sent to Mali to remove the rebels from the northern part of the country. The mining employees who we have talked to in Mali have told us that their mining operations have not been impacted, either in production or exploration, by the problems in the north. There have been problems in other parts of Africa, but we have been watching West African projects closely. CHF has no clients in West Africa, by the way.
TGR: So what are some of the most interesting stories you’re looking at now?
ML: One we like is Teranga Gold Corp. (TGZ:TSX; TGZ:ASX), which is in Senegal. Teranga says it will exit 2012 with production between 210,000 oz and 225,000 oz for the year and in the third quarter cash costs were down to $594/oz. The company has its own mill, which is the only one in Senegal, and Teranga also has the largest land position in the country. It has a strong balance sheet having cash equivalents of $31.2 million (M) at Nov. 1, 2012, and reported a record high third quarter profit of $21.3M. The company says it will eliminate its hedge book by August and will have increasing gold production along with lowering costs of production. Teranga will focus on producing the gold ounces that will provide the best returns.
TGR: What else do you like in West Africa?
ML: Another one we’ve been looking at is Orezone Gold Corporation (ORE:TSX), which is developing the Bomboré project, the largest undeveloped gold mine in Burkina Faso. It has a strong development team and large near-surface tonnage, so it’s going to be a relatively low-cost producer. It has 2 million ounces (Moz) in oxide resources in the top 50 meters, and 80% of its resources are within the top 80 meters from surface. The property is close to the national highway and has nearby water, power and a large labor force, which should translate into reduced development and operating costs.
TGR: Those are some pretty world-class resources.
ML: Orezone’s recent NI 43-101 released in October 2012 contained 4.1 Moz of Indicated and 1 Moz of Inferred resources. This will be a significant gold producer in the next few years.
TGR: Or possibly get taken out.
ML: That’s certainly possible. Given the increasing drilling activity and the increase in gold reserves in Burkina Faso, Senegal, Mali and Ghana, many major and mid-size gold producers will be looking to acquire some of these companies. Orezone is one of the companies that could be taken over.
TGR: What’s been going on with some of the companies you talked about last March?
ML: Riverstone Resources Inc. (RVS:TSX.V) announced on Dec. 19 that it had completed its takeover of Blue Gold Mining. This will add some very strong talent to an already very good management team working to advance the Karma project, its flagship play in Burkina Faso. Riverstone also has three additional properties. Recent drilling activity has been very good. This is another miner that we think will have production in the next few years.
TGR: Was this a strategic merger?
ML: Yes. I think the idea here was that if these two teams got together, they could make a much stronger company. Combining the management teams and their financial resources will, in our view, lower the execution risk of their projects and significantly improve the company’s ability to finance itself in the future.
TGR: What else do you have here?
ML: We talked about Channel Resources Ltd. (CHU:TSX.V), which has the Tanlouka property in Burkina Faso. We like Channel as it could become a mid-term producer of approximately 100,000 oz by 2018. The present Indicated and Inferred estimate at Mankarga 5 is 1.2 Moz. Channel has some other excellent exploration targets and we believe that the projects at Manesse and Tanwaka have the potential to host gold deposits similar to Mankarga 5. The additional exploration could eventually define a resource above the 2 Moz level. This exploration team has done an excellent job as it has been successful in defining a major gold resource. We like these oxide deposits for their metallurgical properties, since it usually means that the deposits can be mined at a low strip ratio.
TGR: What else looks interesting?
ML: The next one is African Gold Group Inc. (AGG:TSX.V); the company is developing the Kobada property in southwest Mali. We think African Gold can begin production in 2015, and by 2017 we are projecting annual production of 125,000 oz of gold. One of the big advantages in this part of the world is the highly oxidized rock, which is relatively cheap to mine and mill and also lies close to the surface. It has other exploration opportunities with the large sulfide resources below the oxide layers, which can significantly increase reserves.
In addition to the Kobada property, the company has other promising exploration targets at Gossokorodji, Diaban and Foroko North. African Gold has been in Mali for years and has personnel who have developed other gold mines in Mali.
TGR: What’s next on your list?
ML: Volta Resources Inc. (VTR:TSX) is a company that has really moved forward, having nine exploration projects. It is currently transitioning itself from explorer to producer in Burkina Faso, at present to converting its flagship asset, the Kiaka gold project, into a producing gold mine. The present NI 43-101 contains 4.1 Moz in the Measured and Indicated categories, and 1 Moz in the Inferred category. Given the size of the resource, I would think that, down the road, Volta could be a potential takeover candidate. Given its excellent resources and $21M in cash and no debt, Volta will have no concerns about having to raise money anytime soon. That’s a significant plus in this market.
TGR: What else do you have?
ML: A lot of people know Pelangio Exploration Inc. (PX:TSX.V) because, going back in its history, it developed the Detour Lake Gold Mine in northern Ontario and that ended up becoming a big winner for shareholders. It now has two properties in Ghana where it has completed some drilling that has recently started to show some interesting results. Its Manfo property lies between the Ahafo mine, which is operated by Newmont Mining Corporation (NEM:NYSE), and Kinross Gold Corp.’s (K:TSX; KGC:NYSE) Chirano mine. You would think Pelangio has a good chance of being on strike with the producers on either side. If it can continue to do more drilling and produce more similar results, we might see some pretty interesting resource estimates come about for this project.
Pelangio also has another very good property, the Obuasi property in Ghana, located adjacent to AngloGold Ashanti Ltd.’s (AU:NYSE; ANG:JSE; AGG:ASX) Obuasi mine, which has already produced 30 Moz of gold. This is an interesting play because of management’s extremely successful track record and because it has added a number of individuals to the management team who have significant experience with mining operations in Ghana. We’ll have to follow and see how the drilling results go, but certainly it is a very interesting play with major upside potential.
TGR: That’s another one to keep an eye on.
ML: The last one I’ve got in Africa is Roxgold Inc. (ROG:TSX.V), which had a proxy battle last summer. Ultimately a deal was completed and I give credit to Oliver Lennox-King and Rick Mazur. Mazur was the executive handling the restructuring and then left when it was done. They put together a strong board and a good management team. This is important because I’ve seen these sorts of proxy battles in the past that ended up destroying some companies.
Roxgold is presently developing three mining properties in Burkina Faso. The company is advancing a high-grade gold discovery at its flagship property at Yaramoko. At the 55 Zone there is an initial resource estimate of 354,000 oz of gold, that graded 17.8 grams/ton (g/t) in the Indicated category and 306,000 oz of gold that graded 7.7 g/t in the Inferred category. These grade are not typical in Burkina Faso where most projects are big volume but low grade. The company has raised $65M to date, so it’s well capitalized for its 2013 drilling program. If the company can continue to increase its high-grade tonnage, it will certainly be a takeover candidate.
TGR: Do you have any wildcard plays anywhere that people might be interested in, either in precious metals or otherwise?
ML: We’ve been looking at a number of zinc plays and probably our favorite right now is Chieftain Metals Inc. (CFB.TSX), which has properties in northern British Columbia. We like this one because, first of all, it has a very experienced management team, which is critical to understanding the metallurgy and the mining in northwestern B.C. Second, with all the zinc mines that are going to close in the next few years, taking millions of pounds out of production, we believe there’s going to be an upward move in the price for zinc, certainly by 2014–2015. Chieftain has recently completed a financing and it should be publishing its feasibility study later this month.
Within a couple of years we think that the zinc price will increase up to $1.40 a pound. That makes a number of zinc plays attractive, especially Chieftain, given its potential to become a zinc producer.
TGR: Where do we go from here, and how should our readers be positioning themselves for what lies ahead in 2013?
ML: As I said, CHF has a number of clients in gold, some low-cost producers, too, but generally speaking, in the gold sector, we would concentrate primarily on jurisdictions we like. West Africa has a lot of advantages compared to some of the more traditional mining areas. One factor is that it is easier to get mining permits compared to some of the jurisdictions in North and South America. West Africa is also flat and dry, has water, power, transportation and a good labor force. In addition, we want experienced management teams that have experience in the jurisdictions where they are exploring.
TGR: Thanks for the ideas and updates, Mark, and we’ll stay tuned and hope for the best in 2013.
ML: Thanks for the opportunity.
Mark Lackey, executive vice president of CHF Investor Relations (Cavalcanti Hume Funfer Inc.), has 30 years of experience in energy, mining, banking and investment research sectors. At CHF, Lackey involves himself with business development, client positioning, staff team coaching and education, market analysis and special projects to benefit client companies. He has worked as chief investment strategist at Pope & Company Ltd. and at the Bank of Canada, where he was responsible for U.S. economic forecasting. He was a senior manager of commodities at the Bank of Montreal. He also spent 10 years in the oil industry with Gulf Canada, Chevron Canada and Petro Canada.
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Charles Gibson, from his vantage point in London, has a unique view of mining companies in Africa. Gibson is the head of mining for Edison Investment Research, which writes unbundled investment research on a range of companies from its offices across Europe, New Zealand and Australia. In this exclusive interview with The Gold Report, Gibson talks about some hidden mining gems in Africa.
The Gold Report: We have a scenario where the price of gold has held up and is trading at about $1,775/ounce (oz), but the share prices of large caps aren’t comparable. What is the reason behind that?
Charles Gibson: Typically, large companies are valued in relation to their margin, the difference between the price they sell gold and the cost at which they mine it. There was a period of margin expansion from about 2009 to 2011 where, by and large, the share prices of big producers did very well. The gold price was rising and costs were under control.
In late 2011, however, this dynamic reversed and the gold price started to tail off at the same time as costs began to pick up. Then there was a period of margin contraction. That’s what’s caused the share prices of the majors to fall.
TGR: Would you factor in the general malaise in the stock market?
CG: Commodities can dance to a very different tune than the broader economy as a whole and the broader stock market. There’s been margin expansion and margin contraction. It won’t go on forever. There is a very close correlation between revenue per ton and costs per ton for mining companies and there are lots of different ways to explain that. But if the commodity price moves, the likelihood is that the cost base will move at some point. That works both downward as well as upward. Commodity price and cost base don’t work exactly in time with each other, but by and large the broad direction is similar. That tends to temper the upside, but it also saves a little bit on the downside as well.
TGR: Given the unremarkable performance in some of the large caps, should investors be looking at small to mid caps for value and growth?
CG: It’s not a question of being small, mid or large cap necessarily. The key question for investors at the moment is: Which companies have costs under control? Perhaps that is due to the jurisdiction they’re in or because of a particular cost basis. If companies have access to hydroelectric power, for example, that often acts as a buffer against rising prices. When costs are under control, margins are under control and companies can benefit from rising commodity prices.
TGR: What’s your view on precious metals prices going forward?
CG: There’s a very strong correlation since 1959 between the U.S. monetary base and the price of gold for fundamental reasons. After the first two rounds of quantitative easing (QE), the implied gold price from that correlation was $1,350/oz. That’s where we were until about a fortnight ago when Ben Bernanke announced QE3, which at the moment is open-ended. Our long-term gold price of $1,657/oz goes through 2013. If QE3 continues to 2014, you’re looking at $1,887/oz and by 2015 it’s more than $2,000/oz.
I stress that this is not a day-to-day trading price. It is the fundamental long-term price. To paraphrase John Maynard Keynes, “Markets can stay irrational longer than you can stay solvent.”
TGR: It’ll be interesting to see what happens in November with relation to QE3. Let’s talk about some names that you’re following in Africa.
CG: Pan African Resources Plc (PAF:AIM; PAN:JSE) is a stock worth looking at with an asset in Barberton, South Africa. However, this is greenstone gold—not conventional South African Witwatersrand gold—in this case, with a 10-year life. It has had a 10-year life for the last 100 years, roughly speaking. It’s a very tight little management structure. It produces about 100,000 oz (100 Koz) every year and has done that for as long as anyone can remember.
Pan African announced its full-year results last week showing earnings nearly doubling compared to the prior year and more than doubling compared to the half-year stage. That is strongly suggestive of a cost base that is well under control.
It also just made a major acquisition of Evander Gold Mines Ltd., which it is buying from Harmony Gold Mining Co. (HMY:NYSE), this time in the Witwatersrand Basin. Pan African’s management has good prior knowledge of operations of Evander. A lot of the board has worked there. Pan African has been able to buy it at a low price. It will be very accretive. The mining plan indicates that it could double Pan African’s earnings in the short term.
TGR: I’m looking at Pan African’s stock chart right now. It’s trading near its 52-week high. There aren’t many North American-based gold producers that could say that.
CG: Pan African’s share price is a testament to the tightness of the management structure and the fact that the company has been able to deliver on its promises half year in, half year out. It has supportive shareholders. There are few substitutes for a good track record in mining circles and Pan African has a very good track record.
I’d like to talk about Aurizon Mines Ltd. (ARZ:TSX; AZK:NYSE.MKT), too.
Casa Berardi on the Cadillac Fault in Québec is the major asset. Its management has an exceptional track record of delivery. It has roughly 160 Koz/year of production and, with very few exceptions, it hits that. It usually hits its quarterly guidance as well.
There are also relatively few shocks on the cost side. Costs have suffered recently as the mine has moved to lower levels. The costs per ton are moving up, but that’s really a one-off effect. Even after that, it’s still producing gold at about $640/oz. At the moment Casa Berardi has a mine life to 2020, but it’s looking to expand that.
In particular, there have been some remarkable intersections made by underground exploration drilling at Zone 123. If confirmed and continuous, it may be that not only will Casa Berardi’s underground mine life be extended, but it may turn out to be one of those Canadian mines where the grade gets higher as you get deeper. Also, because this zone is off the main Cadillac break, it will require less ground support and therefore the additional costs of being further from the shaft will be offset both by higher grades and lower costs.
TGR: The gift that keeps on giving. It also has exploration potential beyond Berardi with Joanna and other assets.
CG: Joanna is split into the Hosco and Heva sectors. Hosco has a prefeasibility study that came out all right. It is refractory ore, which means there were a lot of additional capital expenditures related to autoclaves etc. Management stuck it on the backburner. The area is very prospective, but it’s clear that the mineralization changes to non-refractory moving west, which means that it should be much less costly to develop.
It pleases me the way that management tackled this. Rather than chasing that very obvious goal of getting Joanna into production, the company said, “Let’s just wait a minute. Let’s see if we can improve this.” It went from a feasibility study back to exploration. But now there is the potential for a much bigger dividend at the end than might otherwise have been the case.
TGR: David Hall is not the chief executive officer (CEO) anymore, but he’s probably the man behind a lot of those decisions.
CG: The new CEO is George Paspalas, who is an Australian with a very long pedigree in underground mining. He managed the South Deep extension of the Western Areas gold mine in South Africa for Placer Dome [now Barrick Gold Corp. (ABX:TSX; ABX:NYSE)]. He’s also a chemical engineer with extremely good experience with refractory ore so, in short, he knows about the two things that he really needs to know about at Aurizon.
TGR: I’m interested in hearing a little bit about Cluff Gold Plc (CFG:TSX; CFG:LSE). I just met the management group of this company at the Denver Gold Forum. They seem very keen to introduce this company in a more proactive way to the market.
CG: Cluff Gold has also literally just changed its name to Amara Mining! That aside, its assets, which are in Sierra Leone, Burkina Faso, and Côte d’Ivoire, run the gamut from exploration to production.
The Burkina Faso asset is Kalsaka, which is a nice, relatively small-scale mining operation that produces about 70 Koz/year at about $900/oz. It is providing the cash flow and the profitability to fund the rest of the company’s operations.
The flagship asset is Baomahun in Sierra Leone. I’m expecting a resource upgrade to be announced this quarter followed by a full feasibility study. It will have 130 Koz or more of production from 2015 onward.
Its exploration asset is Yaoure in Côte d’Ivoire. Now, this is an interesting asset in that it has been mined in the past. It has been known to be very prospective. Cluff has done a lot of drilling there. Our best estimate of the resource is roughly 2 Moz. It could turn out to a very significant asset indeed.
Kalsaka generates the money and some of that is used in exploration in Baomahun and Yaoure. Cluff assumed until recently that it would need an equity raising to fund the capital expenditures of Baomahun. However, management has recently said that, given where its equity price is, it’s not happy with the level of dilution. The company is looking at non-traditional forms of finance. Reading between the lines, what we’re probably looking at is some sort of debt instrument with a coupon that’s connected to the gold price. That route is a much more efficient way of funding as far as existing equity shareholders are concerned.
I think that’s part of the reason that the share price has performed very well over the last couple of months. Nonetheless, it is not valued at much more than the implied value of Baomahun. Investors are getting Kalsaka and Yaoure for free. And the company is already generating profits and cash flow.
TGR: It’s interesting. Its small producing mine is funding the exploration. Sega, Cluff’s add-on acquisition to Kalsaka, should have a preliminary economic assessment soon and then there is the blue sky of Yaoure. Cluff announced a strategic alliance with Samsung. Tell me about that.
CG: It is part of its non-traditional funding. Samsung made a $20M credit facility available to Cluff. That is more than enough for the company in the short to medium term. It is looking in the longer term toward a cornerstone funding arrangement to bring the Baomahun project into production.
TGR: I have not seen any mining company entering into an agreement with Samsung. Are we talking about the same Samsung that is the electronics manufacturer?
CG: It is. This is an example of the increasing scenario where dollars are held in Asia and they’re looking for a home. One of the very obvious places to invest, if you’re long dollars, is in gold. In this particular instance, you’re merely looking at the first derivative of that investment strategy, i.e., gold equities. It’s not wholly unknown though for Asian industrial companies to get involved in mining. The one that leaps to my mind is Mitsubishi.
TGR: We’re also seeing a lot of that in the minor metals and specialty metals space right now, too.
CG: I think that, in general, those investments are aimed toward a guaranteed offtake—they have an industrial logic—whereas I suspect that the Cluff deal is more of a pure investment.
TGR: Cluff seems like a very ripe cherry for a company that would want an African asset.
CG: It’s difficult to comment about where mergers and acquisition activity will fall. I think it’s true to say that there is a keen focus on West Africa and there is an assumption in the market that there are more mergers and acquisitions to come in that particular part of the world.
TGR: What can you tell me about Mwana Africa Plc (MWA:LSE)?
CG: Mwana is an interesting company to talk about because its assets are located in such an interesting part of the world—Zimbabwe and the Democratic Republic of the Congo (DRC). It has a very nice little gold mining operation, Freda Rebecca, which produces about 70 Koz/year for about $850/oz. People hear Zimbabwe and think it sounds like a difficult place to operate. Historically, it has been. But I visited the mine recently and it is operating in good order. The plant is pretty rugged. There are no concessions made to luxury at all but in its own way it does work very well.
It’s an amazing ore body. The mine has been open-pitted in the past, but now it’s moving underground. If you go underground, the size of the voids, because of the competence of the rock, is absolutely unbelievable. The voids are easily the size of a church. It is the perfect engineer’s mine.
Freda Rebecca is funding Mwana. It has a majority interest in another complex, Bindura Nickel Corp. (BNC:ZSE), a bulk massive nickel sulfide ore body. It has been on care and maintenance for several years. Mwana just got an agreement with creditors to raise money via a rights issue in order to restart the operation.
Bindura Nickel is underground. Various assets actually have been open-pitted in the past and could be open-pitted again in the future. There are not many assets like this in the world when the rest of the world is shifting from nickel sulfides to nickel laterites. And the entire infrastructure is sitting there in very good order.
The first part of the restart is to get the Trojan underground mine into operation and to produce a concentrate. In due course, with material from other assets and potentially third-party material as well, the idea will be to smelt and refine the concentrate to a pure nickel product.
Bindura Nickel has a history going back to the 1950s when it was developed by Anglo American Plc (AAL:LON). It ran very solidly and profitably for most of its existence. It’s an exciting time for Mwana.
TGR: I noticed that it had a fairly dramatic jump in its share price this month. What was that about?
CG: That was the closure of the Bindura rights issue. When the announcement came out that an agreement had been reached, the money had been raised and that it was closed, it moved Bindura from an asset that is on care and maintenance and costing the best part of $1M a month currently, to one that should instead be cash-flow positive situation within the space of a couple of years.
TGR: Mwana is a multi-commodity company. What else is it mining?
CG: It has two other major assets in the DRC—one copper and one gold.
The first is Zani-Kodo in northeast DRC. It is an exploration asset with about 2 million ounces (Moz) gold proved up. It’s located between AngloGold Ashanti Ltd.’s (AU:NYSE) Mongbwalu and Randgold Resources Ltd.’s (GOLD:NASDAQ) Kibali prospects. It’s probably some of the easiest exploration that I’ve ever seen. The company expects to be able to increase its resource by 50% a year for the next couple of years. At that point, it will be a very significant resource on a global scale.
The other asset is SEMHKAT in the DRC’s copper belt. It is a vast area that has shown indications of copper mineralization. However, it is almost an asset too far for Mwana. It gets the least attention. At any other company, it would have probably been a lead asset, but in Mwana it has had to queue up behind Freda Rebecca, Bindura Nickel and Zani-Kodo for attention.
The company has done a couple of joint ventures at SEMHKAT. It has an original joint venture with Anglo American and a joint venture with Chinese company Zhejiang Hailiang Co. Ltd., which it announced in August. Hailiang will put about $25–40M into the ground and take a majority interest. Mwana will be left with a non-dilutable 38% interest. As a result, SEMHKAT has moved from an asset that was very difficult to value because it was just prospectivity in the ground, to suddenly an asset that can be valued in pounds, shillings and pence.
TGR: It certainly has a lot for only having a $100M market cap. I’m blown away at the possibilities there.
CG: This management team has a track record of working in these sorts of jurisdictions. Look at Freda Rebecca in Zimbabwe, where the company got a mine it rehabilitated back into profitable production with 70 Koz/year.
TGR: Now they’re doing it again.
CG: That’s the idea. A track record like that is worth a lot.
TGR: Let’s leave Africa and talk about Minera IRL Ltd. (IRL:TSX; MIRL:LSE; MIRL:BVL).
CG: While developing and operating a mine in Argentina does currently present some challenges, the Don Nicolas project is in a very mine-friendly province and Minera is halfway through the permitting process. The company also appears to have the support of local communities by recently signing a 10-year surface rights agreement.
I don’t believe there will be nationalization of junior mining companies in Argentina. The government needs foreign investment and is probably not interested in owning and operating mines. More likely, they will do what governments do best and simply take its cut in the form of taxes and royalties.
As for Minera as an investment vehicle, the company has an excellent management team with a proven track record and some fantastic assets within mine-friendly locations.
TGR: Do you have any wisdom for investors on how to navigate the precious metal equity space?
CG: With commodities, you always have a choice in which commodity you’re going to invest. It’s worth being aware of the macroeconomic qualities and profile that those commodities have. There is a spectrum. If you looked in the ’90s, someone would probably think that all commodities dance to the same tune. We’re not in that macroeconomic environment at the moment. The environment we’re in at the moment is one of stagflation, where the economy is struggling to grow and where there are question marks over the value of paper currency. I would strongly recommend that investors be weighted toward the precious end of that spectrum at the current time. The other thing is to spread risk, particularly with the juniors. Be aware of the risk profile of companies; there’s no substitute for research and don’t buy just two or three stocks. That’s fine if you’re investing in the majors, but you need to diversify more than that if you’re speculating in the junior space.
TGR: Well, Charlie, thank you so much. We certainly gleaned a lot of intelligence.
Charles Gibson is the head of mining for Edison Investment Research in London. A chemist by academic training, Gibson spent a decade in the City as a mining analyst at Cazenove and a specialist mining salesman at T Hoare Canaccord, before joining Edison. He has extensive media experience, having written for MoneyWeek and The Business magazines and The Evening Standard. Gibson is a leading authority on mining and guest presents from time to time for LBC radio on financial and business matters.
When Leily Omoumi, a gold analyst with Scotiabank in Toronto, turns her engineer’s eye on a mining company, she can translate insight into profits for investors. The Gold Report caught up with Omoumi at the Denver Gold Forum for this exclusive interview, in which she discusses misunderstandings about Eastern European and West African mining companies and identifies opportunities in Canada and Armenia.
The Gold Report: Leily, you are with Scotiabank in Toronto, but you’re not originally from that area. Tell us about yourself.
Leily Omoumi: I’ve been living in Toronto for many years. I earned a degree in mechanical engineering from the University of Toronto and worked as an engineer for Hatch Ltd. for about four years. Following that, I earned a master’s degree in business administration at Rotman School of Management. I started working at Scotia immediately after. I have been covering gold stocks for a few years now.
I cover gold stocks and one palladium name: North American Palladium Ltd. (PDL:TSX; PAL:NYSE).
TGR: There has been resurgence in the price of gold, which is now at more than $1,700/ounce (oz). While the price of gold has held up during the past several months, gold equities have languished through the summer. But equity prices have been rebounding in the last several weeks. What are your thoughts on that climb?
LO: You are quite right: Even though the price of gold has held up, a lot of equities suffered earlier in the year. Capital blowup, cost escalation and inflation have hit several stocks. Many companies suffered as investors lost confidence in where costs were trending and development projects progressing.
There has been a nice push to the gold price in the past couple of weeks. Some of the losses have been made up and the market is getting to levels similar to last year’s, before stocks really went down.
TGR: We are at the Denver Gold Forum, a great venue for a gathering of institutions, analysts and public companies. It feels like there is a little bit of optimism in the crowd. What do you think?
LO: I agree. Investors have been sitting on the sidelines for quite a while and they’re starting to step back in. In April, at the European Gold Forum in Zurich, the mood was very different—more negative. People were watching from the sidelines and waiting to make a move. Investors have more optimism now. They are ready to step into names, primarily those that have free cash flow and are in production or are close to production.
But many pre-producers continue to be punished because of financing risk. Although the markets are doing better, confidence is not fully back. Even companies that have released decent feasibility or prefeasibility studies have not seen moves in their stock prices because of the financing risk. Companies frequently have initial capital requirements that are larger than the market cap of the company. It can take a long time for a company to finance a project in a scenario like that. Unfortunately in some cases, dilution becomes a significant factor.
Pre-producers have to wait for the right opportunity to raise money. They must do it in tranches, which can be a long process. They have a long road ahead.
TGR: Unfortunately, a lot of those companies already have somewhat blown-out stock structures, which further discourage them from doing equity financings because they don’t want to dilute shareholders any further. They have to look at royalties and large debt financings. We are seeing a lot of creative financings, but we are also seeing some preproduction and development stories that are spectacular values for large caps. Do you agree?
LO: Yes. Large-cap companies are moving ahead very cautiously, however. They are being scrutinized by investors, too, so they are very careful about the investments they make. I agree that there is great value. The market just needs confidence. A couple of good merger-and-acquisition deals could potentially bring confidence back and encourage others to step in. There are a lot of good names out there.
Two development stories that I like are Lydian International Ltd. (LYD:TSX) and Rainy River Resources Ltd. (RR:TSX.V). I like Lydian because of the low initial capital intensity of its Amulsar project. It’s a simple heap-leach project with an initial capital cost of below $300 million (M). Operating costs are below $500/oz. It’s a project that can be financed.
TGR: Lydian isn’t on a lot of people’s radars because of its jurisdiction—Armenia. It certainly is not Nevada or Ontario. Tell us about your comfort level with this company in terms of its location.
LO: I have been to Armenia. Armenia, as you said, is not Nevada. A lot of people are unfamiliar with it, but it appears to be a pretty decent place for mining companies. For example, Dundee Precious Metals Inc. (DPM:TSX) has an operating mine there and other European and private mines operate there currently as well. The country has a modern mining concession law and is open for business. Lydian has not had too much difficulty advancing its permits; it’s in the advanced permitting stage now.
TGR: Lydian has drilled, and has an NI-43-101-compliant resource. What are the next steps?
LO: Lydian released a full feasibility study the first week of September. Some of the numbers I mentioned are based on that prefeasibility study. The initial capital came in at around $270M and life-of-mine cash costs are about $470/oz. The project is expected to go into production in early to mid-2015.
Aside from final permitting, the next big step for the Lydian team is financing. The company has to start placing orders for long lead-time equipment early next year.
TGR: Tell us about Rainy River in Ontario.
LO: Rainy River is in a mining-friendly jurisdiction that is familiar to investors. What I like about the Rainy River deposit is that it contains approximately 8 million ounces (Moz) of Measured, Indicated and Inferred resources. It has a lot of optionality; the company proved that with its updated PEA, which came out in late August. It initially expected to have a much larger operation, with about 32,000 tons per day (Kt/day). Rainy River has since reduced the scale of the operation because of capital constraints. It is starting with a smaller operation, at 20 Kt/day.
The company has been able to push a lot of the higher-grade ore ahead for the earlier years of production. That helps with the internal rate of return on the project. It now expects to process an average grade of 1.38 grams/ton (g/t) in the first five years, compared to previous numbers of about 1 g/t. Over the first 10 years of operation grades are expected to average 1.45 g/t—this includes underground.
TGR: Does Rainy River have a lot of exploration potential? Is there still a lot of blue sky?
LO: Absolutely. It has district potential and there are a lot of targets that the company is still looking at. The underground potential is underexplored in my opinion, and the company is still drilling. Although there is an underground portion in the updated PEA, there is a lot more work to be done.
Aside from that, the company is looking at regional targets. There is potential for other metals as well. For example, it is looking at some nickel bearing targets to the south of the current deposit. However, that’s down the road and is not something the company is counting on right now. But blue sky is certainly there.
TGR: This seems like a potential acquisition candidate based on its jurisdiction and improved grade.
LO: Given its jurisdiction, the scale of the project, with life-of-mine production at more than 200 Koz, it could definitely move the needle for midsize to larger companies. If a major were to look at Rainy River, it would probably build the project differently. It might start with a larger scale right off the bat and increase production levels. A midtier company would potentially look at the project as outlined in the updated PEA, which is a smaller scale.
Nonetheless, it’s the type of project that can move the needle. It is in Ontario. It’s not expected to have permitting issues. There is exploration potential. It’s a good project all around.
Additionally, I believe Lydian, which we spoke about earlier, could be a potential takeover target. Amulsar is a simple and manageable project and could fit nicely with midtier producers that have familiarity with the region.
TGR: Let’s move on to a producer that may not be on the radar of some investors, Dundee Precious Metals. Tell us about Dundee and why you like the story.
LO: I like Dundee Precious Metals because it has production growth, it’s a low-cost producer and it has a pipeline of projects. Its largest operation is the Chelopech underground mine in Bulgaria. The company is currently expanding underground operations and we should see a step change in production next year. I expect production—company-wide—to increase by about 20% in 2013 to over 170 Koz. I expect cash costs to be below $450/oz this year and next. What makes this story a little different is that the company also owns a smelter in Namibia, where the gold-copper concentrate from Chelopech is processed.
TGR: How does Dundee get the material from Bulgaria to Namibia?
LO: The concentrate is transported to Bourgas, Bulgaria’s largest port on the Black Sea, for sea shipment to Namibia. It is then transported by rail to the smelter from the Atlantic port of Walvis Bay. Tsumeb is one of only a few smelters in the world capable of treating arsenic bearing concentrates such as the one produced at Chelopech. It is a long way to go but when it comes down to it, Dundee is a company that is making money.
Its development project in Bulgaria, Krumovgrad, is going through the permitting stages right now. We expect that to be in production in 2016.
TGR: We have talked about the cautious optimism among institutions that might jump into mining equities or add them to their portfolios. Do you have any thoughts about what you see happening as we go into the fourth quarter of 2012?
LO: I think optimism is starting to come back, but it is going to take a while. Third-quarter (Q3/12) financial results should be decent. However, I cover some West African names, and Q3/12 could be relatively weak for some of those companies because of heavy rains that the region has been experiencing.
Going forward, a lot of the midtier and large-cap producers are expected to have a good Q4/12. Many have had heavy backend-loaded years. The combination of optimism in the market, the stronger gold price and better results toward the end of the year is going to have an overall positive impact on the market and the inflow of funds to the sector.
TGR: Some North American investors don’t understand the potential in West Africa. Do you feel like West Africa—Côte d’Ivoire, Burkina Faso, Ghana—represents an opportunity in terms of mineral wealth and share price appreciation for juniors that are developing projects or producing there? Is it a misunderstood jurisdiction?
LO: There is significant mineral potential in that part of the world. However, in certain countries, there are higher-than-average cash costs due to limitations with infrastructure and power costs. Political risk in some regions is the other issue to consider. There have been a number of blowups in West Africa politically, including in Mali and Côte d’Ivoire. That has drained some confidence and I don’t see that changing quickly going forward. Companies with a lower risk profile in North America and parts of South America, and companies with access to good infrastructure and lower power costs, will trade at a higher premium, in my opinion.
TGR: Are the political risks in West Africa higher than the risks in, for instance, regions surrounding Armenia or Bulgaria?
LO: It is hard to generalize, because you have to look country by country. I think the perceived risk in West Africa is a little overblown. Companies even in Bulgaria have had permitting issues in the past. However, Bulgaria is pretty stable politically and has excellent infrastructure. I wouldn’t necessarily compare Bulgaria to countries in West Africa. Ghana is an exception. It is a very stable country with a very established mining industry.
TGR: Do you think West African countries get too much of a discount sometimes?
LO: I don’t necessarily disagree with that statement. Some investors are not familiar with countries in West Africa. They tend to put all of them in one basket. If something happens in Mali, shares of a company with an asset in Burkina Faso also fall—when there is really no relation or connection. In general, European investors are probably a little bit more in tune with what is going on in Africa.
TGR: Thank you, Leily.
LO: Thank you.
Leily Omoumi, a gold analyst with Scotiabank in Toronto, holds a degree in mechanical engineering from University of Toronto and a Master of Business Administration degree from the Rotman School of Management.
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Last year, Africa was the region that witnessed the strongest growth in gold-mining operations. In an exclusive interview with The Gold Report, Nana Sangmuah, managing director of research with Toronto-based Clarus Securities, expects that trend to continue and suggests some immediate smart investments in Ghana, Mali, Liberia and the Democratic Republic of the Congo.
The Gold Report: Gold consultancy GFMS, which is now owned by Thomson Reuters, recently published its 2012 Gold Survey. GFMS predicts that before the end of 2012, the yellow metal will likely reach above its all-time nominal high of $1,920/ounce (oz) in September 2011. The catalysts include inflation concerns and sovereign debt problems in Europe, especially Spain. What are your thoughts on these predictions and conclusions?
Nana Sangmuah: I agree with those predictions and the drivers. One thing that has been missing from the gold rally is inflation hedge demand. With the significant monetary easing that has occurred to drive a global recovery, inflation is definitely going to be an issue at some point. We haven’t seen inflation trade come into gold throughout these 10+ years. That’s the strong headwind that is going to move gold to another level.
TGR: The survey reported that mine production hit a record high in 2011, rising 2.8% year over year to reach 2,818 metric tons (mt). That marks the second straight year that gold production reached a new all-time high. Does that mean the theory of peak gold is dead?
NS: Not exactly. If you peel back the data over the past two years, the greater part of this growth has come from mines digging into their stockpiles and people revisiting old resources that previously were thought not to be economic but at these price levels look economic. There have been very few discoveries despite the fact that there’s been quite a lot of money spent on the exploration front. That rate of increase is not sustainable going forward. And the bigger picture still looks grim because the last big discovery of 5+ million ounces (Moz) is the Aurelian discovery—the Fruta del Norte deposit in Ecuador, which now belongs to Kinross Gold Corp. (K:TSX; KGC:NYSE)—from early in the 2000s. It takes on average at least five years to move from discovery into production, so we’re looking at a situation where the supply is not going to grow that much. If the investment demand is sustainable going forward, basically there won’t be enough ounces to feed that demand.
TGR: The GFMS survey also reported that new gold-mining operations contributed 47 mt of new gold supply, while Africa was the region that witnessed the strongest growth, increasing production by 51 tons (t) despite a 5 t drop in output from South Africa. Do you believe Africa will continue to lead the way in worldwide gold production?
NS: Certainly. The ground is very favorable, and there are a lot of projects that have only scratched the surface. Even in the more prolific zones, which have seen a lot of dollars thrown at them, the concentration has just been on open-pit, near-surface mining. In some of these greenstone belts, you can trace mineralization down to more than 2.5 kilometers (km) at depth. As people get more comfortable with the region’s politics, more dollars are going to move in, and certain grounds will be tested. The key is political stability. As commodity prices go up, countries move their fiscal regimes around.
But I think a lot of countries will smarten up and realize they can attract more investments, which will ultimately generate more revenues to the government if their current regimes are seen to be stable. The Asankrangwa Belt in Ghana is one example. This belt is as old as the Ashanti Belt, but we have just recently seen action on it. So far, within a period of less than three years, 10 Moz have been delineated. Some people would think that certain districts are mature and cannot be coming up with even more discoveries, but that is not true.
TGR: Mali’s interim president said that he wouldn’t hesitate to wage “total relentless war” against the Tuareg rebels who have seized much of northern Mali. Do his words make you less bullish on all West African gold producers?
NS: He’s trying to send a strong signal that he’s all for maintaining stability in the region. And the regional force, ECOWAS—Economic Community of West African States—acted quickly to prevent this from blowing up. A stabilizing force has made its dominance known in West Africa, which I think is going to foster more stability and get people to be more comfortable investing more dollars in the region. Access in general has not really been impaired. The borders are open. People can focus on the day-to-day running of businesses and mines. There’s the potential for a few situations here and there as they try to push the Tuaregs away. But the Tuaregs’ links with al-Qaeda are definitely going to unify the international community against any issues. That means that this is not going to drag on for long, and very soon we should see this issue behind us. We’ve seen similar events before and people have hit the panic button and sold off, but as the situations stabilize, valuations come back strongly. So, I see this as a buying opportunity, and I’ll be focusing on assets. If these assets have not been impaired in any way fundamentally, they should be bought at these levels.
TGR: Ghana is second only to South Africa in African gold production. What are some of the companies operating in Ghana that are well positioned to grow their gold production and see it translate to their share price?
NS: In this current environment, we should be watching the balance sheets of companies to see whether they have enough capital to maintain their growth strategies. One company that I think has a very strong balance sheet is Perseus Mining Ltd. (PRU:TSX; PRU:ASX), which has finished up building a mine in Ghana and announced very strong Q112 results showing good cost containment. Commissioning has gone well and it’s in a ramp-up phase. I think most of the risk is behind it. Perseus is on the cusp of generating a lot of cash flow. That is going to help it bring its second asset, which is not in Ghana, into production. Cast your eyes two years out and Perseus will be producing around 450,000 oz, generating a lot of cash flow that could be channeled into further growth opportunities or shareholder dividends. Currently the resource is 9 Moz and Perseus is spending quite a lot on exploration; about 200,000 meters (m) are being drilled in West Africa. The likelihood of growing 9 Moz into 12 Moz is high. And Perseus has had a very good success rate converting these ounces into reserves, so we should see the production profiles also tip up along the way. At these levels, with no finance hurdles ahead of it, being in a fully funded position and just on the cusp of generating strong cash flows, Perseus is one that investors should be watching.
TGR: Perseus boosted the resource at the Edikan by 1.03 Moz in December 2011. Is it reasonable to think that it could do that again by December 2012?
NS: It’s doing about 200,000m of drilling this year; last year it drilled about 250,000m split between both assets. The rate of resource growth should be more significant because now it’s switching focus from infill drilling to regional targeted. That’s where you see a lot more growth in the resource. I’m quite optimistic that we should be seeing a lot of wider swings in the resource growth going forward. And the company’s picking up new targets in and around the existing mine.
TGR: Ghana also has a number of smaller companies exploring for gold deposits, some of which have had early success. Could you introduce our readers to some of those companies?
NS: There are a lot of junior companies prospecting for gold in Ghana. One of the more successful ones in recent times has been PMI Gold Corp. (PMV:TSX.V; PVM:ASX; PN3N:FSE). It is advancing a brownfield operation previously operated by Resolute Mining Ltd. (RSG:ASX), which mined about a million ounces at 2.2 grams per ton (g/t). PMI came in and has been able to delineate about 5 Moz on the flagship asset. What is most exciting about the company is it has more ground toward the south on the Asankrangwa Belt, on the Asanko project and the Obotan project. This is the first time that ground has been developed by one single company. This points to the potential to grow the ounces profile well north of the current 5 Moz. PMI also has ground—the Kubi project—next to one of the world’s most prolific mines, the Obuasi mine, which has produced and delineated about 60 Moz. And it actively drills Kubi, which is just 15km south of Obuasi. For the first half of the year, it’s drilling about 100,000m on all these targets. And we just saw eight new anomalies discovered last week, signaling the potential to add to the current resource envelope.
TGR: The Obuasi gold mine is operated by AngloGold Ashanti Ltd. (AU:NYSE; ANG:JSE; AGG:ASX; AGD:LSE), which is a major gold producer. Would that make PMI a potential takeover target?
NS: Most of these junior companies that have solid resource growth potential are likely targets.
TGR: Any others in Ghana?
NS: There are quite a few, but we can talk about some other early-stage companies, like Abzu Gold Ltd. (ABS:TSX.V; ABZUF:OTCQX). It’s about to come out with a maiden resource on the ground in northern Ghana in a district that is known for gold-bearing structures.
TGR: On Jan. 19, 2012, you wrote, “Abzu’s vast tenement package with a plethora of targets diversifies exploration risk well for shareholders and its proven management team reduces execution risk.” Tell us more about the management team there.
NS: Abzu’s CEO Allan Serwa is a Canadian who’s been in Ghana for quite some time and has built up a lot of relationships there. He brings to the table the ability to manage community relationships very well—better than seamless. You find a lot of companies with good projects but a lot of problems dealing with communities. So Serwa really gives Abzu a solid platform from which to take off. Paul Klipfel has been a geologist with some of the more senior mines, including Placer Dome Inc. [now Barrick Gold Corp. (ABX:TSX; ABX:NYSE)], and has had some decent experience in Ghana as well. Quite a few other accomplished geologists and company CEOs who will provide necessary direction are on Abzu’s board of directors.
TGR: Abzu’s sizeable land package stretches across four different gold belts in Ghana. What sort of exploration success has Abzu had to date?
NS: Abzu has delineated a mineralization trend of 1.5km in one. I have visited that structure and have seen that it extends well to the north and to the south. On the Asafo Belt right on the Kibi Belt in the south, Abzu has been coming up with some very decent grade intersections of 4+ g/t material. It’s still early but indications point to, with additional drilling, sizeable results.
The concessions are in close proximity to prolific mines. Abzu has properties near Newmont Mining Corp.’s (NEM:NYSE) Ahafo and Akyem projects. It’s got property that is close to Keegan Resources Inc.’s (KGN:TSX; KGN:NYSE.A) Esaase mine. So, these are spanning all the belts coming through to the south. And Abzu is on the Kibi Belt as well—that is also close to a past-producing mine. There is the adage that the best place to find gold is within the shadows of a headframe. I think that is the strategy that guided Abzu in staking all these concessions.
TGR: You also cover companies with gold projects or mines in Burkina Faso, Liberia and even the Democratic Republic of the Congo (DRC). Please tell us about some of those companies.
NS: In Burkina Faso one of my top picks is SEMAFO (SMF:TSX). It’s seen quite a significant pullback in recent times. It has a very solid balance sheet, $170 million (M) in cash, no debt, and it’s generating an operating cash flow of about $130M per year. This company is in a position to fund all its organic growth without coming back to the market. Any value from additional expansions flow to the shareholder. SEMAFO has been able to demonstrate the ability to bring that production on for the past three years. There are a few catalysts coming down the pipeline, including a resource update. And as management continues to show to the market that its large Mana project has resource growth potential with several exploration updates expected, not only in June but after, we should begin to see that attention back into the stock. We will probably see it recover earlier than most of its peers because there’s nothing fundamentally wrong with the company.
TGR: You’ve got a $12 target price on that and a Buy rating. SEMAFO has a promising project in Niger called Samira Hill. What are your thoughts on that?
NS: It is a mine that sits on a mineralized trend that stretches for a good distance. Only about 15% has been tested and developed as pits. So there’s a lot of potential along the strike. In the past, very little capital was reinvested in the mine because ownership was split between Etruscan Resources Inc. (EET:TSX) and SEMAFO, and Etruscan never had enough money to put into expansion activity. The mine has not been performing at its optimum level for some time. That’s changing with SEMAFO now taking full control of the mine and investing a lot more into exploration and capital projects. It’s smaller and we need to see a much, much larger expansion to get more stability in the operation. But I think it’s still a worthy asset to have in the company.
TGR: Tell us about Liberia.
NS: Often people shy away from countries that have had issues. But Aureus Mining Inc. (AUE:TSX; AUE:LSE), which will likely be the first company to commence production in Liberia, is making good strides. Infrastructure-wise Aureus’ New Liberty project is very close to the port, and most of the access to the ground is via a paved highway. That makes it relatively easy to access, compared to other projects in the country. The capital required to kick-start the mine is around $120M—that’s not so huge that it will make this project’s financing risk insurmountable. I see Aureus coming up with its first production sometime in 2014. At this level, it’s one of the highest grade projects in the whole of West Africa near surface. And that’s just the beginning. About 40km north is its main asset, New Liberty, which in itself has a lot of potential to grow in surrounding anomalies that have been delineated. Northwest of the structure is a new 13km anomaly that has been picked up. The grades that Aureus has been picking up from initial intersections on this system are quite encouraging. So, there’s definitely a gold district there and the grades are quite compelling. That would definitely have a good impact on cost.
And we like the DRC. That country has had its issues in the past, but as with any other such situation, there’s always a time when it stabilizes. The fact that the election was conducted is a good thing. There were a lot of irregularities, but post-election issues have not been too severe, and that’s a good sign that the DRC is maturing and stabilizing. You see a huge discount in companies operating in the DRC, which in my opinion is not warranted, because it has one of the most prospective mineral belts in the world.
We just saw the first commercial gold production coming with Banro Corporation (BAA:TSX; BAA:NYSE) picking up the march. And we’re going to be seeing Kibali from Randgold Resources Ltd. (GOLD:NASDAQ) come through. I just visited the Kibali project and was very impressed by the progress made for relocation, which is probably the most challenging part of construction. With a solid technical and mine-building team in place Randgold expects to bring Kibali into production by 2014 without a lot of challenges. As these two continue to do well, people will change their perception of gold mining in the country.
Another that I would highlight as very cheap at these levels is Kilo Goldmines Ltd. (KGL:TSX.V), which is on the Ngayu greenstone belt and will be commencing drilling very shortly. David Netherway and Alex van Hoeken have taken over, and they are seasoned mining personnel who focus on the exploration growth potential of their large land package. One similar ground to the Kilo ground is Geita, which in the 1990s started as a small resource from old mine workings and has grown to north of 10 Moz. It’s a similar story for Kilo. It has an old mine at Adumbi, which is currently around 1.8 Moz, and there are a whole slew of prospects around it. This is one of the few times that a company has enough drill rigs to chase some of these targets. It’s very early, but there’s a lot of growth ahead of Kilo—including the fact that Kilo also has an iron ore exposure that the market is not paying anything for. So, you rarely get something for free, but Kilo could be an example of where that really works.
TGR: An iron-ore sweetener, as you’ve called it. In a March 30, 2012, report, you said you expected a rerating of the stock. When?
NS: Rigs are on-site and drilling has commenced. It has its own sample prep lot, so turnaround times are not going to be that long. As news starts to flow, which could be as early as midyear right through the end of the year, and people begin to appreciate the size potential of this asset land package and also the grade profiles, that’s when everyone will start waking up to the opportunity and drive the re-rating.
TGR: Do you have some parting thoughts on African gold plays?
NS: People should continue to focus on the fundamentals. Take advantage of the situation, which will turn around and stabilize, to pick up on names that you missed out on and wait for the disconnect between the commodities and the equities to correct. I see very little downside risk at these levels.
TGR: Thanks for your insights today.
Nana Sangmuah is managing director of research at Toronto-based Clarus Securities. His previous industry experience includes the Prestea underground mine, AngloGold Ashanti’s Obuasi and Iduapriem mines, and Gold Fields’ Damang gold mine. He has over eight years of global mining equity research experience that covers more than 60 mining companies worldwide in the gold, base metals and diamond sectors and has in-depth knowledge of mining projects in West Africa. Sangmuah completed a Master of Business Administration in finance at the University of Toronto’s Rotman School of Management in 2004 and obtained his Bachelor of Science in engineering from the University of Mines and Technology, Ghana, in 1999.
Brock Salier, a mining analyst with GMP Securities Europe, sees plenty of gold coming out of Africa in the coming months and years. In this exclusive Gold Report interview, he says increasing political stability, good geological prospects and governmental recognition of the benefits of mining operations are reasons to look there for growth.
The Gold Report: Brock, you cover many companies based in Africa. What do African countries offer that other jurisdictions do not?
Brock Salier: I would have to say geological prospectivity. African countries are relatively underexplored and underdeveloped. That means African exploration and mining companies have far greater likelihood of discovering new ounces and of expanding production at existing mines.
The other key is sovereign risk, which is relatively good in Africa. We define sovereign risk as the number of assets that have been nationalized or taken away from mining companies. When I compare Africa to Southeast Asia and the former Soviet Union, Africa scores much higher.
TGR: Are brokerages like GMP being forced to look at countries operating in Africa for growth?
BS: Quite the opposite. We have a choice of jurisdictions and we’ve chosen Africa as one of our focus areas. For us, the African asset base is attractive. We see more listed companies operating there and a lot more success stories relative to elsewhere.
TGR: Are there any traditional gold mining countries that you might take a flier on, perhaps Ivory Coast?
BS: Absolutely. We’re actively working in Côte d’Ivoire. Despite recent civil unrest, the country has transitioned to a new democratically elected head of state. The geological prospectivity is so high that mining companies are flooding in. The asset quality is stunning. I would target the Ivory Coast as a favorite investment location.
Liberia and Sierra Leone are relatively underexplored compared to Ghana and Burkina Faso, both of which have democratically elected heads of state. Despite very recent civil unrest, Liberia and Sierra Leone are now stable, open for investing and have some really exciting targets.
Neighboring Ghana is much better known for its gold, yet it’s also much more explored and the explorers have smaller licenses; the producing assets are more mature. The Democratic Republic of Congo (DRC), which has had an up-and-down history, is one of our favorite investment destinations because of the geological prospectivity.
TGR: What accounts for the increased stability in West Africa and what are your preferred jurisdictions there?
BS: Wealth generation has played a role in the region’s stability. The wealth generated in Ghana in the last 20 years has made many of that country’s neighbors want to emulate its success. To have ongoing, direct foreign investment, you need a sustained, peaceful state. There is an incentive for them to push toward stability.
From a geological perspective, my preferred destinations are Mali, the Kénieba inlier in Senegal and Burkina Faso. The Ivory Coast is another exciting destination, given its geological proximity to the highly mineralized Ghanaian gold belts and historic underinvestment. In the last 12 months, Liberia has seen a huge influx of gold juniors. I wouldn’t be surprised to see exploration success increasing there.
TGR: In some regions, we are seeing project nationalization in various forms. Will that find its way into the African countries?
BS: I genuinely believe nationalization is not a major issue in Africa. Looking at the historic incidence of nationalization, it’s not common in Africa. It did happen in the DRC with First Quantum Minerals Ltd. (FM:TSX). In the DRC’s case, there is such a strong desire to create an environment suitable for foreign investment, it genuinely does not want to send a message of nationalization to the foreign community.
TGR: In your company models, you typically value gold companies using a gold price of $1,575/ounce (oz) of production and $80/oz in the ground. The gold spot price has been volatile lately, and your price per ounce of production might be considered high by some analysts. Do you plan to make any adjustments?
BS: It’s important to point out that we use a gold price assumption rather than a forecast. We typically choose $1,575/oz as a stable price and then look at the sensitivity. We suggest that investors take their own view on the gold price.
Having spent a lot of time on new development projects in Africa, I see a lot of support at $1,100–1,200/oz because of supply constraints. The assets are maturing. The grades are falling. The diesel price is escalating, along with taxes and royalties in some places. Costs are higher.
TGR: Brokerages in Toronto typically use a 5% discount rate for companies operating in Canada. You use a discount rate of 6% for companies operating in Africa. Does that extra 1% account for the additional risk in Africa?
BS: Ironically, most European brokerages use a 10% discount rate for African gold projects. We use 10% for base metal projects, but 6% for gold projects because gold companies are far more scalable than other commodities. There are more deposits to be found. It’s easy to develop gold deposits.
In response to the 5% vs. 6% question, we capture that difference in net asset value (NAV) multiples. When we value African gold companies, we use a variety of NAV multiples. While we use a higher discount rate, we account for that by using a different NAV multiple.
The key thing for any investor looking at a gold analyst’s research is to make sure the discount rate and the gold price are consistent. We use the same discount rate and gold price across the firm. Then we look at our valuations relative to our coverage universe.
TGR: Would you consider your model aggressive?
BS: I would say not, because of the huge support in the gold price and the huge demand for gold mining companies. Gold equities are outperforming other mining equities because there is a lot of investment support and gold companies are the easiest to understand and take into production. They’re the most scalable. On that basis, gold equities definitely trade at a premium to many base metal and bulk commodity producers.
TGR: Let’s get into your coverage sector. You cover African Barrick Gold Plc (ABG:LSE), which operates the Bulyanhulu gold mine in Tanzania. In your Oct. 20 research report, you basically said that African Barrick is seeking a takeover target. What sort of catalyst would that be for the company’s shares?
BS: The key catalyst to any gold producer is increased production on an accretive basis, meaning increased production on a per-share basis. African Barrick struggled to increase production in Tanzania with mature assets. Given its strong cash balance, I believe the company will be able to buy production without issuing new shares. That could prove to be a tremendous, positive catalyst for the stock.
TGR: Which juniors would be likely targets?
BS: We believe a company like African Barrick will look for juniors in a stable country, with numerous future growth opportunities, existing production and growth projects. As outlined in our initiation report the two that stand out are Teranga Gold Corp. (TGZ:TSX; TGZ:ASX) and Avocet Mining Plc (AVM:LSE). Both have existing production in the 120–250 thousand ounces per year (Koz/year) range, lots of exploration upside and, most importantly, would be affordable with capitalizations well under $1 billion (B).
TGR: Will African Barrick ever get to the large-cap producer status of some of African players like IAMGOLD Corp. (IMG:TSX; IAG:NYSE) or Gold Fields Ltd. (GFI:NYSE)?
BS: If it did acquire a junior producing 200 Koz/year, production could very quickly lift over 1 million ounces per year (Moz/year). That immediately takes it to production well above a company like Randgold Resources Ltd. (GOLD:NASDAQ), a far higher-rated peer in London.
Looking to the future, it would be all about additional acquisitions and exploration. We’ll have to wait and see what acquisition strategy it executes.
TGR: Let’s move on to Banro Corporation (BAA:TSX; BAA:NYSE), another Canada-domiciled company. Banro reported its first gold at Twangiza in early October. Banro is a preferred stock you cover. What are the catalysts for Banro?
BS: Banro is an extremely lucky developer and producer in that, in addition to the Twangiza mine, it has two large, undeveloped gold assets that, geologically, should become mines: Namoya and Lugushwa.
In our recent initiation we noted that the key catalysts for Banro are taking its second and third projects, Namoya and Lugushwa, into production. In the short term, the milestones are those that enable progress toward production. We expect the final engineering study for Namoya around year-end, with construction to start early next year. Lugushwa is expected to release a revised resource around year-end and we expect a preliminary economic assessment shortly thereafter. That means analysts will be able to value Lugushwa on a discounted cash flow (DCF) basis for the first time.
TGR: It will take about $120 million (M) in capital expenditures (capex) to bring Namoya into development. When is production slated to start?
BS: We expect the company will start construction around March 2012. There will be a 12-month build, so it can get a targeted first gold pour around March 2013.
TGR: Does Banro have enough money to fund that capex for 12 months?
BS: Namoya’s capex estimate is around $120M. We recently published a report in which we estimate that Twangiza should generate $140M of free cash flow to fund Namoya. Obviously, the budgets are difficult to tie down. But broadly speaking, Banro should be able to cover the capex at Namoya.
TGR: How is production going at Twangiza?
BS: The company has only just announced its first pour; we’ll have to wait and see. When I visited, I was impressed with the engineering team and the design and build, which was being done extremely quickly in an arduous environment. No doubt there will be teething issues, but I’m confident that ramp up should happen in line with target at year-end.
TGR: You mentioned that the DRC nationalized some of First Quantum’s assets, and Banro had its exploration concessions seized back in the early part of the last decade. What kind of relationship does Banro have with the DRC government?
BS: Banro works extremely closely with the government. The government is very happy to see new mines in the eastern part of the country for the first time in modern history and the first modern gold mine to be commissioned as well. The DRC is seeing a big influx of skills, as well as taxes and royalties being paid. In the long term, driven by the copper industry, the DRC sees how well it can do from mining and how it can help the country. My view is that the government intends to maintain a peaceful outlook and to keep the mining industry going.
TGR: GMP follows exploration companies like Loncor Resources Inc. (LN:TSX.V; LON:NYSE.A), Roxgold Inc. (ROG:TSX.V) and Orezone Gold Corporation (ORE:TSX), plays that are not getting support in the market.
BS: Valuation is very difficult. As a geologist by training, I pick producers where I think the resource is, or has potential to be, big enough to be mined and where the geological conditions support additional discoveries.
Loncor, Roxgold and Orezone have already drilled what will eventually be delineated as mineable projects. All have a very good likelihood of finding new projects, although that is always more speculative.
It is difficult to value an exploration company on a DCF basis, so we use the enterprise-value-per-ounces-delineated method and compare that to the peer group. Most listed African pre-producers trade at an average of $80/oz. Then we put a higher valuation on those deposits that have more readily mineable ore—such as higher grades or open pit mineable—and a lower valuation on those with lower grades or more difficult jurisdictions or mining conditions.
TGR: Loncor is a preferred stock you cover; its Makapela project in the eastern DRC doesn’t have a resource yet. How big do you think that resource could get?
BS: I think Makapela will define more than 1 Moz. The company still has a lot of drilling to do and we should see results in mid-2012.
The beauty of Makapela is that there are almost certainly subparallel zones there. Thinking about the next one to three years, I’m convinced it will find more zones and grow over time. From what we’ve seen so far, the potential for more than 1 Moz is there. And, the grades at Makapela are stunning.
We often use the adage that grade is king, and certainly at 9 grams per ton (g/t) even over the narrowest 4–5 meter (m) width, Makapela is very easily mineable mechanically and economically. That should give good returns.
TGR: How does Makapela compare to projects belonging to Roxgold and Orezone?
BS: It’s very similar to Roxgold’s resources. Roxgold recently found slightly narrower veins, but extremely high grade. It’s very different from the resources you typically find in Africa, which are more likely to be around the 2 g/t range, open pit mining and much larger deposits.
One of Loncor’s advantages is its joint venture with Newmont Mining Corp. (NEM:NYSE). That agreement targets a 5 Moz, lower-grade, perhaps 2–3 g/t, open pit deposit. Between Makapela and the joint agreement, Loncor has a strong twofold strategy.
TGR: And Orezone?
BS: Orezone fits in a new breed of deposits we’re seeing in Burkina Faso, alongside Volta Resources Inc. (VTR:TSX). Those companies have relatively lower grades at 1 g/t, but huge size. All of them have potential for 3–5 Moz. The attraction of those deposits is not the grades, but the sheer scale.
TGR: Very few people know much about Burkina Faso. Can you give us a brief overview of its stability?
BS: I was in Burkina Faso last week. It had issues earlier in the year, when civil unrest in Côte d’Ivoire interrupted the supply chains for staples such as fuel and food into Burkina Faso. As a consequence, food prices went up, and the local populace grew uneasy. Now, the supply lines have been re-established and the populace is very supportive of the long-term head of state, Blaise Compaoré. The mining industry is flying ahead. Burkina Faso is one of the best destinations in Africa to invest in from stability and geological prospectivity bases.
TGR: Some of our readers like base metals plays, and you follow a small copper play in the DRC called Tiger Resources Ltd. (TGS:TSX; TGS:ASX). What brought you to that name?
BS: In this economic climate, I believe it’s important to pick mining stocks that don’t have large, upfront capital requirements. That can often be an insurmountable hurdle if the share markets aren’t open for fundraisers.
We recently initiated coverage on Tiger Resources, which alongside all the copper producers in the DRC, has the advantage of a small, exceptionally high-grade starter resource. For less than $30M capex, the company built a plant producing 30,000 tons per annum of copper in concentrate. Similar to Banro’s expansion model, Tiger self-funds a large component of its expansions. We love the geology of the DRC. We think it’s far more prospective than the much-lower grade copper deposits in Botswana, and for Tiger that means there is a lot more opportunity for Tiger to pursue a merger or acquisition, now that it’s an established producer.
TGR: Do you have any other preferred stocks you would like to share with our readers?
BS: One of my preferred stocks is Sable Mining Africa Ltd. (SBLM:LSE). Its current market cap is $150M. It has a strong balance sheet, $110M back in March. As we outlined in our recent initiation report, it’s about to start drilling on what I think are the most exciting and largest iron ore exploration targets in West Africa. Looking at its two targets in Liberia, I see potential for some of the largest iron ore discoveries to be delineated in the last decade. They are both within 70 kilometers (km) of existing railway, so there is good infrastructure as well.
TGR: That is a significant distance. Will Sable be building rail?
BS: Absolutely. Many of the iron ore deposits being discovered in West Africa are 150km or more from the nearest port or existing rail project. So, while a 70-km railway sounds like a lot, compared to other West African projects, it is far closer than most. The attraction is the potential for in excess of 10 billion tons (Bt) of iron ore, which is a phenomenal amount and more than warrants building 70km of railway.
TGR: Sable also has some coal projects in its portfolio. What can you tell us about those?
BS: Its South African project is almost ready for a bankable feasibility study to fund construction. Its project in Zimbabwe is even more exciting. Its portfolio there has the potential for 4 Bt of thermal coal with coking coal. Although Zimbabwe is going through a period of reform, we believe the current investment climate is suitable for exploration, which enables Sable to undertake exploration and feasibility studies. As such, for Sable investors, the key value lies in the iron ore portfolio.
TGR: What is the upcoming news flow for Sable?
BS: The company has spent some 18 months acquiring projects, undertaking geophysics and establishing road infrastructure to drill the targets. This means there has been limited news flow, but with the drilling starting in January across the iron ore portfolio in Liberia, we expect the news flow will significantly pick up.
TGR: Is there a good spot on the Internet where people can go to see new resource stories coming to market?
BS: It’s very difficult to track. Probably the best source for people in North America is the Producers and Developers of Canada International Convention Trade Show & Investors Exchange, which is a huge attraction for these stories.
TGR: Brock, thank you for your time and insights.
Brock Salier is a mining analyst with GMP Securities Europe.
Attention Shoppers: There are some amazing values currently available at bargain prices in the energy department. That’s pretty much what Chen Lin told us in this exclusive interview with The Energy Report. The current level of risk aversion by most investors has left the doors wide open for those who are willing to see real values and major potential in oil and gas producers.
The Energy Report: You last spoke with us in early June. What has transpired in the oil and gas markets since, and has it altered your investment thesis?
Chen Lin: The oil price has been going up and down because a lot of traders are mispositioned and are scrambling around. That makes the market very volatile. However, WTI is around $100 again, which is quite surprising because we are still in the middle of a recession. World oil demand is still there, and whenever there’s a drop in the oil price there’s a lot of buying. I’m quite surprised that oil is still around the $100 mark. Personally, I would like to see it in the $80 to $90 range. That’s actually good for the oil consumers. If gasoline is below $3.00 that really helps the U.S. consumer.
TER: Domestic natural gas prices, on the other hand, have been in a continuous downtrend since June. It seems shale gas has created a glut. What’s your assessment of that situation?
CL: There’s so much natural gas being produced in the U.S. that we can’t consume it and, then there are no facilities to export it. The oil/natural gas price ratio may go up further. It really depends on how much gas is produced. If you want the market to really work you need to create more natural gas demand with export facilities or a policy to make cars run on natural gas. Then drivers can enjoy $1/gallon equivalent in gas. That would be a huge demand boost and would make natural gas prices go higher. Without those on the horizon, the natural gas price may come down further.
TER: So, what do you think would happen to the oil market if the Eurozone situation deteriorates further?
CL: It would be negative for the oil market; that’s for sure. Globally, investors must take into account the demand disruption in Europe versus the demand increase in developing countries, which is still an ongoing trend. If there is a depression in Europe, of course oil will go down, probably as far as it did in 2008. If Europe can avoid a depression, we may see an even higher oil price.
TER: How has your energy stock portfolio performed since we spoke in June?
CL: Last June, I was in the process of reducing energy stocks because of the European crisis threat. In the past few weeks, I started to increase oil exposure substantially because there are a lot of very cheap energy stocks. You can buy your oil stocks for pennies on the dollar. Also, energy stocks, even though they are very capital intensive, are not as capital dependent as mining stocks. Energy companies can drill a well and then pump the oil and sell it. Then they can use the capital to finance the next well, whereas mining companies need to keep raising money to maintain production. That is why I like oil producers. With $70 -$80 oil, they can make good money, and $100 oil is really great money. They will have a lot of capital to deploy and enjoy a lot of cash flow.
TER: You get a pretty immediate payout and don’t have to sit around for years waiting for approvals and licenses and building. So, there’s definitely that advantage.
TER: In June you mentioned that your biggest holding, at that point was Mart Resources Inc. (MMT:TSX.V). Is that still the case? What’s been going on with the company since then?
CL: That’s still the case. I’m holding a lot of Mart Resources. During the summer when the market turned south, I was still holding the stock because I really believe in this project. I heard the company was making presentations at conferences where it was talking about the potential for very large dividend payouts, starting next year. Right now it’s trading about one times after-tax cash flow, according to the management. So, it can basically pay out any dividend it wants. It will probably start low—maybe $0.05 or $0.10. A $0.10 dividend is almost a 20% yield at the current share price. Then it will start going higher because it is going to accumulate so much cash from its oil drilling program. Every well in this year’s drilling program is a successful well—every well! I think two are around 10,000 bpd. One is 6,000–7,000 bpd. In North America, if you have 600 or 700 barrels, it’s a very good well. These are much bigger. So, Mart is just waiting to reach a deal with the pipeline company so it can start pumping more oil out. It’s supposed to be very soon. Once it reaches that stage, it will be cash-flowing at one times market cap. That will be a huge catalyst. Plus, the dividend payout will be another big catalyst. I’m looking for a much higher stock price.
TER: This is Umusadege Field in Nigeria you’re talking about, is that right?
CL: Right. Mart just found an amazing amount of oil. Its well production in the past 2–2 ½ years has shown no decline. In North America, after a month or two it could drop in half, like in the Bakken. The steady production means the company is sitting on a much larger pool than people can imagine. The next catalyst will be its reserve calculation. With all the production it’s had and all the successful drilling, this year’s reserve will be much higher than last year’s. With last year’s reserve, if I remember correctly, the 3P net asset value (NAV) of 2010 is way over $1.00 per share. This year it could easily double that, maybe even more. Meanwhile the stock is still at $0.64. That tells you how much upside it has just from the NAV. Then you can look at it from cash-flow side and the dividend side and you can see that the stock is very, very undervalued.
TER: So, what’s the market cap for the company at this point?
CL: I think it’s about $200 million (M) and they will probably cash-flow more than $200M.
TER: Boy, that is a real bargain, isn’t it?
CL: I’ve been holding this as my largest position because I feel so compelled. It’s been undervalued for a long time. Partly it’s because the market was very bad this year. Nobody really paid attention. In the meantime, the company has had one drilling success after another. Not just successful but very successful. The market has shown no response to that. But the company can immediately sell the oil and get into cash-flow. So, if the market doesn’t respond now, it will respond later. That’s why I was holding it as my largest position throughout the turmoil this year.
TER: Do you think is the project’s location in Nigeria might make some investors wary?
CL: That could be the case. The Nigeria situation is a little bit volatile. But, again, this is an OPEC nation and Mart exports through its standard pipeline. It has some interruptions from time to time, but management has already factored that into its cash-flow calculations.
TER: What do you think the chances are that the company will get bought out by a major with this kind of production?
CL: It could be. There was another Nigerian company that was bought out by a Chinese company for $7 billion (B) last year. Mart will likely be producing at that level in a year or so. Right now it only has a $200M market cap. So, you can see the upside is huge. Furthermore, the company does not need to come to the market to raise money. That’s why it’s in an ideal situation and why I like it.
TER: Another one that you were quite positive on last time was Harvest Natural Resources (HNR:NYSE). You said that you thought that it might be up for sale. What has transpired with that one?
CL: Its Venezuelan project is still for sale. That project is actually generating very nice cash flow. The company has about $3–$4.00 cash on its balance sheet. So, it’s pretty well cashed up. It is producing oil from its oil field in Venezuela and it is paying dividends. It uses the money to drill wells elsewhere. The stock had a little bit of a setback when the company hit a well in Indonesia and the first part of the well was not as good as people expected. But it hit a very good well off of Gabon in Africa and then it will drill another well in Oman. Plus, it is continuing to drill in Indonesia. So, it has a lot of excitement coming. The company is still trying to find a buyer for its Venezuelan asset and probably a Chinese or Russian company that is closer to the government that might buy it.
TER: So, the upside still looks pretty good for that one as far as you’re concerned.
CL: Yes, the upside is big. It’s just that the market has not put all the pieces together yet and calculated how much the company’s assets are potentially worth.
TER: Maybe that’s because Harvest is spread out geographically and people have a hard time understanding it versus if it were all in one country or one location.
CL: Exactly. That’s also a big issue.
TER: Another one you talked about last time was Porto Energy Corp. (PEC:TSX.V). It had a new gas discovery in Portugal. At that point, the value of that was much greater than the price of its stock. What’s going on with that one and where do you think it is going?
CL: Right now the market is so afraid of risk that investors seem to be getting rid of any company that’s associated with risk. Porto is a perfect example. It already has a natural gas discovery and is trying to expand and bring that into production. The natural gas pipeline runs through its property. The company was IPO-ed earlier this year at $1/share. Right now it’s about $0.25. It’s getting close to the cash it has on hand and it can generate immediate cash-flow. The Portuguese government is extremely supportive of what the company is doing because the nation wants the tax revenue and the jobs. Portugal’s government is trying to help Porto anyway it can so production can come online.
TER: So that one is definitely undervalued, compared to where it was in June, with a lot more upside potential.
CL: Exactly. There are a lot of companies, both in energy and in mining, that have been hit hard. If you are willing invest with a little bit of risk appetite, you can find a lot of very undervalued stocks that can go up very significantly once the market stabilizes. I’m still trying to stay with companies that have strong cash flow, and good balance sheets so that they don’t need to come to the market to raise money. That can help you weather the storm.
TER: Are there any other companies that you might want to mention at this point?
CL: I’ve been taking a position in quite a few energy companies, some quite aggressively. One is Pan Orient Energy Corp. (POE:TSX.V). I had the stock before. It’s at $2 recently from $6 earlier this year. The company raised money at more than $6 earlier this year, so it has a very strong balance sheet with about $1/share on its balance sheet. It drilled two wells in Indonesia. One was a failure. The second one was non-conclusive. The company couldn’t finish it. So, it stopped and tried to find another driller. It will start drilling, I believe, this month. In the meantime, the market hit the stock hard. Pan Orient has a producing oil field in Thailand, which is producing a lot of cashflow (It is trading at about 2 times cashflow). It also has an oil sand property in Canada. In addition, it will be drilling this big potential well in Indonesia. Can the stock go lower? It’s possible. But, I feel it’s so undervalued that I started buying it quite aggressively.
Another stock I bought quite aggressively recently is PBN, PetroBakken Energy Ltd. (PBN:TSX). It is paying a 10% dividend right now and the stock is less than $10.00. You get a monthly $0.08 per share dividend. The stock was hit very, very hard because it missed its earning guidance in the past few quarters. In addition, it has a sizeable debt. So investors are worried about that, which has caused rounds of selloffs. It sold down to where it was paying a 15% dividend. So, I picked it up not long ago at a slightly lower price. It had very good production in the recent quarter and seems to have hit its targets. Management has indicated it has no problem paying all the dividends as long as the oil price doesn’t crash. So, basically you’re getting paid a 10% dividend while you wait for the stock to appreciate, which it is.
TER: How do you think energy investors should plan for the coming year, given the turmoil in Europe, the world and domestic economic situations and the 2012 elections?
CL: I’m just looking at global production, supply and demand. Investors should know that India has no strategic oil reserves and it is a very important oil user right now. China is still expanding and building its strategic oil reserves. Last time I checked, China’s oil reserves can last only one-third as long as U.S. reserves. China will likely fill up more of its tanks on any dip in the oil price. There should be good demand for oil in the current market unless we have a complete breakdown of the euro.
On the investment side, I like to invest in land-based oil producers because sea-based oil production has high capital requirements. I also prefer oil producers versus natural gas producers in North America because these kinds of companies tend to perform better in this market.
TER: Do you expect the year-end tax loss selling season to present some good buying opportunities?
CL: Oh, yes, absolutely. For example, on Pan Orient, one of my plans was to wait until tax-loss selling in December to buy, but in November it already dropped to below $2.00. I said, “Okay, let’s buy it right now, right here.” There could be more tax-loss selling coming, but these are very good opportunities to buy—especially companies with very strong balance sheets and good cash flow, which don’t need to raise money. The dip will, most likely, be temporary and there will be very good buying opportunities for a lot of these stocks.
TER: So, we’ve got another few weeks to pick up some bargains before the end of the year.
CL: Yes. I do want to mention that, generally, the oil market bottoms in the winter and then goes up in spring all the way to summer. So, we’re coming to a very strong part of the seasonal oil price cycle.
TER: That’s a great suggestion. Thanks for taking the time to talk to us today.
CL: Thank you for the opportunity.
Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors, Inc. While a doctoral candidate in aeronautical engineering at Princeton, Chen found his investment strategies were so profitable that he put his Ph.D. on the back burner. He employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis.
Britain’s international aid budget costs the equivalent of 22 days of national borrowing from international markets. By 2015, British Aid will have increased by 34.2% to £11.5 billion per annum. Including personal donations and state spending, Britain gives 0.8% of GDP in international aid. With state aid increasing, more people should ask: Why are average per capita incomes in Africa lower than 40 years ago after $1 trillion of aid being given over that period?
If there is one thing I simply do not understand in this scenario, it would have to be why Britain feels compelled to help Africa at all. The British government’s only concern should be with taking care of its citizens and acting directly in their best interest. (Of course, as a libertarian, I’m inclined to argue that this can be accomplished simply by ensuring that property rights are observed, and that the taxation necessary to ensure this result is as small and painless as possible.)
I simply do not see how giving aid to Africa is in the best interest of British citizens. Need cheap labor? Asia is a good place for that, and doesn’t generally require near the amount of aid that Africa does. Besides which, Asian labor is more reliable in terms of quality, and many Asian governments have made a point of developing their infrastructure. So why care about Africa?
This question becomes extremely poignant once on also considers that African countries have not simply stagnated in spite of aid, but have actually regressed. This being the case, it seems obvious that aid, if not hurtful, is at least irrelevant to African countries. And if they can’t manage the money transferred to them from the pockets of productive first-world citizens, then how and why would anyone think that they are worth investing in?
Quite simply, it is time to cut the purse-strings to Africa. They squander the generous gifts given to them time and again, and it appears that this trend isn’t going to change anytime soon. If insanity is doing the same thing over and over again while expecting different results, then the sane thing to do at this point might be to cut the aid and force Africa to stand on its own feet. And who knows? It just might be crazy enough to work.
An intriguing empirical finding from the institutional perspective of economic development from Daron Acemoglu, Simon Johnson and James A. Robinson (link):
“Botswana has had the highest rate of per capita growth of any country in the world in the last 35 years. This occurred despite adverse initial conditions, including minimal investment during the colonial period and high inequality. Botswana achieved this rapid development by following orthodox economic policies. How Botswana sustained these policies is a puzzle because typically in Africa, ‘good economics’ has proved not to be politically feasible. In this Paper we suggest that good policies were chosen in Botswana because good institutions, which we refer to as institutions of private property, were in place…
Why did institutions of private property arise in Botswana, but not other African nations? We conjecture that the following factors were important. First, Botswana possessed relatively inclusive pre-colonial institutions, placing constraints on political elites. Second, the effect of British colonialism on Botswana was minimal, and did not destroy these institutions. Third, following independence, maintaining and strengthening institutions of private property were in the economic interests of the elite. Fourth, Botswana is very rich in diamonds, which created enough rents that no group wanted to challenge the status quo at the expense of ‘rocking the boat’. Finally, we emphasize that this situation was reinforced by a number of critical decisions made by the post-independence leaders, particularly Presidents Khama and Masire.”
Financial Times reports (link) on the new measure of poverty proposed by economists from Oxford University. The authors suggested the modification of current measure of poverty which, defined by the World Bank in annually published World Development Report, is currently set at the threshold of $1.25 per day or less. The new measure proposed by economic researchers from Oxford University sets the definition of poverty in a more sophisticated framework based on the household availability of access to clean water, education, health care and other durable and non-durable goods. The new method, called Alkire-Foster approach, incorporates the qualitative elements into the measurement of poverty.
Using the new method, the authors examined poverty rates in four Indian provinces and evaluated the approach in comparison to the existing income method which had been used in economic and policy analysis by the World Bank and other institutions of economic development. The authors found a significant divergence of poverty rates when measured in both methods. For instance, under Alkire-Foster approach, the poverty rate in Indian state Jharkhand is 50 percent higher compared to the rate of poverty measured under the income method. On the other hand, the authors of the new poverty measure have shown that in some Indian provinces such as Uttaranchal (link), the official measure of poverty highly over-estimates the effective poverty measure as defined by Oxford’s Poverty and Human Development Initiative. The multidimensional worldwide poverty index is also availible on the web (link).
The intuitive question arising from the data and empirical research on poverty is whether higher economic growth in less developed countries boosts the growth of income per capita and what is the role of institutional characteristics in economic development. The authors of the above-mentioned measure of poverty have shown that despite abundant economic growth in past years and falling income poverty rates, the share of population without access to clean water, sanitation and minimum required nutrition remained unchanged. The percentage of malnourished children in India decreased from 47 percent in 1998-98 to 46 percent 2005-06.
The theoretical and empirical literature on economic growth suggests that there is an inverse U-relationship between inequality and income per capita known as Kuznets curve (link). The intuition behind the relationship is simple. At the very low levels of income per capita, income inequality is low. Alongside the course of growing income per capita, income inequality steeply increases and, after reaching a maximum, it decreases as countries achieve higher levels of income per capita. The rate of income inequality is closely related to the evolution of economic policies over time. Wagner’s law, discussed in one of the previous posts, states that government spending over time increases due to long-run income elastic demand for public goods and capture of the democratic system by the particular interest groups that pose a permanent pressure on the growth of government spending and resist the reversals of government expenditures by trading votes.
There’s a wide array of disagreement among economists on the effect of income inequality on economic growth. Back in 2001, Joseph Stiglitz re-examined the East Asian economic miracle and concluded that the evidence from the period of high economic growth in East Asian countries suggests that income redistribution has a positive effect on economic growth (link). Stiglitz’s argument is based on the income distribution in East Asian countries during the economic miracle. East Asian countries have been known for relatively even distribution of income demonstrated by high Gini index and relatively high income tax rates.
On the other hand, the empirical investigation of the initial conditions in East Asian countries before the economic miracle shows that the political influence of interest groups had been relatively weak compared to Western Europe after the World War 2 when the productivity growth stalled from early 1970s onwards. The relative weakness of interest groups and a stable judicial system, inherited from English common law tradition, enabled high economic growth in the longer run given an enduring stability of property rights protection and the rule of law. In such conditions, income redistribution had relatively little effect on economic growth since the empirics of East Asian miracle suggests that the sizable proportion of growth in East Asian countries (Malaysia, Singapore, Korea and Taiwan) had been driven by technological progress, investment and export orientation. Considering export orientation, Rodrik et. al (2005) provided the evidence (link) on the positive effect of high-quality export orientation on economic growth. The productivity growth in East Asian countries between 1975 and 1990 had been a pure example of economic miracle defined by the share of growth that could not be explained by the contribution of labor and capital input. In Taiwan and Hong Kong (link), total factor productivity accounted for about 60 percent of output per capita growth. Between 1975 and 1990, in Singapore, output per capita had increased by 8.0 percent. Consequently, the resulting outcome of almost two decades of robust productivity growth had been a significant decrease in national poverty rates (link). The lowest poverty rate, as defined by the measures of home authorities, is in Taiwan where 0.95 of the population live below the poverty threshold.
The basic set of policies that alleviate extreme poverty such as providing access to clean water, nutrition, medical protection against HIV/AIDS and basic sanitary standards have a positive effect on the economic growth and the standard of living. However, the major cause of persistent under-development in Subsaharan and Tropical Africa is mostly the lack of institutional enforcement of property rights, the rule of law and independent judiciary. In spite of billions of USD of direct foreign aid, countries such as Zambia, Sierra Leone, Mali and Rwanda endure in persistent poverty and under-development. Esther Duflo, this year’s recipient of John Bates Clark Award, has shown in several studies how field experiments can enlighten the understanding of incentives in least developed countries (link). Understanding the significance of incentives in reducing poverty is crucial to further examination of the relationship betwen income inequality and economic growth.