The Energy Report: What’s your big-picture view of Canadian junior oil and gas companies?

Robert Cooper: The business plans for junior and midsize companies have changed dramatically in the past five years, largely due to three game-changing events. The first was the elimination of the royalty trust structure. Number two was royalty changes in Alberta. The third was the advent of horizontal drilling.

Through the mid-2000s, the trusts were essentially industry Pac-Men scooping up smaller companies. With a couple of thousand barrels of production per day, companies had an obvious exit plan via sale to the Trusts. Once the trust structure was eliminated in October 2006, so was the appetite for mergers and acquisitions (M&A) from the trusts as they had to retool their own asset bases. Many of the midsize trusts were acquired themselves and morphed into larger companies.

Secondly, the ill-conceived royalty changes in the fall of 2008, which have since been rectified, were extremely punitive to conventional producers and explorers. As a result, juniors had to adapt to lower geological risk models in order to stay in business. Finally, the development of unconventional plays through technological changes, principally horizontal drilling and multi-stage completions, caused the business model to change again, this time to a better-capitalized and longer-term business plan.

Today’s smaller producers tend to have a signature property that is a resource play. The companies are usually better capitalized and generally larger than they were five years ago. While M&A still occurs, it’s for strategic assets, unlike the previous market environment, where companies could put together some assets and find a buyer after three years. Now juniors need to have a scalable business plan and properties with enough scope such that if they seek to be acquired, their properties are sizeable enough to be a signature growth property for the much-larger acquirers.

TER: What are you looking for in the coming months for the oil and gas markets?

RC: Overall we’d expect continued volatility in the equity markets. The macro situation is clearly in a massive state of flux on a number of fronts. Sovereign debt concerns clearly represent the largest near-to-medium-term threat in our view. No one knows exactly what the ramifications will be if Greece or another peripheral European country defaults. But in investors’ minds, that will inhibit risk taking, and that’s negative for small-cap stocks and commodities, including crude oil. That said, we’re much more constructive on crude than natural gas, despite the apparent downside risks in crude. Even with consistent prints in the $80s, most western Canadian sedimentary basin producers would still have pretty robust economic returns. Crude oil is ultimately a secular growth story with rising supply costs and rising demand.

With natural gas, I’d say we are neither bearish nor bullish. There might be periodic trading opportunities that are largely related to seasonality, but the big move down has taken place. The supply curve has changed, and that’s severely impacted the price. On the other hand, we don’t yet see a reason to become bullish.

I’d say we need to see a structural move higher in the demand curve for natural gas, and that could manifest itself through the elimination of coal-fired power plants or the implementation of natural gas-fueled vehicles for long-haul trucking, for instance. In Canada, it could be the development of export markets to Asia that could fundamentally alter the equation for Canadian producers. North America is clearly awash in natural gas for the foreseeable future. It’s still bewildering to me why the U.S. doesn’t incorporate natural gas into the energy mix in a much greater fashion. It would do wonders for reducing U.S. reliance on foreign sources of energy.

TER: Getting to specific companies that you cover, what are the selection criteria that you use in determining which companies you want to cover?

RC: We’re normally bottom-up value investors but incorporate a macro overlay. We assemble a list of candidates and then do our due diligence on the companies that meet our criteria. First, we look at product split—gas or oil or liquids-rich gas. All of them can be very profitable at certain times in the cycle. I’d be more biased toward oil and liquids-rich gas right now. Two, we’re looking at the plays and properties—conventional or unconventional. Our focus tends to be on unconventional resource plays. The third item would be management. Are they trustworthy? Have they had success previously and are they significantly, personally invested in their companies? The fourth thing would be operations. Do they have a high working interest in their properties? Do they own or control their infrastructure? Do their properties consist of repeatable play types, repeatable drilling inventory with multi-zone potential? Do they have scale and scope? The fifth thing is capital structure or valuation. Is the level of capitalization congruent with the type of opportunity the company is pursuing?

We’re value investors, so we tend to look for situations where there’s a mispricing of assets or a market misunderstanding combined with a pending catalyst that will propel that stock. If we’re correct, this provides the opportunity to earn outsized returns.

TER: Just for a little further background—about how many companies are there in the oil and gas business in Canada of a viable size that would be of interest for you to cover?

RC: It’s gotten smaller lately. Off the top of my head I’d probably say there are over 100 public companies on our radar, about 60% of which are small-to-medium-cap companies.

TER: Can you tell us about some of the companies you particularly like and give us a little detail and reason why people ought to be interested?

RC: We’ve been focused lately on Yoho Resources Inc. (YO:TSX.V), Crocotta Energy Inc. (CTA:TSX) and Open Range Energy Corp. (ONR:TSX). Yoho and Crocotta have the scale and scope in their properties that we think will ultimately lead them to be acquired. Open Range is a hybrid. It’s a top-decile gas producer with an excellent gas-weighted property in the Deep Basin of Alberta. It has another division called Poseidon Concepts, which is a fluid handling business. Open Range announced in early September that it’s spinning both these businesses out to shareholders. Its gas property still has the scale and scope that we like and think it will be acquired. The fluid handling business is going to be a whole new entity that has material growth and cash-flow generation capacity. But all of these companies fit our criteria. They’ve got enough scale, scope and potential that someone might decide to buy them, take over the property and apply some capex to it to really accelerate growth.

TER: Was that the philosophy behind Open Range Energy’s spinoff?

RC: It was starting to look like it was suffering on a small scale from what we call the “conglomerate discount.” Some investors wanted to participate directly in the tank business while others wanted to participate on the E&P (exploration and production) side. It made sense to separate the two and let investors choose a pure play in which they can participate.

TER: About a year ago, ONR was trading around $1.60 and now it’s moved up to the $9.00 range. What are the prospects here after the split up? Is there still some upside at this entry point?

RC: The tank business is where the big growth is. It is scheduled to pay a $0.09 per month dividend, so, it’s going to be a hybrid growth-plus-yield entity. Open Range basically created this unit from thin air. An engineer in the field figured out how to construct fluid handling tanks in a manner that allowed them to be easily assembled in the field in a matter of hours. The tanks have obvious advantages in that they are easy to use and assemble, reliable and eliminate logistical problems because they are easily transportable and its use results in a substantially smaller environmental footprint. ONR management patented the concept and managed to create a business from scratch in early 2010 into a projected $130M EBITDA (earnings before interest, taxes, depreciation and amortization) in 2012. It’s had a phenomenal growth trajectory and we think that there’s still room to grow, particularly in the U.S.

When the company is spun out, it will be able to operate on its own and it’ll attract a different investor base, mainly yield investors. In terms of market share, we think there’s still probably room to double before potentially significant competition enters the space. It’s running at 80% operating margins now and that’s inevitably going to attract competitors. But because they’re the only player in the space at this time, they’ve got the early-mover advantage. The faster they maximize their market share, the more able they will be to deal with competition from a position of strength. But in the near-term, once it’s spun out at the end of October (assuming investors approve), investors will be collecting what looks to be a ~15% yield out of the gate. It’s very difficult to find this level of yield in today’s market.

TER: They used to pay something like that in the old days, didn’t they?

RC: Yes; and the upside is that if it trades down to a 10% yield investors could see potentially a ~50% capital appreciation, plus a healthy dividend. The main risk is competition. As we mentioned, the margins are stellar and that is ultimately going to result in new entrants in the market. The large service companies such as Baker Hughes (BHI:NYSE), Schlumberger (SLB:NYSE) or Halliburton (HAL:NYSE) would be formidable competition down the road.

TER: That’s still a pretty phenomenal growth story in a short period of time.

RC: It truly is.

TER: What about Yoho and Crocotta?

RC: They’re both pure E&Ps. We like Yoho for a bunch of reasons. Yoho’s CEO is one of the most impressive exploration geologists we have followed. He’s consistently early on high-potential plays and he’s done that again within Yoho. He’s run three or four different companies and had success in each. Yoho has the largest, or very close to the largest, exposure to gas in place of any junior we know of in western Canada at over three trillion cubic feet (Tcf.). Now, “resource” is not the same as reserves, but it’s a pretty good indicator that reserves can be captured with some prudent development. There are three material plays within the company right now that are not, in our view, recognized by the market. One of the two main plays is called the Duvernay Formation in West Central Alberta. The second one’s called the Montney Formation in Northeast B.C. The Duvernay has been the subject of a lot of chatter in Calgary as industry has spent close to $1.6 billion (B) on land in the last year and a half on the trend.

Majors such as ConocoPhillips Company (COP:NYSE), Encana Corporation (ECA:TSX; ECA:NYSE), Talisman Energy Inc. (TLM:TSX) and others all have announced major positions on trend that is thought to contain very high amounts of gas and liquids in place per section. Yoho is by far the smallest player in the Duvernay and, as such, has the most leverage to drilling success. The Montney, on the other hand, is a very well known formation. It’s also thought to have significant gas in place.

Yoho’s partnered with a large and successful company on this play and they’re actively drilling over the next fiscal year (YO has a September 30 year-end) on both plays in an effort to further quantify the potential. Both plays produce liquids-rich natural gas. If they’re successful, we see the potential for material leverage to reserve and production growth. The plays are certainly large enough that Yoho will ultimately be attractive to larger companies. The key risk here is financial. Wells are expensive and Yoho is a smaller company.

TER: How about Crocotta?

RC: Crocotta is another very well-run company. Similar to Yoho, the CEO’s been successful in past E&P companies he’s led. This is his fifth company on that front. The company has an excellent balance sheet and the capacity to expand and accelerate its drilling program over the coming months. Two main plays are in Alberta’s Deep Basin and in the Montney, Northeast B.C. In the Deep Basin, Crocotta has a multiyear inventory of low-risk, high-return, liquids-rich natural gas wells. The company has recently expanded this inventory through a farm-in with an industry major. Over the next couple of months we’d anticipate continued production growth coming from the Deep Basin property. Secondarily, we’d expect some incremental drilling in the Montney, which holds significant gas in place. Competitors all around Crocotta have had very good results from the Montney. If Crocotta has similar success, we think it could add significant reserves. Finally, Crocotta’s CEO has done a great job creating value, as he’s had to transition the asset base to adapt to the factors we mentioned previously. He has a great sense of the market and he’s a significant shareholder himself. We’re pretty confident that he’s going to do the right thing on behalf of shareholders.

TER: So, what are your expectations as to where the stock is headed?

RC: We think $4.00 is achievable and, with luck, it could be higher than that. “With luck” means with a more constructive macro environment in which E&Ps are acquisitive. We view the properties as top tier and they have scope and scale—key criteria in our view when looking at potential acquisition targets. The main risks are commodity prices and drilling/completion risk.

TER: What do you think energy investors should be aware of at this point, focusing on the next six to 12 months, to maximize profits and minimize risks?

RC: Energy prices are dependent on the economy; that really drives investor sentiment with respect to taking or reducing risk. Proper stock picking is very important: Companies with good fundamentals offer a buffer against those macro issues. If we’re looking at a disintegration of the euro, for instance, small-cap stocks are not going to be in vogue, and that’s a big risk and headwind. However, if you take a longer-term time horizon, the junior energy sector in Canada certainly has potential to offer some excellent returns.

TER: What is the downside risk for oil if the economy takes an abrupt turn for the worse?

RC: Good question. You certainly could see $60 or $70 oil. We’ve already seen prints in the $70s for crude oil a few weeks ago. We would be quite concerned if emerging economies catch the flu from developed economies and those regions really slow down. That’s where you’ll see the most deleterious impact on crude oil prices. But if they don’t, then beyond periodic hiccups in the economy and the cyclical moves, supply costs are rising and demand is on a step change higher every year. So on a longer-term basis, we advise investors to have exposure to crude oil. In the short term, investors will need to watch the health of the economy because European issues will weigh heavily on the market.

TER: In the meantime, you’ve given us three interesting stocks to consider. We appreciate your time and input and look forward to talking with you again and seeing where things have gone at that point.

RC: Thanks; I hope I’m right.

Robert Cooper, CFA is an energy analyst based in Calgary with a focus on Canadian oil and gas exploration and production companies. Robert has more than 10 years experience in the investment industry and has been covering the Canadian oil and gas sector since 2006. Robert is a Calgary CFA Society board member and recently served as president of the Calgary CFA Society.

The Energy Report: Thanks for joining us today, Mr. Wangler. You and your associate, Neal Dingmann of SunTrust Robinson Humphrey, follow quite a number of energy stocks as well as the oil and gas markets in general. Oil prices have been relatively stable over the last few months with oil in the $90-$100/barrel (bbl.) range, and gas in the $4.20-$4.80/thousand cubic feet (Mcf) range. What are your expectations for the oil and gas markets in the next 6 to 12 months?
Jason Wangler: I think we’re really going to see a lot more of the same trading ranges. In the last couple of years, the economy, especially in the United States, has been building back from the terrible situation of late 2008 and early 2009. In 2009 and 2010, we were growing slowly and getting back to a level that was making more sense. But now that we’ve gotten a little more than halfway through 2011, there are still a lot of issues here in the United States. The debt ceiling and budget crisis and the general concerns with the economy not growing as fast as people expected have all had their effects.

We see the Brent crude prices $15 to $20 ahead of where the West Texas intermediate (WTI) oil prices are here in the States because there is excess supply in the U.S. right now and not as much expected demand for that oil. If you look at gas, it’s very much the same way, not only in the U.S. but worldwide. The other countries around the world would love to have the amount of natural gas that we have. The U.S. is blessed with the riches of natural gas from its shale plays. So you’re probably going to see gas stay in the $4-$5/Mcf range and, I think, probably below $4.50/Mcf for the most part, until we have either a demand or supply change that’s very dramatic. That would probably have to come from the demand side either in exporting natural gas or additional uses, whether it be for vehicles or heating more homes or something of that nature.

TER: It’s interesting how the whole gas situation has turned around because there was all this talk a few years ago about building ports to import liquefied natural gas (LNG) and now we’re talking about exporting LNG.

JW: It is amazing. The “shale revolution” has really changed the dynamic for a fuel that was very hard to come by but can’t be easily transported. You have to build these very large, expensive ship-loading facilities. Some people looked at the market in the U.S at the time and wanted to build import facilities because we would need them and we’ve leaned on Canada and Mexico for quite a few years to supply us with natural gas. Now we have so much at $4/Mcf, we wish those countries would need some of ours. Exporting LNG could start to balance out how much oil we have to import.

TER: Looking at your coverage list, some of the stocks are under $0.50 with market caps under $20 million (M), and others are big institutional favorites that trade above $100 with market caps over $50 billion (B). How do you decide which companies you want to follow?

JW: My colleague Neal Dingmann and I look for names and stories that interest us. We look at the management teams as well as where the assets are located and actually break our coverage down based on specific basins. I cover the Williston Basin in North Dakota and everything west. He covers Eagle Ford in Texas and everything east. And then we try to cover a group of names in each basin in different life cycles of each play. It could be one that’s just a very early entrant, which may have a $100M market cap, such as a Voyager Oil & Gas Inc. (NYSE.A:VOG) in the Williston, up to somebody who’s in the $10B+ range, such as a Continental Resources Inc. (NYSE:CLR) or a Whiting Petroleum Corporation (NYSE:WLL).

TER: You seem to be quite hot on the Williston Basin. Tell us why you like it so much.

JW: It’s one of the most economic and best resources that we have, not only in the U.S., but, really, in the world. There’s lots of running room and we’re very early into the play with lots of acreage still to be drilled. We could be up there for 50 or more years drilling very, very strong wells and putting lots of oil into U.S. tanks. The Eagle Ford and the Utica in Ohio have interesting and up-and-coming plays, but the Williston really has been shown to be as economic as any other, if not the best. It’s always nice to be in an asset that has the best type of results.

TER: A lot of these Williston stocks that you’ve recommended in the last few months have had some respectable moves. Is there still some good upside available there?

JW: I think there still is. The winter was colder than usual in North Dakota and Montana. After the winter season they had floods, which caused a lot of problems throughout the Midwest in general, starting up in North Dakota and Montana.

So, there were a lot of problems with shut-ins. They couldn’t work at the same pace they typically had been able to so production numbers were not as high as expected. Wells were not coming in on the expected timeframe. So, some of these stocks took a significant hit. The weather has been good since the beginning of June. Now we’re really starting to see some very impressive rates. Going through the second quarter earnings season, when we start hearing these names report, I think people are going to understand why they’re going to be a little bit lower than we originally expected entering the year.

Today, a month or two since the weather improved, we are able to say that this is a resource that makes sense. And as long as the weather works, we can really start churning out some very impressive numbers. So, I look for the Williston names to really have some impressive growth rates, not only for the full year, but, mostly based on just the second half of this year, because the weather has finally started to cooperate.

TER: Can you tell us about some small-cap names you particularly like at this point?

JW: One of them is a very early stage play in the Williston called Kodiak Oil & Gas Corp. (NYSE.A:KOG). The company has about 100,000 net acres at this point and is really starting to turn on a lot of wells. It should actually be able to start talking more and more about some very impressive production growth rates, not only for this year but next year. In the next couple of quarters, Kodiak could double production in only one quarter because it is able to bring on three, four or five wells. It currently has a couple of rigs running and will be moving to five rigs by the end of this year. Next year, 2012, we should see explosive growth much as we saw from Brigham Exploration Company (NASDAQ:BEXP) a few years ago. So, I look at Kodiak as an earlier stage play in the Williston with a very nice acreage position and cash on the books. When the additional rigs start running, it’s just a matter of focusing on operations and getting the oil out of the ground.

One other one is GeoResources Inc. (NASDAQ:GEOI). It’s a very interesting small company with a strong management team and a great balance sheet. The company has been around for quite some time and has been able to put together nice positions in both the Williston and the Eagle Ford. It’s just starting to drill now on those positions as the operator. It has a couple of wells in the Bakken that weren’t as great as maybe some other results. But, I think you will see some better results coming out of there as the company comes to understand the resource. Then down in the Eagle Ford, GeoResources just reported some very impressive results a few weeks ago coming out of the Gonzalez County area, a little bit further north than most people thought the Eagle Ford to be. It has some good partners and I think you’ll continue to see it be able to add rigs and really start moving that production level much higher.

TER: What else do you like?

JW: Another one that makes a lot of sense to me is Gulfport Energy Corp. (NASDAQ:GPOR). The company is in the Utica Shale as well as a lot of other places. Utica has become a play that everyone’s really curious about and Chesapeake Energy Corporation (NYSE:CHK) is really the only other one that’s talked about Utica very frequently. According to Chesapeake, Utica has the potential to be better than the Eagle Ford. It will be very interesting to see as we start getting some results out of that Ohio area. Gulfport is also drilling wells in south Louisiana and in the Permian Basin of Texas, and in the Niobrara in the Rockies. It also has some oil sands in Canada. Gulfport has a lot of different very strong assets predominantly focused on oil. And it’s been able to keep the production moving forward. So, I think that the good asset base will continue to turn into better and better cash flows moving forward.

TER: Any other low-priced ones you like?

JW: One other one I like is Abraxas Petroleum Corp. (NASDAQ:AXAS). It’s a smaller name with a position in almost every interesting play that’s not only already being produced in the U.S, but also a few others that are emerging as well. The company is in the Bakken area, the Eagle Ford and the Niobrara. It’s also in a couple of other plays including a small one called the Alberta Basin in Montana that’s becoming more and more exciting as Newfield Exploration Company (NYSE:NFX) and Rosetta Resources Inc. (NASDAQ:ROSE) start to do a little more work there. Abraxas is really a very good company getting out there early and picking up some acreage. Now it’s focusing on drilling that acreage, getting the production to the market and then growing its cash flows. But it’s one that I think is very interesting from an asset standpoint. With a stock price under $5, this is one you could really look at as a nice entry point into quite a few different interesting plays.

TER: You also cover Venoco Inc. (NYSE:VQ). Do you have any thoughts on it?

JW: Venoco is an interesting story but the company has had a tough year so far. It’s in the Monterey Shale in California. It and Occidental Petroleum Corp. (NYSE:OXY), are really the only two companies that are in that play in size, at least that we hear about on a regular basis. It’s taken the company a little bit longer than I think it would have hoped for. Tim Marquez is a smart guy and he’s been the CEO for quite some time. But the play has just really not come along quite as quickly as it had expected. Venoco has got some solid assets and solid production but the stock’s really gotten hit pretty hard over the past six months or so.

A lot of people are banking on this Monterey Shale becoming a very interesting and substantial shale play, and it just hasn’t done that yet. I think ultimately it will work, whether it’s Venoco or somebody else out there. I think Venoco has a great position. But, like a lot of other things, it just takes a little bit more time than we or even the company would like to see and so we’ve seen the stock come down. But it’s starting to get a lot more interesting down here in the sub-$12 range. I think it’ll start looking a little better as production ramps up and Venoco gets a little further up the learning curve on the Monterey Shale.

TER: So, generally, what are your expectations for the coming months that people ought to be aware of, concerned about or hopeful for, as far as investing in oil and gas stocks?

JW: The last few quarters really have all been very strong for the entire industry. Oil prices have been very healthy but gas prices not necessarily as much. The biggest questions have really been the macro situation. Is the economy going to grow? Is there going to be a situation like we had a few years ago where oil just absolutely fell off of a cliff? If it can stay in a range bound area, it will be much easier to make smart decisions on a company-to-company basis regarding who you really like and why you like them, as opposed to the whole industry having to come down.

I think that the industry right now is still severely undervalued, probably closer to the $70–$75/bbl. range for these stock prices versus oil trading in the $80-95/bbl. range. That’s because there’s a fear that the economy is going to pull down the market and oil and the stocks are just going to have to come down because higher oil prices have taken a toll on potential growth.

But the $90/bbl.+ range is a fair range. I think it makes sense as far as the world economy and I think that there’s still enough room for the country to grow, in terms of GDP and everything else, to keep these stocks moving and to keep oil prices where they should be. So, I think there’s a lot of room for these stocks to move. I would just continue to watch what the economy and oil prices do because those are going to be your two big drivers as, right now, these companies are making a lot of money at this $90-$95/bbl. range.

TER: So, to sum up, as far as you’re concerned, there’s more upside at this point than there is downside.

JW: Yes, I think so. For the companies, there’s a lot of upside and not as much downside. The assets they should be able to find with these shale plays are very repeatable. They are capital intensive but as long as the companies can maintain a good balance sheet, you’re safe there. At this point you’re in a price area where you really need to pick one or two that you want to get into and get comfortable with their management teams. The biggest overriding factor at this point is going to be what oil prices do. And what drives that is what the economies, not only here but across the world, are going to do. That’s the thing I think is going to be the most important factor.

And, like you said about the upside, I think one other thing that’s interesting and that could be one of those big upside drivers is that there’s going to be a lot more consolidation. Many of these smaller names will get picked up by larger names that have a lot of cash and want to find a way to grow their production and cash flows further. They need to go out to these new emerging plays in order to do that. So, I think you’re going to see continued consolidation in the market, which I think again, would be very positive for investors who go into these smaller to mid-cap names that may be taken out by the larger names at a nice premium.

TER: That sounds like a pretty optimistic picture for people who are willing to take a shot at some of these promising deals.

JW: Absolutely.

TER: We appreciate your taking the time to talk to us this afternoon and all the good information you’ve given us, Jason.

JW: Thank you.

Jason Wangler has over five years of equity research experience focused on the exploration and production (E&P) and oilfield services (OFS) sectors of the energy space. Jason previously worked at Wunderlich Securities Inc. and Dahlman Rose & Company before moving to SunTrust Robinson Humphrey. He also previously worked at Netherland, Sewell & Associates, Inc. as a Petroleum Analyst. He received his master’s in business administration from the University of Houston, where he was also named the 2007 Finance Student of the Year. He received his bachelor of science degree in business administration with a focus on finance from the University of Nevada, where he was named the 2003 Silver Scholar award winner for the College of Business Administration. In 2010, he was highlighted as a “Best on the Street” analyst by the Wall Street Journal and has been a guest on CNBC.

The Gold Report: James, in June you advised selling off all stocks and investing directly in precious metals. What prompted you to dump juniors and go to gold and silver?

James West: It was evident to me that the risk to equities in our space, the junior miners, was going to increase as the debt issues in Europe and the United States continued to fester. Back in June, the likelihood of the U.S. not raising the debt ceiling in time for the August 2 deadline was considered very remote. But the last minute deal was nothing more than a Band-Aid on an open artery. The partisan politicking could result in rating agencies downgrading the U.S. triple A rating with or without a default. You can hardly rate the world’s largest sovereign debt load as triple A after this most recent fiasco. And when you consider that the only solution is to raise the debt limit, issue more debt, print more money and further debase the currency of the world’s largest economy—well, to me, it’s just plain dangerous to be holding equities in anything under those circumstances. That environment only bodes well for gold and silver prices.

TGR: So now that there is a deal, will equities rise and gold and silver fall?

JW: Temporarily, yes. That’s exactly what I think will occur. Given the gnat-like attention span of investors and the deluge of information flow we are all immersed in, it is what’s happening right now that dictates market movements. With these temporary deals done, for the next few weeks, it will seem like the problems have been solved, disaster averted and the party will be back on.

TGR: So we should sell gold and silver and buy equities?

JW: You bet. Sell the precious metals at the high, buy the juniors who have been beaten up in recent months and wait for the next batch of horrible news to make precious metals turn around and head north. It’s a volatile market, but junior precious metals explorers and near-term producers are finally going to get some of the attention that has been absent for the last few months.

TGR: We saw you on BNN last week in Canada, and you mentioned that you were looking at copper juniors as well. Is copper going to benefit from the same influences as gold and silver?

JW: Well, copper has been holding on close to all-time highs despite softening growth in China. That’s because speculative groups, like hedge funds and ETFs, are actually buying physical copper and storing it in warehouses. So not only do we have a growing portion of diminishing global production being taken off-line and stored for investment reasons, but copper consumption for industry, while it may weaken as China growth slows up a bit, is still strong in India and Brazil as those economies continue to expand rapidly.

TGR: We hear you have also launched a fund to invest in emerging miners. What’s that all about?

JW: The Midas Letter Opportunity Fund is a Luxembourg-registered Special Investment Vehicle, which is a sub-fund of the Commodity Capital AG fund. Tobias Tretter, the former top fund manager for Deutsche Bank’s gold fund, and I came up with this idea to capture all of the early-stage, pre-IPO opportunities that come my way as publisher of the Midas Letter. Up until now, I just haven’t had the bandwidth or the manpower to take advantage of these ideas. So we put together this fund, which is capitalized by members of the Canadian A-List of mining entrepreneurs on one hand, and the A-List of high net-worth, private family offices in Luxembourg and Switzerland, to provide a place where the two groups can access each other’s value propositions. The fund does well because it’s got access to pre-public deal flow, and the European investors do well because they have a window into these pre-public opportunities through the fund, where they get the chance to participate in secondary and tertiary post-IPO rounds.

For Midas Letter subscribers, it’s a win as well, because now the newsletter becomes the journal of the fund’s investing activity. While subscribers can’t generally participate in the fund, they can participate in what the fund is buying, and hear about pre-IPO opportunities that other newsletters generally don’t bother to cover because there is no way for the investing public to access these deals.

TGR: So, the Midas Letter now only covers what the fund is doing?

JW: No, no. Of course, I still have my personal investing activity that will make up a lot of the content of the newsletter, too. But most likely, my personal activity will reflect the opportunities that the fund has uncovered. This will also free us up to shoot more Midas Letter Mine Tour videos, where we visit developing projects around the world, and in a National Geographic- or Discovery Channel-level of production video, answer the questions that all investors, institutional and private, would want to know about these projects.

TGR: Wow. So, you are busy, to say the least. What companies do you see yourself investing in going forward?

JW: Well, as far as gold companies are concerned, we follow closely what’s going on at Baron Group in Vancouver, headed by David Eaton. He has a process where he gets companies to list inexpensively on the CNQ before moving over to the TSX Venture. Baron has an absolutely stellar collection of strong companies coming together.

TGR: For example?

JW: Well, where to begin? I guess we’ll start with the older ones, Evolving Gold Corp. (TSX.V:EVG; OTCQX:EVOGF; Fkft:EV7), which is one of Quinton Hennigh’s first big wins. Quinton is an epicenter of geological discoveries unto himself, and he figures prominently in a lot of the stories we like right now. As most people know, Evolving Gold has a joint venture with Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) on its Rattlesnake Hills project in Wyoming, and is owned at least 15% by Goldcorp Inc. (TSX:G; NYSE:GG). Despite that, the company trades at a great discount to enterprise value considering the advanced stage of the deposits.

United Silver Corp. (TSX:USC) is another excellent example of the Baron Group. It started life on the CNQ and raised $10M (million) there before moving over to the TSX senior board. Things were going well until Charles Pitcher was hired to lead the company. He blew the treasury and let the company stagnate before leaving it in shambles. Fortunately for USC shareholders, a deal with Stan Bharti’s Forbes & Manhattan merchant bank will see new leadership, another round of capitalization, and the advance of the company’s project at the Crescent Mine. If you don’t think it is cheap now, compare that to the $250M IPO planned for the Sunshine Silver Mines Corp. (NYSE:AGS) with participation from Morgan Stanley, UBS Investment Bank and RBC Capital Markets. The Sunshine Mine produced an astonishing 360 million ounces (Moz.) of silver since 1880, but the Crescent Mine, which has produced only 25 Moz. in its history, did so at a grade of 27 oz./ton—the highest in the district. Keep in mind that Sunshine has 17 other exploration projects and a second very advanced project in Mexico, so comparing USC to Sunshine is not exactly apples to apples. My point is that silver mining in the Coeur d’Alene belt in Idaho is attracting some weighty players.

Current offerings from the Baron Group include Golden Fame Resources Corp. (TSX.V:GFA), whose mission is to “acquire and put into production historically productive gold, silver and copper properties that have become economic due to the robust upward movement in metals prices.” The company has $7M in the kitty, and started work in July on the Algun Dia copper-gold-silver project located near the city of Guanajuato, Mexico, into which it is earning a 70% interest. Algun Dia is an advanced-stage exploration project with demonstrated past economic production of gold, silver and copper from a major vein-hosting structure with mineralized true widths exceeding 10m (meters). Historical reports indicate that 2002 through 2007, the property produced approximately 15,000 tons of ore during periods of test mining. That resulted in approximately 750 tons of gold, silver and copper concentrate processed at the Peñoles Mining mill.

Another one I’m looking forward to with great expectations is Novo Resources Corp. (CNQ:NVO), which has management in common with Gold Canyon Resources Inc. (TSX.V:GCU), a Midas Letter favorite for the last year. In particular, Quinton Hennigh, the geologic force behind many of the Baron Group’s deals, is said to be particularly excited about Novo’s prospects, and is the company’s president. Novo has the exclusive right to earn a 70% interest (as to gold and minerals associated with and normally mined with gold) in the tenements comprising certain mining leases covering the Beatons Creek conglomerates located in Western Australia.

I can’t stress enough the value in Confederation Minerals Ltd.’s (TSX.V:CFM) Newman Todd project, a joint venture with Redstar Gold Corp. (TSX:RGC). That project in the Red Lake district in Ontario is starting to shape up into what is looking more and more like 5 Moz. of gold. The source of that geological opinion has requested anonymity, but, safe to say, it’s not me pulling a number out of the air. In my opinion, the current share price level will prove to be a steal when the market realizes what’s going on underground here.

TGR: Now what about copper? You’ve recently been quoted as being quite bullish on copper.

JW: To be clear, I think copper is in a long-term bubble formation in the classic sense. The price is rising despite weakening demand fundamentals out of China, and Brazil and India are absolutely not the sustainable demand powerhouses painted by the mainstream media. J.P. Morgan is taking delivery of physical copper into warehouses in support of its copper ETF, which is putting an insanely artificial demand pressure on the metal. That means when the copper bubble pops, so will this and other ETFs based on copper, which will exacerbate the downward momentum copper will face when China pops. And increasingly, there are signs that the China bubble may be starting to deflate a little.

That all being said, the China growth machine will still gobble up a lot of copper, so for the time being, world consumption, diminishing supply and growing demand for the physical metal for investment and hoarding purposes will continue to maintain the price near or beyond all-time highs, which makes copper exploration plays are of supreme interest to us.

In particular, I’m a huge fan of CuOro Resources (TSX.V:CUA) and its Santa Elena property near Medellin, Colombia, where two shallow holes were drilled to depths of 3.55m and 7.61m, respectively, at a down dipping angle of 20 degrees (widths represent down hole core lengths and the true width is unknown at this stage). At 1m intervals, 1.5 in.-dia. cores were assayed from these shallow holes. The highest individual result was from hole C4-4; it returned a 1m interval grading 9.51% copper, while the two holes averaged 5.63% copper over 7.61m and 4.53% copper over 3.55m. Those are some stellar grades. Now there’s at least one drill going on the project with two more on the way. The company will drill an initial 25 km. to be immediately followed by an additional 15 km. With over $20M on hand to cover exploration for the next two years, it’s as “de-risked” a copper exploration play as you can get, which is why you’re seeing the premium valuation.

TGR: I understand you’re in the Yukon right now. What are you doing up there?

JW: We’re here to make some videos with a professional TV crew in support of our new product, Midas Letter Site Visit Reports. We are visiting exploration projects in the Yukon that will be the subject of videos seeking to answer all of the questions that determine a mining project’s economic viability. We do that through interviews with technical talent on the ground, as well as interviews with regional stakeholders to make sure we are not just getting the sweetened version from the companies. Then we distribute the videos first to Midas Letter subscribers and unit-holders of the Midas Letter Opportunity Fund, and then to the general public.

TGR: So who are you going to see while you are there?

JW: Well, the primary one at this point is the Wellgreen Deposit held by Prophecy Platinum Corp. (TSX.V:NKL; OTCPink:PNIKD; Fkft:P94P), John Lee’s spin-out from Prophecy Coal Corp. (TSX.V: PCY) that just announced a 10 Moz. combined platinum group metals and gold inferred resource, with 0.4% nickel and 0.4% copper to go along with it. Some pretty good rare earth grades are in there that are not part of the equation yet. All of this is just from 2.3 km. of a 17 km. strike length. We are going to find out just how good the potential is for a major extension to the existing resource as drills are turning and a lot of analysts head up there to kick the tires.

A list of other companies we’d like to shoot is a little premature to discuss, but suffice to say we are looking at the cream of the Yukon crop.

Publisher of Midas Letter, James West has devoted 20 years to helping small companies in the resource sector—helping them raise money, further their projects, build their identities and get their stories in front of investors on the lookout for quality investments with excellent returns. The Midas Letter Opportunity Fund, is an institutional and high net-worth-only open-ended fund based in Luxembourg that specializes in early stage investments in Canadian-listed precious metals explorers.

The Energy Report: Since you last spoke with The Energy Report in April, the O&G markets have been pretty much sideways. What do you think is going to happen in those markets over the next 6 to 12 months?

Josh Young: My investments generally aren’t contingent on specific commodity prices. I do expect that oil will continue to trade in a range and I think that natural gas prices are below the marginal cost of production and should trend up over time. The types of things I’m looking for are really mispriced situations where it doesn’t matter quite as much whether oil is $80 or $120/barrel (bbl.). It only matters that a company is undervalued.

TER: So, basically you’re looking for bargains that are undiscovered or unrecognized by other people. Is that correct?

JY: Yes, I try to find situations where a stock is cheap enough at lower commodity prices that it would still be a good investment and where an identifiable event is likely to unlock substantial value in the near future.

TER: We see all these references to various areas and geological formations such as the Marcellus, Barnett, Bakken and Eagle Ford shales. For those readers who aren’t familiar with these areas and names, maybe you could give us a quick tutorial that could help to make references to them a little clearer?

JY: Sure. I’ll give them in the context of specific investments I’ve made, which run the gamut across some of the better known and more economic shale plays.

The Marcellus Shale is widely known as the most economic natural gas shale play and one of the most economic natural gas formations in the U.S. It ranges from West Virginia all the way up through Pennsylvania into New York. Typically, wells there are economic even at natural gas prices below $4/thousand cubic feet, making them very favorable compared to other gas shale plays.

I have exposure to the Marcellus Shale through an investment in Gastar Exploration Ltd. (NYSE:GST). Gastar is the cheapest way to play the Marcellus on a per-acre basis and has over 15,000 acres in the core of the liquids-rich portion of the play with over 83,000 total net acres in the play. The company has some well results coming out soon from the liquids-rich portion of the play that should highlight their value.

Switching over to oil shale, two of the most favored oil shale plays are the Bakken oil shale up in North Dakota, which ranges across northwestern North Dakota and eastern Montana and the Eagle Ford Shale play, which ranges across much of southern Texas.

I have exposure to the Bakken through an investment in U.S. Energy Corp. (NYSE:USEG). In the early development of the Bakken a couple of years ago, USEG financed Brigham Exploration Co. (NASDAQ:BEXP), which is now one of the largest pure Bakken play companies in the world. U.S. Energy has a fantastic position in, and is trading at a large discount to its peers in the Bakken Shale. Wells there, at current oil prices, earn anywhere from a 35% to 100% internal rate of return, depending on the specifics of the well. Wells come on with very high initial oil production that declines fairly rapidly, but the company gets paid back fairly quickly.

Similar to Gastar in the Marcellus, U.S. Energy is one of the cheapest ways to get exposure to the Bakken and they already have meaningful production and reserves. Eventually the market will discover them and the stock will trade up in line with or potentially in excess of its peers.

The Eagle Ford Shale ranges from dry gas in the south up to a wet gas play with a combination of natural gas and oil or natural gas liquids. Further north, you get pure oil production and very little gas or natural gas liquids. I have exposure to the Eagle Ford from a couple of investments. It is one of the most economic shales to drill. U.S. Energy recently announced it is drilling a few thousand net acres in partnership with Crimson Exploration Inc. (NASDAQ:CXPO). The market gives them zero value for that acreage. The company has completed one well, but hasn’t announced the results yet. It’s in a really good area right next to a Chesapeake Energy Corp. (NYSE:CHK) well that did extremely well. I expect that U.S. Energy may have some good exposure.

Some companies, like U.S. Energy, trade at a large discount to their peers. Other companies trade at an extremely rich valuation compared to their peers. One company that is comparable to a company like U.S. Energy is Aurora Oil and Gas Ltd. (TSX:AEF; ASX:AUT). Aurora has a small amount of acreage in the Eagle Ford, not much more than U.S. Energy, and less than U.S. Energy has in the Bakken and Eagle Ford combined. But Aurora trades for almost a $1.5 billion valuation. So, compare a U.S. Energy, which is getting almost no credit for its Eagle Ford and has a $120M (million) valuation, to a company like Aurora, which is getting a tremendous, almost $90,000/acre credit for its Eagle Ford acreage. It definitely gets you excited about U.S. Energy’s prospects.

Finally, any discussion of shale fields would be incomplete without mentioning the Barnett Shale. The Barnett is one of the original natural gas shale plays where the technique of drilling horizontally and using multiple-stage hydraulic fracturing was developed. I don’t currently have any investments with meaningful exposure to the Barnett. But, the Barnett is a really good example of what to expect from other plays where a lot of small companies were involved and as the play matured, were bought out or consolidated or traded up to a fairly rich valuation. Companies like Gastar and U.S. Energy could trade up to rich valuations too or potentially be taken out as their respective plays get developed.

TER: You talked in April about Equal Energy Ltd. (TSX:EQU; NYSE:EQU), which is an interesting Canadian company. Can you bring us up to date on what has developed with them since April?

JY: I still think Equal is trading at a very large discount to its peers. It hasn’t announced well results recently and there hasn’t been a lot of news flow beyond an acquisition and subsequent equity offering, so the stock has languished. There will be well results over time but there is nothing in particular coming up in the near future, at least from an operational perspective.

There is some possibility the company could spin off one or more of its assets into a royalty trust, which Chesapeake is actually in the process of doing and SandRidge Energy Inc. (NYSE:SD) successfully did with the SandRidge Royalty Trust. If Equal Energy went this route, it could potentially achieve a much higher market valuation than it currently has. In the interim, Equal could be a bit quiet for the next few months.

TER: How about some where you think there is going to be some action coming up that people can get excited about?

JY: I’ve made interesting investments recently that I’m quite excited about. The first one is a company called Gasco Energy Inc. (NYSE:GSX). The company recently completed an equity offering in which I participated. It is a natural gas company with a field in Utah’s Uinta Basin, which is more of a conventional gas field play. Despite having a small production base, the company needed money to survive for the next 18 to 24 months while it develops the new oil plays it thinks it found. I’m inclined to agree that there is oil in place and that it will be recoverable. The company currently has around a $30M market cap and $120M in debt. If Gasco discovers oil and it is of the order of magnitude that it expects, this could be a tremendous home run.

In California, Gasco developed a number of prospects and sold them to a large, undisclosed, publicly traded company that is active in California. This undisclosed partner is funding 100% of the well cost on five different exploratory wells in order to earn an 80% interest in the wells. Gasco gets to keep 20% without having to pay for the drilling. That is very exciting for a small company to be able to get exposure to some potentially 20 Mbbl. or greater prospects and not have to pay anything for it. The company expects to drill the first well in the third quarter of 2011, the second in the fourth quarter and the remaining ones in 2012. That adds a lot of upside potential from there.

Gasco’s main gas field is actually in the Uinta Basin, situated between Newfield Exploration Co.’s (NYSE:NFX) Monument Butte Field, which has been really successful as a conventional oil play, and Questar Corp. (NYSE:STR). Questar drilled an oil well in the Green River block on the trend that the Monument Butte Field produces from, immediately on the other side of Gasco’s acreage. Questar will be drilling more wells on their acreage. So, it looks like there’s an area that has been delineated by that well.

Gasco also has some old wells on that same Green River trend, drilled in the 1980s, which had been producers for a long time. Some of them are still producing a few bbl/d. It is very likely that when Gasco drills a couple of wells on the Green River trend, it will hit oil and those wells will be highly economic. The impact of having an economic oil play could produce a multiple times valuation uplift. The most I can lose is the money I invested, but I could make five or ten times my investment.

TER: That is a nice multiple for anybody. So, what else do you like?

JY: I seldom buy debt, but there is a natural gas company in which I actually own preferred stock. This preferred is convertible and it’s currently yielding 12.5% and trading around par. The common is trading only 15% away from the conversion price. It is a very undervalued natural gas stock that is out of favor called GeoMet, Inc. (NAS:GMET).

The preferred stock provides a margin of safety and pays me to wait. If the company went insolvent or if there were some sort of prolonged downturn, the preferred offers more protection than the common. Plus, it pays 12.5% annually. If natural gas prices recover, GeoMet could be worth two or three times what it is trading for now.

I have done a lot of work on GeoMet and on the field it is developing. The company had a problem in one of its fields where its wells were not producing as expected. It changed its fracking technique and it looks like it fixed the problem and could potentially be looking at substantial additional reserves, which are definitely not priced into the stock. There is a lot of operational upside in addition to potential from natural gas prices.

This has been a very illiquid situation and it was hard to build my position. But, people really want yields and this is a nice way to get this combination of yield as well as a chance for a substantial equity return.

TER: Well, it sure beats 2% to 3% in Treasuries.

JY: It does, and GeoMet has meaningful natural gas production, cash flows and reserves that backstop the value of the investment and provide some potential inflation protection and exposure to an improvement in natural gas prices. GMET is far and away my favorite debt security at the moment.

TER: Anything you like in Canada?

JY: There are a couple of other companies that I own stock in that are worth mentioning. Petro-Reef Resources Ltd. (TSX.V:PER) is one of the more promising junior oil and gas companies in Canada that U.S. investors may not have heard of. It has a conventional natural gas field where there appears to be highly prospective oil zones above and below the gas zones from which it is already producing. The July production rates are about 300 bbl. of oil plus about 700 bbl. of oil equivalent (boe) natural gas per day. Their current enterprise value is about $30M.

Using a $100,000 per flowing bbl. of oil metric, you get the natural gas production for free. Using a natural gas metric, you get their oil for very cheap. In addition to being cheap on current production, it looks like Petro-Reef is on the path to meaningful rampup by drilling additional oil wells. It has around a 20,000-acre position in an unconventional play in Canada called the Swan Hills, where it has completed a well. The company is still looking at the data and might actually lease a little more acreage before announcing results. I invested on the assumption that the Swan Hills play won’t work. But, there has been a lot of activity and positive well results in the area; it sounds like the company likes what it sees. If the play actually works, it will be a huge home run.

TER: Do you have some other ones that you would like to talk about?

JY: There is one more company that I have been involved with off and on for years and built up a position in again, relatively recently. It’s called Sonde Resources Corp. (NYSE:SOQ). It has $50M in cash, no debt and a market cap of around $200M. It is trading for around the value of its existing production. It has a lot of unconventional acreage in Canada from residual natural gas production that it is in the process of developing, with a lot of un-booked upside.

Sonde recently sold one of its assets and repatriated the cash to develop its unconventional oil acreage. It also owns a portion of a recent large oil discovery on the border of Libya and Tunisia. Prior to the problems in the Middle East, it looked like this discovery could be worth hundreds of millions of dollars to Sonde. The company said it was in active discussions with potential joint venture partners to farm out some of its interest to get carried in the development, or possibly to sell it. The possible upside is in excess of its market cap and total enterprise value right now. Development of the find is on hold but the company has continued to study and delineate it. It sounds like it is sitting on over 100 Mbbl. of oil in this one discovery. And it has a tremendous amount of additional acreage, where it will be able to explore for other prospects with similar potential. So, this could be a real game changer that isn’t reflected in the stock price. Neither is the company’s unconventional acreage. Only existing production appears to be priced in.

There is potential upside whenever the situations in Libya and Tunisia get resolved. Meanwhile, you get a great, undervalued natural gas and oil company in Canada. Sonde also has well results expected shortly from an area called the Drumheller, which could be a meaningful driver. I have a lot of respect for the Sonde’s CEO, Jack Schanck. For a number of years, he was the co-CEO of Samson Oil, a private company out of Tulsa and helped the company get into North Dakota and a number of other areas. He grew it from a smaller company to a larger, more successful company before leaving to go off on his own. He has assembled a team, some from Samson and elsewhere. I am very excited about Sonde because it has quality management and you get to actually invest at a substantial discount to net asset value.

TER: Any final thoughts on what investors should be looking at or concerned about in the coming months regarding the energy market and what could be a catalyst to make it go up or down drastically?

JY: A number of things could go wrong or could go right. From my perspective, the important thing is whether you are in a good company that is value priced like a U.S. Energy or an Equal, a Gastar or a Gasco. If the company hits oil or sells an asset, the stock is going way up and if not, the stock isn’t. A lot of really talented people out there are analyzing the macro-picture and trading oil commodities. I focus on these small, under-followed public oil and gas companies with attractive risk/reward odds.

TER: Those all sound like pretty interesting and undervalued opportunities. Thank you for taking the time to tell us about them.

JY: I appreciate it. Thank you very much.

Josh Young is an honors graduate of the University of Chicago, where he majored in economics. Before founding his own investment management partnership, he worked with Mercer Management in Chicago, after which he joined a private equity firm in Los Angeles. He also worked as a buy-side analyst and money manager in a single-family investment office with more than $1 billion under management.

The Gold Report: When you last spoke with The Gold Report in May of 2010, you gave Laurentian Securities’ price forecasts for gold that turned out to be pretty conservative pretty quickly. What are you predicting for gold prices now?
Eric Lemieux: I was quite conservative, and obviously, I underestimated gold’s momentum. I think right now the price of $1,600/oz. is set to go even higher in light of the increasing global economic turmoil. The U.S. debt ceiling and credit rating will fuel gold’s price rise to even greater heights. Add in the European bankruptcy threats and you have the catalysts to justify gold’s further appreciation. Demand is largely based upon the view that gold is effectively a monetary instrument and a “valeur refuge” (store of value). Together, I think they explain the gold price action in the last year, which has been quite remarkable, but based on good fundamentals.

TGR: So, you must have higher target prices for gold now?

EL: Yes, those have been revised and our range is now between $1,650 and $1,750/oz. until 2015. I set a very long-term price of $1,000/oz., which I think is still conservative, but I think it’s justifiable since this is probably the marginal cost for producers. Gold still has some great upside, but I may not be the one who says it’s going to go up to $5,000/oz. I see price stability, less downside risk and I think the $1,500/oz. range is probably something that we can envision in the long term.

TGR: Is gold in a bubble?

EL: I think not at all. Right now, if you look at the fundamentals, there are reasons for the precious metals’ strength. On the supply side, there are still some challenges. Mine production has pretty much stayed constant, and the best deposits have been mined. We’re now going to lower grade deposits. There are more jurisdiction and social challenges to mine gold. So, from the supply side, these are elements that provide some support to the price of gold.

TGR: Laurentian is based in Quebec and your focus is mainly on opportunities in Eastern Canada, from where most of the gold produced in Canada has come. As far as the recent changes in Quebec’s tax regulations, what effect do you envision that might have on exploration and the mining industry in general, especially for the junior companies that rely on certain tax benefits?

EL: Obviously, I think there has been an impact. The government has made some questionable changes to mine legislation in line with the “resource nationalism” going on in the world. Governments have been pressed to increase royalties and tariffs on mining operations. The legislation in Quebec has tried to address this and an increase is probably acceptable to a certain measure.

However, one thing that is really frightening in Quebec now is that some municipalities can have a say on claims and project status. That explains in part why Quebec has gone down in the Fraser Institute ranking because of the uncertainty that has been created in some aspects of the mining legislation.

The fact that they’re increasing the royalties is perhaps fair in light of the strong commodity prices. There’s a bit of give and take and the industry eventually has to give a little. At the same time, I think the government has perhaps been very aggressive about raking in even more profits and caving into special interest groups. What is really dangerous right now in Quebec is this trend of wanting to control the claims and what can be done in terms of development and even exploration.

TGR: Do you think there might be any re-thought or reversal here if they end up seeing opposition from the mining industry?

EL: I think so. The metaphor we use is “Balkanization” of the mining resources, which is very dangerous. Once people are aware of the adverse impact that is having on the economy, I think they will realize that perhaps the government has gone too far, resulting in a readjustment. The pendulum swings from one side to the other, and now that we’re really going to one end, hopefully we’ll be able to eventually find a balance.

TGR: Historically, most mining in Eastern Canada has been underground mining when gold prices were relatively low and you had to have fairly high grades to justify the costs of doing so. With $1,500/oz. gold, we seem to be seeing a lot more talk about companies doing open-pit mining in much lower grade areas with much larger tonnages. Is this something that is going to be happening more in the future?

EL: This is definitely the wave of the future. Improvements in mining methods and economies of scale allow for bigger open-pit operations. The other thing that I think we will probably see also is bigger underground bulk mining scenarios such as Agnico-Eagle Mines Ltd. (TSX:AEM; NYSE:AEM) Goldex mine near Val d’Or. So, I think that will be another wave of the future where you will have these bulk mining operations. In the Abitibi Greenstone Belt, open-pit operations are fully justifiable. I think the fact that you saw Osisko Mining Corporation’s (TSX:OSK) Canadian Malartic project go ahead and perhaps be a success story is a catalyst for more of these operations.

We will see these done in a sustainable manner in the sense that they will have to get community and First Nations acceptance with minimal impact on the environment. When you say an open pit, people think of an eyesore, but once they see the benefits that can be reaped for the local population in general, I think people will be more open to this sort of operation. In the long term, these big open pits can actually be transformed into lakes and it’s not necessarily a big eyesore after operations end.

TGR: When you talked with us last year, you discussed a number of companies you liked, and Premier Gold Mines Ltd. (TSX:PG) was one of them. They just announced this deal to acquire Goldstone Resources Inc. Can you update us on what’s going on with Premier?

EL: Premier has been very active on several fronts. The company has four key sector area plays located in safe jurisdictions and offering excellent infrastructures. In Nevada, the company acquired the Saddle gold project in 2010. In the Beardmore-Geraldton area, it is owns the Hardrock project and has reported a new, growing 3.6 million ounce (Moz.) global gold resource. Premier also has two projects in the Red Lake District, and the PQ North project in the Musselwhite District of Ontario. Premier just acquired Goldstone Resources and expanded its land package considerably in the Beardmore-Geraldton area. It now controls a strike of about 50 km., consolidating a mining camp district—which could be interesting for any major that wants to position itself there. So Premier has set itself up for discovery and it is ready to do some very good project development.

TGR: Another one you talked about was PC Gold Inc. (TSX:PKL) and it is still quite active up there. What’s going on with that situation?

EL: I have to say I don’t follow PC Gold closely; it’s not a company that I have actually covered, but I think the company just provided an update to its mineral resource, which now stands at 1.26 Moz. This, again, is a recipe of revisiting old mining camps with a new set of eyes and advanced geological concepts. It’s one that is interesting because it has an open-pit scenario with an underground component that, with time, may allow the company to play with different mining methods.

TGR: The James Bay region has turned into a hotbed of exploration and a lot of companies are looking at things up there. One that you talked about in the past was Eastmain Resources Inc. (TSX:ER). What’s going on with that situation?

EL: The James Bay region is a hot area that is vast and underexplored. It will become even hotter as Goldcorp Inc.’s (TSX:G; NYSE:GG) Eleonore Project gets its permits for full blast construction toward the end of this summer.

What I find interesting for the James Bay area and Northern Quebec is the fact that the Quebec Government has just announced the Quebec Plan-Nord that will provide even better road, power and communication infrastructure to the area. Although there is some amazing infrastructure right now in the James Bay area, potential expansion, on a sustainable development basis, should provide a competitive advantage.

The Cree Nation, Inuit and Innu people are participating more and more, which opens up to sustainable development in that area and bodes well for social acceptability.

Eastmain has three very good positions—the Eastmain Mine, Clearwater and Eleonore South projects. The last one is a joint venture with Azimut Exploration Inc. (TSX.V:AZM) and Goldcorp. Eastmain released a new global resource estimate of 1.6 Moz. in April on the Eau Claire deposit. There was a substantial increase in the measured component of the mineral resource estimate. The project includes both an open pit and an underground target. The open-pit component has about 4.1 million tons grading 4.7 grams/ton, which is at the higher end of grade for open-pit mined gold deposits. So that is a positive.

Eastmain is currently drilling toward the west of the 450 West Zone in a new zone called the 850 West Zone that wasn’t part of the mineral resource estimate in April. There is a lot of upside to increase that mineral resource, both for the underground potential and the open pit scenarios. I expect that for the Eau Claire Project some news will emerge in the course of the year. I think some interesting things will come from the Eau Claire as the company has the advantage of good infrastructure and accessibility.

Eastmain also has the Eastmain Mine Project, which was quite remote. It’s going toward Stornoway Diamond Corp.’s project where the Quebec government will soon extend Route 167, the Otish Mountain Route. Eventually, it will be accessible via a hard surface road rather than an old winter road. The Eastmain Mine Project has now started to drill and has about 15,000m planned. Again, this is a gold project with a known mineral resource that is open for expansion.

The Eleonore South Project is a joint venture with Goldcorp and Azimut Exploration located to the southeast of the Eleonore deposit. Goldcorp is working very aggressively on the Eleonore project, and building a world-class mine there, but I know it is also active on the exploration front in areas further from the mine site. I believe the Eleonore South project will eventually be re-worked by the partners and could become an interesting development project in the long term.

TGR: Another one up there is Virginia Mines Inc. (TSX:VGQ), which is also active. What’s been going on with that company since the last time we talked about them?

EL: They’re very active. Virginia will have about a $17M exploration budget for 2011, of which $9M will be partner funded. New, high-quality partnerships include IAMGold Corporation (TSX:IMG; NYSE:IAG), Quadra FNX Mining Ltd. (TSX:QUX) and Anglo-American PLC (LSE:AAL).

The key for Virginia is its strategic acreage in James Bay and northern Quebec, where the company has been able to develop expertise that continues to be recognized. Virginia has a lot of projects going on right now. It is very aggressive. It is manned by explorationists who are able to generate and advance projects. I think it is just a matter of time before the company makes more discoveries. With a $17M budget, we can expect a lot of important news from Virginia.

Remember that Virginia discovered and holds a 2.2-3.5% NSR royalty on the Eleonore deposit, now going into production for Goldcorp by 2015. As the Eleonore project continues to grow, the project is being de-risked with the on-going exploration shaft and ramp sinking.

TGR: That sounds pretty positive. How about Midland Exploration Inc. (TSX.V:MD)? You also talked about them last time and that company has some interesting things going on.

EL: Yes, I always like to say that Midland is like a smaller version of Virginia in that it has the same sort of quality management and the same sort of explorationist business model. Midland also eventually farms out projects to quality partners.

The company is active on several fronts. In the course of 2010-2011, it acquired new projects by staking. I always appreciate the fact that a company is able to acquire projects by itself through staking rather than acquiring a property with a partner or from someone for shares and money. I believe it is good when you can do a thorough geological assessment of an area, pinpoint areas that haven’t been staked, then go and get them for cheap. Here in Quebec, it’s not very expensive to acquire claims through map staking. I think it’s very positive that Midland can generate and acquire projects relatively inexpensively.

Midland is active on several fronts—gold, base metals, rare earths. It is exploring for gold with Osisko Mining Corp. (TSX:OSK), Aurizon Mines Ltd. (TSX:ARZ; NYSE.A:AZK), North American Palladium Ltd. (TSX:PDL; NYSE:PAL) and Agnico-Eagle Mines Ltd. So, we can expect lots of news as projects are drilled. Midland just announced a gold and nickel discovery on the Laflamme property, which is a partnership with North American Palladium. Midland also has a project called Casault, which is east of Detour Lake on the Quebec side. It’s an area that I think will become a hot spot because of the size of the Detour deposit and the focus on possible satellite deposits. The Quebec side it hasn’t been explored much because it’s very swampy land, but a few companies are very well positioned in that area, including Balmoral Resources Ltd. (TSX.V:BAR) and Adventure Gold Inc. (TXS.V:AGE). Certainly the Detour/Sunday Lake Deformation Zone will be the most interesting revived gold belt to watch evolve and is well worth continuing to explore. So Balmoral, Midland, and Adventure Gold are well-positioned. The key words for Midland are diversification, partnerships and exploration.

TGR: Another interesting one is Detour Gold Corp. (TSX:DGC), which is building the largest gold mine in Canada. You talked about this company last time. What is the update there?

EL: I would summarize by saying: On track, on schedule and room to grow. I think it’s a 14.9 Moz. reserve with more room to grow and perform. The company is building a world-class mine with a strong operating team north of Cochrane in Northeast Ontario. The pieces are coming together and that’s very positive. The project is being de-risked in a very good and sustainable gold price environment. I think this project should be on a lot of people’s radar screens.

TGR: Are there any other thoughts that you would like to leave us with at this point?

EL: The Quebec Plan-Nord should put a spotlight on northern Quebec. The Ungava Peninsula, even higher up than the James Bay area, is perhaps the next frontier for Quebec exploration. Toward the east, near Labrador, the iron ore is a hot spot. There is even talk about expanding the railways in that area.

Up in northern Quebec, a number of companies are working toward discovery and advancing some huge deposits in rare earth elements (REE), uranium, gold and copper. These are very early stage, but I think there are some good elements for long-term development. Global warming might even result in year-round shipping lanes. Virginia is probably the beacon. I wouldn’t be surprised if someday world-class deposits are developed up there.

TGR: So we’ll have to stay tuned. Thanks for taking the time to bringing us up to date on these opportunities.

EL: Thank you.

Éric Lemieux is a mining analyst who joined Laurentian Bank Securities in 2008. He worked for nine years as a consultant responsible for applying Regulation NI 43-101. He has worked at the Montreal Exchange, and prior to that managed exploration projects for Cambior, Noranda and Soquem. He holds two master’s degrees, in mineral economics (Colorado School of Mines) and in metamorphic-structural geology (Laval University).