By The Gold Report, on February 6th, 2012
 Economics and politics. Accretion and repletion. Mergers and acquisitions. Joe Mazumdar, senior mining analyst with Haywood Securities, sees all of these as catalysts for a rebound in the junior gold space in 2012. In this exclusive Gold Report interview, he reveals the names of companies he expects to take off.
The Gold Report: What is the consensus among Haywood analysts on what 2012 will bring for mine commodities, particularly precious metals?
Joe Mazumdar: Last year, risk aversion was a common market theme. In 2012, some of the same global economic concerns, such as the ongoing Eurozone crisis and the future of the euro, will continue to draw attention. But we also believe there is potential for positive economic indicators, primarily from the U.S., where there have been upticks in manufacturing and GDP growth. Also, unemployment in the U.S. is down to 8.5%, generating some consumer confidence. Recently, GDP growth for Q411 came in at 2.8%, which was slower than consensus forecasts—3%—but still the strongest in over a year.
Political factors will play a role in 2012. There could be a change in leadership among four of the five permanent members of the U.N. Security Council. The presidential election will be a key focus of the U.S. and global market. There are also presidential elections in Russia, France and Mexico. There also may be a changing of the guard in China in the latter part of 2012. The potential for changes in leadership in these key nations will generate a bid to market volatility in 2012.
Beyond gold and silver, our preferred commodity sectors include copper, iron ore and coal. Gold continues to be adversely affected by its own volatility, which continues to tarnish its reputation as a safe-haven asset. We note that during 2011, U.S. Treasury securities, the most liquid safe-haven asset, was a preferred recipient of capital investment, providing a ~10% return, its highest annual return since 2008 when it was 14%.
TGR: Will the strengthening American economy have an adverse effect on the gold price?
JM: Yes, the gold price quoted in U.S. dollars will be hindered by any U.S. dollar strength based on economic growth and increasing consumer confidence. In the current environment, gold, quoted in U.S. dollars, is still holding up well at price levels over $1,700/ounce (oz).
We note that the Federal Reserve said recently that it remains concerned about the “vigor” of U.S. economic growth and pledged to maintain low interest rates until at least 2014. The latter is a positive for gold prices.
In the medium to long term, increasing confidence levels in U.S. economic growth we believe will drive higher capital investments domestically and potentially raise inflation expectations, which would be a positive for gold.
TGR: What about silver and copper?
JM: We see copper on the brink of a rebound in 2012. The London Metals Exchange inventories are at low levels and Chinese imports of refined copper accelerated in the latter part of 2011. Copper is covered by Stefan Ioannou/Kerry Smith of Haywood Securities and they highlight a structural tightness in the copper market as supply growth remains constrained while a portion of future production growth resides in higher geopolitical risk jurisdictions. They note that the GFMS has estimated a deficit of 372 Kt copper in 2011 and forecast yet another deficit for 2012, 101 Kt.
Chris Thompson covers the silver sector for Haywood Securities and has commented that despite the growth in investment demand over the past five years, silver is still very much an industrial metal. Volatility, he believes, will be underpinned by potential contradictory moves by those who see silver as an industrial metal and others who seek it as an investment asset.
TGR: Did the junior mining sector hit bottom in 2011?
JM: Within the current cycle, I think it has hit bottom. For me, the question remains: What are the catalysts that will move individual stocks up within the sector?
For a number of the majors, growth has been increasingly difficult to achieve given the higher amounts of reserves they must replete on an annual basis. Companies such as Newmont Mining Corp. (NEM:NYSE) have been offering higher and more levered dividend payout structures to attract investors.
In 2012, we see the potential for more merger and acquisition (M&A) activity, specifically in the junior to intermediate sector, given the plethora of small-cap stories in the gold sector. Producers have performed better with respect to their paper in 2011, compared to development stocks, and boast healthier balance sheets. M&A activity will be driven not only by a desire for growth but also motivated by financing risk to capture any synergistic opportunities such as sharing infrastructure and the potential to merge critical skill sets. There is a paucity of people who can bring projects into production and operate them. Merging structures and management is very important right now in the junior and intermediate sector. Without it, a lot of these companies with development assets may continue to struggle.
TGR: Do you expect the Kinross Gold Corp. (K:TSX; KGC:NYSE, Not Rated) write-down to have an adverse effect on M&A?
JM: Large projects that are required to move the needle in the growth strategy of a large gold producer have a scale and scope that naturally expose them to significant execution risk. So, in a nutshell, escalating capital costs for projects of this magnitude are nothing new.
The M&A opportunities I refer to are at a scale that would be accretive to a junior to intermediate company from a growth perspective and offer opportunities to capture synergistic value. From a valuation perspective, many companies with development stage assets are trading well below their underlying asset valuations. M&A activity allows also for some consolidation in the junior sector given the plethora of small-cap gold plays.
TGR: Did you make any adjustments to your investment thesis following the dip in precious metals equities late in 2011?
JM: In our top picks, which we put out on Jan. 9, we focused on producers generating cash flow and developers with permitted or on a clear path-to-permitted projects in low geopolitical risk jurisdictions.
One pick was Midas Gold Corp. (MAX:TSX, Not Rated), whose flagship asset, the Golden Meadows project, hosts a global resource of 5.8 million ounce (Moz) in the Yellow Pine Stibnite area on a large land package (11,600 hectares) in west-central Idaho, a re-emerging gold district. The company is working toward an updated gold resource estimate before the end of Q112, leading to a preliminary economic assessment (PEA) by Q312.
TGR: Can you give us another name on your list?
JM: Yes, Midway Gold Corp. (MDW:TSX.V; MDW:NYSE.A, Sector Outperform, CA$3.25 Target Price). It has the Spring Valley gold project, an intrusive-hosted gold deposit with a global resource, we estimate at over 5 Moz, in a district close to Lovelock, Nevada, where Barrick Gold Corp. (ABX:TSX; ABX:NYSE, Sector Outperform, CA$61 Target Price), is earning in up to 70% by 2013 by cumulatively spending US$38M.
From a metallurgic perspective, the gold is free, not occluded in pyrite and potentially amenable to be economically extracted via a heap-leach process. Barrick, the joint-venture operator, is currently drilling the edges of the deposit to find out how big it could be. This means the near-term news flow will be linked to drilling results and less about a resource update in 2012.
Midway has a portfolio of projects that it is capable of bringing on-line. Its Pan project, a low strip open-pit, heap-leach gold project in Nevada, has submitted a completed bankable feasibility study and a plan of operations. Its Gold Rock project, only 8 kilometers from Pan, is in an earlier stage where we anticipate a resource by Q112 with additional drilling in Q2–Q312, leading to another resource update by Q412 and a PEA by 2013. Additionally, Midway is working a low-sulphidation, high-grade gold project in the Tonopah District.
Midway has a portfolio of projects and is assembling a team to build and operate them. Its COO, Ken Brunk, formerly with Newmont and Romarco, is very familiar with the permitting process and developing/operating projects in Nevada. I believe the company can manage this project pipeline of financeable projects in the low geopolitical risk jurisdiction of Nevada.
TGR: Your target price for Midway is $3.25, up $0.25 from your last report. With that many projects in the development stage, it seems that Midway would be a prime takeover target, especially given its joint venture with Barrick.
JM: Barrick is looking at a number of projects in Nevada, some of which are billion-dollar-plus projects that would add significant ounces to its production profile including Spring Valley, Goldstrike and an expansion at Turquoise Ridge. I believe that Spring Valley may be a target for Barrick going forward as it has potential to contain a +5 Moz global resource and lies in Nevada where Barrick has a significant infrastructure and asset base.
However, the other components of the company’s portfolio, which include smaller open-pit, heap-leach projects, such as Pan and Gold Rock, that could potentially produce between 70–90 thousand ounces (Koz)/year, would not move the needle for most majors. These smaller projects do generate cash flow and are more readily financeable by a company the size of Midway. They could also be attractive to an intermediate operating group looking at accretive transactions with junior developers.
TGR: You cover Orvana Minerals Corp. (ORV:TSX, Sector Outperform, CA$2.25 Target Price), which is in production at its Don Mario mine in Bolivia and its El Valle-Boinás/Carlés (EVBC) mine in Spain. From June to October 2011, gold grades there increased incrementally from 1.4 to 2.17 grams per tonne (g/t). Nevertheless, Orvana’s throughput at EVBC is below your forecast. Results at Don Mario in Bolivia also were below estimates. Is this a make-or-break year for Orvana?
JM: It is a critical year for the company. Bill Williams, formerly Orvana’s vice president of corporate development, is now the CEO. He is an ex-Phelps Dodge vice president and has been instrumental in generating the revised technical reports on both operations, EVBC and Don Mario Upper Mineralized Zone (UMZ), while advancing the Copperwood project. We believe his appointment reflects the company’s focus on getting the operations back on track.
Orvana is currently in the process of re-benchmarking both EVBC and Don Mario UMZ. For Don Mario—an open-pit mine with an upper mineralized zone containing a lot of copper, as well as gold and silver—Orvana has delivered a new life-of-mine forecast that addresses the difficulty of getting copper out using a leach precipitation flotation circuit on a much bigger scale than has been used before. The Don Mario operation also has been troubled by high costs of reagents for the circuit, which has raised the processing costs.
We had originally forecast an annual production profile of 10–15 Koz per year of gold and 10–15 million pounds (Mlb) of copper. We are now looking at a production profile of 9–10 Mlb copper and 8–9 Koz of gold, whereas Orvana is still signaling 13 Mlb of copper and 12 Koz of gold. In Q411, the Don Mario UMZ operation produced 2.5 Mlb of copper and 2.3 Koz of gold, which is a positive. Now, it has to consistently achieve its new benchmarks over the next few quarters so the market can gain confidence in its operational abilities.
At Orvana’s flagship, the EVBC gold-copper project in northwest Spain, the operational issues have been related to head grades. Underground bottlenecks have hindered the company’s ability to blend higher grade feed to the processing plant. We anticipate that a shaft will be in place by April/May 2012, which should alleviate some of the bottlenecks. We had originally forecast that the feed grade, at steady state levels, would be in the area of 5 g/t. However, revised guidance indicated that it would be lower, 3–3.5 g/t gold, which also conspired to lower our target. We anticipate a revised technical report for EVBC prior to March 2012 with updated life-of-mine forecasts.
Orvana’s Copperwood project in upper Michigan is a 50 Mlb/year copper project, now in bankable feasibility study, and Orvana is seeking to permit this year. Even with up to 800 Mlb of copper reserves, we believe that the Copperwood asset is not being valued at its current price levels as Orvana has been heavily discounted in the market due to poor operational performance.
TGR: Given the lower recoveries and production estimates at Don Mario UMZ released in late January, you lowered your target price by $0.15 to $2.25. Yet you still give it a sector outperform rating. Why?
JM: Due to the heavy market discounting related to disappointing results from both operations over the past few quarters, Orvana still provides about a 100% return to our target from where it is trading right now. I continue to believe that management can redeem themselves by achieving the revised benchmarks consistently over the next few quarters. As Orvana meets its goals, I believe the market will appreciate the cash flow being generated, worry less about its working capital position and give the company credit for its advancement of the Copperwood project.
TGR: Prodigy Gold Inc. (PDG:TSX.V, Sector Outperform, CA$1.20 Target Price) recently published an updated PEA on its flagship Magino gold project in northern Ontario. Your model for Prodigy, using the updated PEA, projects a 20,000-ton/day operation, producing 222 Koz of gold per year over 13 years at total cash cost of roughly $775/oz. That would generate annual earnings before interest, taxes, depreciation and amortization margin of more than 50%. Yet, your target price of $1.20 is only about 40% above where Prodigy is trading. Why so conservative?
JM: Given that gold indices provided a negative return in 2011 ranging from 13% to 20%, I think that a positive 40% return to target is probably not conservative in the current market environment. With respect to the valuation, I have adjusted for the technical and execution risk of the study level (PEA) and the fact that I have modeled a larger mineable resource base than that used in the December 2011 PEA. As a company derisks the project from PEA to a feasibility study, I revise the multiples applied to the asset valuation.
Prodigy is planning a significant drill program of 60,000m in 2012 to infill/upgrade and expand the resource base while condemning areas for locating site facilities. We also anticipate an updated resource by Q312 leading to a feasibility study by Q412.
TGR: Do you expect a takeover offer for Prodigy?
JM: I try not to work off the takeover model because it is highly uncertain but focus on the underlying valuation. While I do believe that the Magino asset would be a good takeover candidate for an intermediate, I think that there are opportunities for consolidation and capturing some synergies with Richmont Mines Inc. (RIC:TSX; RIC:NYSE.A), which has an underground operation that abuts Prodigy’s land package. Consolidation would probably be a good idea, given that Prodigy could have underground targets within the same host rocks as Richmont, which has a fully permitted and functional process plant.
TGR: In your last interview with The Gold Report, you talked about Revolution Resources Corp. (RV:TSX; RVRCF:OTCQX, Not Rated). You said it was looking for analogs of Romarco Minerals Inc.’s (R:TSX, Not Rated) Haile Deposit in the Carolina Slate Belt. What’s happening with Revolution now?
JM: Revolution still occupies a significant land package of 7,500 acres along a 25-kilometer corridor within the Carolina Slate Belt at its Champion Hills Gold project in North Carolina. It drilled 19,150m in 2011 and is working on a resource estimate in 2012. Currently, gold equity plays exploring in the Carolina Slate Belt are strongly tied to news flow from Romarco’s multimillion-ounce Haile gold development project in South Carolina and its ability to permit it. In an effort to diversify its portfolio, Revolution acquired a significant land package (~400,000 hectares) in two prospective regions in Mexico from Lake Shore Gold (LSG:TSX, Sector Outperform, CA$3.50 Target Price) in 2011. These assets host high-level low-sulphidation epithermal, gold and silver mineralization and we anticipate news flow from drilling results by Q1–Q212. The company wanted to present the market with multiple catalysts from a diversified asset base and this project has allowed it to achieve that goal.
TGR: In late December 2011, Eldorado Gold Corp. (ELD:TSX; EGO:NYSE, Sector Outperform, CA$19.00 Target Price), made a takeover bid for European Goldfields Ltd. (EGU:TSX; EGU:AIM), which has gold exploration and development properties in Greece, Turkey and Romania. Last year, you discussed Carpathian Gold Inc. (CPN:TSX, Sector Outperform, CA$0.90 Target Price) and its Rovina Valley copper-gold-porphyry project, which contains about 10.7 Moz gold equivalent in Romania’s Golden Quadrilateral. Does the proposed European Goldfields takeover make Carpathian Gold more attractive to larger suitors?
JM: Barrick’s private placement in August 2011 into Carpathian to fund additional drilling at Rovina Valley already speaks to the attractiveness of these gold rich porphyry systems to larger suitors. Mining activity in Romania is heavily linked to news flow on the permitting activities at Rosia Montana operated by Gabriel Resources Ltd. (GBU:TSX, Not Rated).
Eldorado Gold’s proposed takeover bid for European Goldfields does put in a bid for assets in Europe, however, the majority of European Goldfields’ assets are located in Greece (Olympias/Skouries) and less so in Romania (Certej). For me, the takeover trigger was related to the receipt of permits to develop its Greek projects in July 2011. Permitting of those projects took an extended period of time. A positive permitting environment in Europe bodes well for Carpathian at Rovina Valley and it will benefit from any positive news flow from Gabriel. The risks include royalty increases and potential free carried interest that the government wants to negotiate.
TGR: Royalties are going from 4% to 8%. That certainly is not positive, but to get those revenues the government has to permit the mines.
JM: Herein lies the rub. On Jan. 3, we lowered our target by $0.10 on Carpathian to $0.90 to accommodate an increase in the gold and copper royalties to 8% at Rovina Valley. However, on the positive side, by defining the mining royalty rates and the tax structure and negotiating a free carried interest, the Romanian government has shown its desire to have these companies invest in these projects and generate the revenue streams within a restructured rent-sharing framework. We note that the local government is also looking to privatize some state-owned mining assets to raise revenue.
TGR: What do analysts, investors and companies need to look out for in terms of geopolitical risk?
JM: I would highlight countries—emerging or developed—that are in economic dire straits with prospective geology whose mining sector is underdeveloped and has untested mining laws and poor infrastructure. Geopolitical risk carries a few facets including outright expropriation to creeping nationalism, which is linked inextricably to a company’s ability to develop/permit the project. These countries will continue to seek foreign direct investment to explore/develop these assets. Outright expropriation is difficult in countries where there is no mining history and a paucity of critical skill sets locally, unless of course it is looking to sell the asset to another bidder. Alternatively, the country may alter its mining laws to increase its share of resource rents derived from the exploitation of these assets. We have observed higher rent sharing globally via increased royalty payments, higher taxes and/or the introduction of windfall tax structures in countries such as Peru, Argentina and Romania, to name a few.
Assets in higher geopolitical risk jurisdictions must provide the investor a high return and quick payback commensurate with the elevated risk profile. Note that assets within higher geopolitical risk jurisdictions may be more difficult to finance and there may be a limit on potential takeover suitors, depending on their risk appetite. To properly risk adjust and quantify these uncertainties remains a challenge.
TGR: Is that because it is not going away?
JM: Let’s not forget that mining is a great way to get an injection of direct investment into an economy and generate employment. For example, high rates of unemployment in developed countries such as the U.S. and European countries are driving mining activity in places where permits have historically been difficult to attain.
TGR: Joe, thank you for your time and your insights.
Joe Mazumdar is a senior mining analyst with Haywood Securities in Vancouver. Previously, he served as director of strategic planning at Newmont Mining and was the senior market analyst for Phelps Dodge. He has held a variety of geologist positions with other mining companies including RTZ, MIM, North and IAMGold working in South America, Australia and Canada, rounding out ~20 years industry experience. He holds a Bachelor of Science in geology from the University of Alberta, Canada, a Master of Science in exploration and mining from James Cook University, Australia, and a Master of Science in mineral economics from the Colorado School of Mines, U.S.
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By Bron Suchecki, on January 27th, 2012
Worth reading this response by Victor the Cleaner in FOFOA comments to this question: “At the moment, in order to influence the Gold price downwards, all that needs to be done by the authorities in LBMA and COMEX, is to raise the margin requirements.” This is complete and utter nonsense.
LBMA is a trade association and not an exchange and as such does not set any ‘margin requirement’. The LBMA member firms are typically those banks and other financial institutions that trade gold and silver OTC in London, but non-members around the world also trade OTC with these institutions.
When Newmont has some trucks on the road on the way to the refiner, they might want to sell that gold immediately to eliminate any further price volatility from their accounts, and so they might phone JPM and sell that stuff forward. None of the two counterparties is a speculator here. Newmont does have the real stuff, and JPM does have the cash. So even if they would require collateral, this would not influence the price.
Yes, there are probably some raw recruits who follow websites such as TF and who trade COMEX futures in under-capitalized accounts. Yes, CME occasionally raises the margin. Yes, they may just be checking who is the under-capitalized novice and who really has the cash in order to purchase the gold for the contracts they hold. Yes, they may just rip off the clueless novice for fun (and money). But to think this would set the spot price of gold is quite a hubris.
The OTC market is ten times bigger than COMEX, and so it pushes COMEX around in a way that most COMEX-fixated goldbugs don’t understand.
If you want to keep gold cheap in the long run, you need to create a huge volume of gold loans, expand the ‘money supply’. If you want to manage the price of gold intra-day (and yes, there is indeed statistical evidence for this), you need to sell a lot of gold at spot in a short period of time. But you can do this only if you are a credible financial institution and only as long as you can hand over the allocated whenever your counterparties request it. So you need to understand extremely well what you are doing and how much physical per paper you need to be able to show. Hiking the COMEX margin is a side show.
What I find rather disappointing is the extremely poor quality of the discussion that is presented on the typical precious metal websites. This is financial product pushing of the same quality as pre-1999 when they IPO’d the companies that sell dog-food online.
Here are FOFOA, people discuss a very good reason for owning gold. For some reason, the mainstream goldbug websites totally ignore the good reason and push gold with inconsistent nonsense instead.
Why is that? Want to scalp PSLV? Want to create a mania, sell them financial products (including GoldMoney which is no longer ‘money’ by the way) and then when the big blackout comes, grab the gold for cheap from those who sell in panic because they never understood why they owned it in the first place? Very sad. And when the Financial Times calls the goldbugs confused idiots, sadly, there is even some truth in this statement.
If Victor keeps this up I’ll be out of a blogging job.
By The Energy Report, on January 25th, 2012
 Last year marked the third-largest growth in the potash industry, but hesitancy from India and China may put things on hold in 2012. However, MGI Securities Analyst Corey Dias still expects to see a lot of positive news coming out of the junior potash space. In an exclusive interview with The Energy Report, Dias specifies which companies he’ll be following for progress.
The Energy Report: Total potash demand in 2011 was estimated at 56 million tons (Mt), and the market has traditionally grown at a rate of about 3.5%/year. Do you believe we’ll see a similar increase in 2012?
Corey Dias: I think 3.5% could be at the high end of growth for 2012. I would expect slightly lower growth this year given that India is delaying its potash purchases until the end of Q112. China is also determining its exact needs, and there are rumors that it may reduce its imports this year versus 2011. Everything tends to depend on price. Canpotex (the marketing company for Saskatchewan potash producers) and its Belarusian counterpart are holding out for higher prices than India and the China currently seems willing to pay. With those delays, demand will probably be slightly below the historical 3.5% growth rate.
TER: Potash Corp. (POT:TSX; POT:NYSE) of Canada has shut down two mines in that country, and The Mosaic Company (MOS:NYSE) says potash buying is slow right now as buyers are taking a wait-and-see approach. What do you make of Potash Corp shutting down those two mines?
CD: It is a prudent approach. The company doesn’t want to flood the market with product as it would like to sustain a reasonable potash price that could provide a reasonably profitable return. By shutting down these mines, it’s limiting the output and that should keep the price at a fairly stable level. It’s not a question of shutting down so much capacity that prices are going to spike; it’s simply a way to keep potash prices relatively stable until the moment when a larger buyer comes back into the market, whether it’s India or China.
TER: In 2011, potash had the third-largest price increase among the 32 commodities ranked by the Scotiabank Commodity Index and, over the span of 2011, potash rose about 32%. The leading indicator of potash prices is often the price for corn, which is down significantly after some bumper corn crops in Eastern Europe, Russia, and Australia. What do you believe will be the average price per ton (t) for potash in 2012?
CD: Potash prices seem to be ranging between $450 and $550/t at the moment, depending on the port of delivery. It will probably stabilize around the $500/t level in the short term. I don’t see any reason for a significant spike in the price at this point. Although the corn price has recently seen a dip, it still remains above its historical average. Moreover, given the fact that the U.S. Department of Agriculture said that its stocks-to-use ratio is still well below the historical average, it would take a significant amount of corn production to reach the normal level of 15–20% in terms of that ratio, and reaching that level of production to meet this ratio could be a real challenge, especially when corn demand continues to grow. Therefore, while corn is slightly down, I don’t think there is going to be a downward trend in the corn price, or a complementary downward trend in potash.
TER: You don’t believe that potash will be in the top 10 performing commodities in 2012?
CD: I think it will have a fairly average year. I don’t think it will repeat its price performance in 2012 as it had a relatively low price point from which to start in 2011. It will probably stay somewhere in the middle of the park vis-à-vis other commodities.
TER: In an interview with The Energy Report in May 2011, Dundee Securities’ senior analyst Richard Kelertas predicted that we would see $750/t potash at some point before May 2013. What’s your perspective?
CD: As you said, that was in May 2011. The market looks a little different now than it did then. The fact that India is pushing back on pricing and delaying its purchases and China is reassessing are going to mitigate the potential upside of the potash pricing. Probably $600–650 is a reasonable price going to 2013, but there are a number of different factors that come into play in addition to India and China, whether it is production capacity being added to the market via brownfield or greenfield projects, whether or not there is a recovery in the European market, or whether or not the U.S. recovery continues. The fact that farmers seem to have a lot of money coming out of 2011 could, at worst, bode well for holding a pricing floor on potash at current levels and could potentially even support a higher price. I think that $600–650/t is reasonable.
TER: Tell us about your coverage universe and the types of companies you cover.
CD: I’m now ramping up coverage in the potash space. My first report was about Passport Potash Inc. (PPI:TSX.V; PPRTF:OTCQX), a name that I’ve followed since early 2011 when I was working in an institutional equity sales capacity at MGI. I really like this story and the fact that it’s in a safe, mining-friendly jurisdiction. An opportunity to build a mine in a potash-rich region—the Holbrook Basin—with only two competitors in the Basin could provide an opportunity for consolidation. It is a story with a great deal of appeal.
Generally, I’m looking at small-cap developers and am not restricted to North America. There are developers in Africa and South America that could be appealing in the same way. It will be up to clients to decide whether or not they have the risk tolerance for assets outside North America.
TER: Is that typically the type of company that MGI covers even in the other sectors?
CD: We tend to cover smaller-cap names. Large-cap names would be a bit more difficult for us to champion in a lot of ways because we wouldn’t necessarily get the mind space from clients for large-cap ideas because clients are well covered by banks and bulge bracket firms that are looking at the Potash Corps of the world, companies like Agrium Inc. (AGU:NYSE; AGU:TSX) and Mosaic.
TER: Passport Potash’s share price took a beating in 2011. It’s currently developing the Holbrook Basin potash project in Nevada. Why do you believe that junior is going to rebound this year?
CD: Part of Passport’s problem this past year was based on the market itself being quite volatile, especially toward the end of the year. In general, small-cap names tend to suffer the most in those circumstances. But management made a few promises to the market that it was unable to keep and probably didn’t realize the extent to which it would be punished by the market by having missed deadlines. However, I believe that the company is starting to right itself. It is in the process of putting together an NI 43-101-compliant resource estimate, which we expect to be released by the end of Q112. Following that, we should see a preliminary economic assessment or scoping study and, further, a prefeasibility study from Passport in order to show the economic viability of its project. In addition, there was an announcement on January 18th that Passport has brought on a new chairman who has significant operational experience gained during his time with Rio Tinto (RIO:NYSE; RIO:ASX). It also has added Ali Rahimtula, who has experience in India, which is key in this type of business because there is the potential for an offtake agreement with an Indian partner. Passport has acknowledged the fact that it needs more relevant experience on the board, and has clearly begun to address this shortfall.
Like most of the names in the junior developer space, there tends to be a rerating—in terms of valuation—of these types of businesses once milestones are met along the road to production. As Passport meets its milestones, the market will likely provide the company with a more positive valuation via a re-rating of its stock. The company’s stock price hit bottom at $0.17 toward the end of last year. Since then, it has been able to at least project to the market that it does have some deadlines, which it intends to meet. Passport has engaged the engineering firm ERCOSPLAN to complete its NI 43-101. ERCOSPLAN has a really good reputation in the marketplace and has done a lot of work for developers in the potash space worldwide. The market now understands that the company is working very hard to meet its current deadline and, once met, Passport will have a potash resource estimate to put to the market. The market at that point will respond favorably, in my opinion.
TER: A competitor operating in the same basin that Passport is operating in, the Holbrook Basin, already has an NI 43-101 resource of 125 Mt potassium chloride (KCl). How large do you expect Passport’s resource to be once it’s published?
CD: The competitor has about 94,000 acres of land, while Passport has about 81,000 acres. If we were to use a ratio of acres to contained tons of KCl for the competitor and apply it to what Passport has, Passport would probably come in somewhere about 100–101Mt of contained KCl. Remember, this is in no way a forecast that I am making as to the size of Passport’s resource. Even if Passport has something like 80% of that number, I think it’s still a decent-sized resource. In my report, I am forecasting that Passport will produce about 1Mt/year over 40 years. That implies about 40Mt of in situ KCl. If we’re talking somewhere between 80–100Mt of contained KCl, there is significant opportunity for Passport to increase the size of production on an annual basis, or it gives a bit more leeway in terms of what the potential resource size could be, on a contained-ton basis.
TER: You have a Speculative Buy on that particular equity. What is your 12-month target?
CD: My 12-month target for Passport is $0.75.
TER: Another junior in that space, Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX), jumped out of the gate in 2011 and slipped above $2 in June 2011 before spending the rest of the year retreating from that benchmark. It now sits well below $1. Will that junior rebound this year? If so, what are the catalysts that are going to make that happen?
CD: I think so. Allana probably jumped up based on speculation more than anything else, but as the actual resource-related numbers come in, then it tends to start trading at some kind of multiple based on its enterprise value (EV), whether it’s EV:resource or EV:ton KCl, et cetera. When the market sees that it’s getting closer and closer to production, that’s when the valuation will start to improve. I think that is something that could happen this year. When one has an asset that doesn’t have any economic information tied to it, it’s very easy to speculate as to what you think the value should be. Obviously, the closer one gets to production, then there are hard and fast numbers that one can start applying some kind of multiple to in order to value a company like Allana Potash. That’s probably why it’s now down below $1. It’s probably more reasonably priced here and as more news comes out that’s favorable to the company, then you should start seeing the stock move back up.
TER: What are your thoughts on the Danakil potash project in Ethiopia?
CD: The Danakil project is interesting because it’s a near-surface project, which means the capex should be low. I think that it will have a fast track to production, which is another positive. And the fact that it’s probably selling to India, and perhaps China, is another positive because there is a quicker trade route to those countries when compared to North American or South American potash producers.
That said, there is no domestic demand for the product in Ethiopia. The companies that I believe have an advantage are those that have domestic demand or significant domestic demand, whether it’s a place like the U.S., which imports most of its potash needs, or South America—Brazil in particular—where 90% of its potash needs are imported. Ethiopia is also landlocked, that is, it has to go through another country in order to reach the port. Moreover, there is a greater possibility of political risk in Africa than in the U.S. or in Brazil. However, if everything remains stable, I think there could be a big opportunity for Allana, especially given its low operational cost base.
TER: What are some other small-cap potash plays that you expect will outperform in 2012?
CD: Verde Potash (NPK:TSX.V) is planning to produce a unique product called Thermopotash. Thermopotash, derived from the combination of glauconite and limestone, is a slow-release potash product with no chloride, which is great for crops like tobacco, coffee and oranges. In addition, the company is exploring the use of a new technology—the Cambridge process—which could potentially convert Verde’s potassium-rich rock to regular KCl. This would be a massive opportunity in Brazil. In terms of available infrastructure, Brazil falls behind North America but is certainly ahead of Africa.
Rio Verde Minerals Development Corp. (RVD:TSX) is another small company operating in Brazil that recently confirmed that it has potash on its property. The stock has moved up a little bit on the back of that news. Once an NI 43-101 resource estimate is released for Rio Verde Potash’s potash asset, we should see another re-rating of the stock.
Karnalyte Resources Inc. (KRN:TSX) is another one. Once again, I tend to favor the junior potash developers that have a bit of a unique element or bring something a little bit different to the table. Karnalyte is focusing on extracting potash from the potash-bearing carnallite layer, which is unusual for Saskatchewan because other producers and developers target the sylvinite layer that is usually closest to the surface. Karnalyte’s deposit is based on an anomaly where there is a significant carnallite layer that is relatively near-surface vis-à-vis the sylvinite layer. The technology that it is planning to use also could provide a magnesium byproduct and sodium chloride byproduct, both of which the Company could potentially market and sell in the future. Karnalyte has a number of things going for it; I think management is very strong. The fact that it has four patents pending for its technology could mean that what it ends up with is going to be very unique. It has a massive land holding and has only conducted advanced exploration on 20% of it. Fnially, it plans to expand its plant by using cash flow generated from its initial buildout.
TER: It has done a nice job of managing its share flow, too, with only about 21M shares outstanding vs. something far greater for a company like Allana.
CD: Yes.
TER: Or do you prefer a larger share count, such as Allana, with its 193M shares verus 20M for Karnalyte?
CD: When you’re in the small-cap space—and especially if your float is small—it becomes a bit riskier for clients to hold when the markets are a bit more volatile. It’s one thing to get into a stock, but when the market is volatile and a client is looking to exit a position, it’s very difficult to do if the trade volumes aren’t there. That’s the risk with Karnalyte. The average trade volume is 34,000 shares a day. So if you have a position that’s 100,000 shares, it’s going to take you roughly three days to get out of that position, and that assumes that you can be 100% of the trading volume over those days. And you could end up driving its price down significantly while you’re trying to exit your position. Having a more liquid position in a stock like Allana that you can get in and out of a lot more easily would likely appeal to portfolio managers.
TER: Could you give our readers an outline of what to look for in the small-cap potash space over the next year or so?
CD: You’ll see a number of companies starting to reach the prefeasibility and feasibility stages. At that point, these companies will start to look for strategic partners, whether it’s to fund the buildout of the products or secure an offtake agreement for the product that’s going to be produced a few years out. At that point, we’ll start to see which projects are going to be viewed as more viable. There probably won’t be enough demand to drive a need for every single junior potash developer that is currently out there to actually move into production. That said, there is also the possibility that some of these companies will be absorbed by larger entities that are looking to enter the potash space given the future, positive fundamentals for potash or those that are currently in the market and are looking to increase potential capacity moving forward. I expect to see a lot of positive news coming out of the junior potash space, especially as a few of these companies meet milestones in order to get a little bit closer to production and production becomes more of a reality.
Corey Dias has worked in the capital markets industry since 2003 and has spent eight years in institutional equity research and institutional equity sales. In addition, he has worked for a U.S. hedge fund, where he shared responsibility for the running of a $400M portfolio and sought out assets for private equity investment on behalf of the fund. Mr. Dias holds a Master of Business Administration from the Richard Ivey School of Business at the University of Western Ontario.
By The Energy Report, on January 20th, 2012
 With oil reserves less and less accessible to western majors, producer stocks can carry significant geopolitical risk. In this exclusive interview with The Energy Report, First Asset Investment Management Inc. Senior Vice President John Stephenson explains why service-oriented companies are smart selections for risk-averse energy investors. No matter what happens in the oil and gas business, the companies doing the drilling have solid prospects in this market environment.
The Energy Report: 2011 was a pretty exciting year with oil prices all over the map, largely fueled by the European debt crisis. What do you expect are going to be the hot topics affecting energy commodities in 2012?
John Stephenson: The spread between Brent and West Texas Intermediate (WTI) prices, which was a big story in 2011, will continue to play a role. I expect a lot of talk about how WTI has once again resumed its place as the global benchmark. Another big topic, as it always is, will be the continuing geopolitics of oil, be it a possible Arab spring in Saudi Arabia or Iran’s nuclear program and how that impacts the world. In terms of possible black swan events, the Environmental Protection Agency (EPA) or other regulators could limit horizontal drilling and fracking. However, that could be very positive in the short run for natural gas prices.
TER: What caused the big spread between the WTI and the Brent prices?
JS: Everyone used to look at WTI as the main global benchmark for crude oil prices, and Brent historically traded at a slight discount. Then, over time, Brent started trading at a premium to WTI. What people have to understand is that these benchmark contracts specify grade and location. The delivery location of the WTI crude contact is Cushing, Oklahoma. Because it’s landlocked, you can’t get crude in from the Gulf region, which actually traded in line with Brent. There also wasn’t enough pipeline capacity to get the large inventories of crude that had built up in Cushing out to other global markets. So it really was an infrastructure issue that caused the price spread. Now, various companies have gotten together and proposed pipeline alternatives that would alleviate this glut of oil at Cushing. Therefore, you’ve seen the spread go from $25 to about $11.40, where it is today.
TER: Your management company, First Asset Investment Management Inc., manages a variety of different commodity-focused funds. What is your 2012 energy outlook?
JS: Our outlook is very supportive and positive for oil. One of the interesting things about oil is that despite the dire headlines, mainly out of Europe, oil has held in as well as it has. In fact, it’s been hitting eight-month highs recently. Why is that? Partly because demand is so strong. We saw record demand globally in August and near-record demand in October and November and continuing strong demand despite the fact that Europe appears to be dipping into recession and growth is potentially slowing a little in Asia. This is why I’m very positive on this and expect to see oil go higher.
Natural gas, on the other hand, is very weak. It’s sub-$3/million cubic feet (MMcf) right now, and I think it will continue to be weak. Historically the period between December and March is when natural gas trades at a premium to its summer prices. This is actually the first winter I can recall seeing it trading at a discount.
TER: Weak natural gas prices are a result of increased shale gas production through fracking, which has created a significant oversupply in the last year or so. Is this going to continue, do you think?
JS: Yes, the U.S. has 200–250 years of reserves of shale gas at current production rates. I don’t see any reason at all for it to change unless, of course, the EPA or someone else were to rule that fracking was detrimental to the environment and there was a moratorium placed on drilling. That could be a black swan event and could change things. If things continue the way they are, there’s no doubt that prices will stay low. Now, clearly, there is some opportunity to export this, but that means building a liquefaction terminal, probably on the Gulf Coast or some other part of the country where people are willing to have a liquefaction facility. That would turn natural gas into a liquid to be transported to Asia or potentially to Europe, where the prices are much higher than they are in North America.
TER: So even though we may have hit peak oil, we certainly haven’t hit peak gas.
JS: No, I don’t think we’ve hit peak gas. Four years ago, the talk was that we were running out. They were going to build terminals on the Gulf Coast to take liquefied natural gas from Trinidad and other places, gasify it and put it in the U.S. pipeline system and supply the northeast in particular with natural gas. Now we’re finding we have so much of this stuff in various shale deposits that we have the potential to become a huge energy exporter. Hopefully that will be the case, but for now we don’t have the infrastructure in place to make that happen.
TER: In some respects it’s a happy turn of events compared to previous supply concerns.
JS: Not if you’re a producer of natural gas, but if you’re a producer of oil, it’s great. If you’re a consumer of electricity, then it’s great.
TER: As far as your portfolio selections and your outlook for this year, you’re clearly leaning much more toward oil and gas liquids. What other factors do you think are going to be affecting prices this year and into the future?
JS: What impacts prices for commodities is supply and demand. I think you’re going to see that demand continues to grow. The reality of why we’ve hit record world demand is not because consumers in the U.S. are doing so much driving. It’s rather because consumers in Asia are doing so much driving. China is now the number-one car market in the world. Who would have thought? If you look at total energy consumption, including coal and other sources, China has overtaken the U.S as the number-one consumer of energy in the world. That trend will continue and put upward pressure on oil prices over time.
The other theme that I think is important for investors to understand is that most of the majors have had real trouble finding replacement reserves to keep producing at the same level. Most of the industry has run from one country to another, where they’ve been kicked out. When Lee Raymond was running Exxon, he ran over to Russia, then to Nigeria, then Venezuela. The settlement that Venezuela was willing to offer Exxon for its assets was a pittance. This is typical of what we’re starting to see around the world. It’s very hard for most of the majors to find new reserves and to continue to produce at the same levels because most of the world that has energy is not open or friendly to the West. This creates a huge problem for these companies.
Given that backdrop, investors need to find companies with reserves in geopolitically stable locations, or where companies are not in the business of generating the reserves; they’re in the business of helping oil companies produce those reserves. That leads you to the service sector, which I think is a lower-risk area. Investors can stay in North America and invest in companies they know and understand without worrying about geopolitics.
TER: What are some of the names that you like in the service sector?
JS: I think if Saudi Aramco, the largest oil company in the world, is going to do a job and it’s going to produce a new field, it will call in Halliburton Co. (HAL:NYSE) or Schlumberger Ltd. (SLB:NYSE). It’s not going to call in Exxon Mobil Corp. (XOM:NYSE). It doesn’t need Exxon’s expertise or capital. But it does need Halliburton’s or Schlumberger’s expertise. These global majors are going to do well on the service side. In the last 25–30 years, the industry has gone from positive bullish cycles to bearish cycles. The people who had the expertise in down-hole seismic techniques, who understood how to operate drill bits at various angles and how to cement and case wells and all of these other things became outsourced to the service industry. The true oil business expertise is in the service industry; that’s why I see it as a sound investment.
TER: So if I may make a mining metaphor, it’s the guys that supply the shovels to the miners that are going to make the money, not necessarily the miners.
JS: Absolutely. It’s the California Gold Rush all over again, except it’s the global energy rush, and you want to be in the picks and shovels business, not necessarily in the prospecting business laying claims. If you’re a Western company and you’re laying claims, chances are you’re laying claims in some part of the world that doesn’t want you there and that may kick you out down the road. Then what do you have?
TER: What are some other companies in your portfolio holdings that you particularly like at this point?
JS: One area to look at is the smaller energy service companies, like Calfrac Well Services Ltd. (CFW:TSX) and Trican Well Service Ltd. (TCW:TSX). Again, there is an increasing amount of drilling that’s happening, even on the gas side. It’s just happening with these new horizontal drilling and fracking techniques. These are the guys who supply this equipment. That’s very strong.
I also think you want to look at the oil companies that don’t have problems with reserves and short reserve life, including some of the Canadian oil sands producers. I would recommend Suncor Energy Inc. (SU:TSX; SU:NYSE) and Canadian Natural Resources (CNQ:NYSE; CNQ:TSX). These stocks are cheap. They’re trading as if oil were $55 or $60/barrel (bbl) when it’s over $100/bbl. These low valuations offer a great opportunity.
TER: Looking at your portfolio in your First Asset Energy and Resource fund back at the end of last quarter, Sept. 30, you were about 78% in cash. Was that a strategic decision? Have you changed that cash into equities at this point?
JS: No. We were very defensive at that time, and I think the reason was pretty simple: Europe was blowing up and when any major economic zone is blowing up, I don’t think you want to be in commodities or commodity producers. Now we’re seeing that the market has stabilized, and you’re going see growth going forward. Valuations certainly never got ahead of themselves in either individual stocks or in any energy sector, so I expect valuations to move higher at this point.
We’re no longer at that same cash level. Our position at that time reflected an overall nervousness about the world. When you have these dominant issues, you need to take your money off the table, which we did. Ultimately, the trade was to the downside, and we preserved value by doing that. I’m very proud that we were able to raise so much cash and be truly defensive at a time when the market was dropping quite substantially.
TER: Are there any of your other attractive portfolio holdings that you’d like to discuss at this point?
JS: I think in terms of other commodity themes that are working well, certainly Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) would be a great name—that’s on the copper side; it is the largest pure copper producer out there. On a similar vein with a little bit better growth and a little bit more sensitivity to the market—meaning it will move a little more dramatically than the market itself—would be First Quantum Minerals Ltd. (FM:TSX). That’s another name that I think does very well.
We haven’t talked a lot about the agricultural names. If we’re talking about the broad resource base, it’s been a tough time in the agricultural space, particularly for the fertilizer companies. But I continue to think Potash Corp. (POT:TSX; POT:NYSE) looks attractive, especially at this level. Agrium Inc. (AGU:NYSE; AGU:TSX) looks attractive at this level. It’s a little more defensive than Potash. The Mosaic Company (MOS:NYSE) has struggled. I would probably recommend CF Industries Holdings Inc. (CF:NYSE) over Mosaic. Those are the areas that I would look to.
Also, in terms of other oil and gas producers, Canyon Services Group Inc. (FRC:TSX) does well. Transocean Ltd. (RIG:NYSE; RIGN:SIX), a big supplier of offshore platforms, will do well in this environment. Even Baker Hughes Inc. (BHI:NYSE) is transitioning its fleet to more horizontal drilling from straight vertical drilling. Those are all names that we have held and will continue to hold in the future and expect to do well.
TER: To sum things up as far as the energy outlook for 2012, what would you like to tell us?
JS: I would say that energy remains the most important of all the commodities. It will be the most important in 2012 and likely in 2020. Even though we’re over 100 years into the energy era, we are still very much dependent on oil. While it may seem expensive when we’re filling up at the pump or when we look at the futures prices, it’s still cheaper than orange juice on a volumetric basis. There is no substitute for oil, at least no good substitute. There is no technology right now that is commercially viable enough that could change the industry in the way that horizontal drilling and fracking changed the natural gas world. So I think you’re going to see oil prices move considerably higher.
Demand no longer is being driven by America; it’s being driven by Asia and predominantly by China. That trend will continue. In many parts of the world where demand is growing the fastest, namely the Middle East as well as some parts of South America and Asia, fuel prices are subsidized. In an environment where gasoline prices are subsidized, the consumer isn’t feeling the full impact that we feel here in North America. So for those reasons, I think we’ll see oil prices move higher, stay higher and exit 2012 at least $130/bbl. Natural gas prices, on the other hand, will remain range-bound in the $2.50–3, maybe $4, range. It’s very hard to see a successful investment strategy for investors there, other than with the service companies that are going to be the beneficiaries from all of that drilling.
TER: I think that pretty well sums it up. We appreciate your thoughts and input today.
JS: My pleasure.
John Stephenson is a senior vice president and portfolio manager with First Asset Investment Management Inc., where he is responsible for a wide range of equity mandates with a particular focus on energy and resource investing. He has been recognized by Brendan Wood International (BWI) as one of Canada’s 50 best portfolio managers for the past three years. He is the author of The Little Book of Commodity Investing (John Wiley & Sons, 2010), which has been translated into five languages and Shell Shocked: How Canadians Can Invest After the Collapse (John Wiley & Sons, 2009), and writes a free bi-weekly investment newsletter, Money Focus, which reaches a global audience of more than 125,000 (www.reportonmoney.com).
Stephenson is regularly quoted by Bloomberg News, Reuters, The Associated Press, The Wall Street Journal and The Globe and Mail and is a frequent guest on Bloomberg TV, CNBC, CNN, Fox Business and Canada’s Business News Network (BNN), Sun TV and the CBC. He is frequently the keynote speaker at investment conferences throughout North America. Stephenson holds a degree in mechanical engineering from the University of Waterloo, an MBA from INSEAD, as well as the Chartered Financial Analyst (CFA) and Financial Risk Manager (FRM) designations. He lives in Toronto.
By The Gold Report, on November 14th, 2011
 In an environment of declining steel prices, Geordie Mark, mining analyst with Haywood Securities in Vancouver, nonetheless believes that iron ore juniors are poised for a rebound. Read his reasons for optimism in this exclusive Gold Report interview.
The Gold Report: About 37% of the world’s population is in China and India, countries in the early stages of their use of steel and, thus, iron ore. You’ve said their infrastructure requirements should trend up “for a number of years, if not decades.” Yet, benchmark prices for steel are down 15% since March. Is this price weakness a short-term problem or is there cause for concern?
Geordie Mark: I think we are looking at a shorter-term issue related to a tightening in money supply in China, particularly affecting the smaller mills. These smaller mills need to moderate output or get injections of commodities at lower prices. But we are still looking at underlying demand growth to meet the needs of increasing industrialization in the advancing economies, particularly in China and India.
TGR: Even though iron ore stockpiles are within 3% or 4% of record levels?
GM: We believe that stockpiles in ports and so forth are higher largely because steel demand is higher, and there is a coincident increase in iron ore imports. Compared to last year, China’s year-to-date crude steel production is up ~12%. If we measure inventory in terms of a proportion of steel output, we see that this higher inventory level has formed a plateau over 2011.
The recent pricing downturn for iron ore appears to correlate to a short-term issue in money supply where steel mills are sitting on more expensive inventories. This pricing scenario has witnessed a rebound over the last week where renewed demand and restocking has been taking place in China at cost and freight prices of $130/ton (t). The relative drop in China’s inflation rate announced on Tuesday also provides us some solace for an increased potential fiscal loosening in China.
TGR: Some producers have shut down furnaces because of an excess amount of steel in the market.
GM: We usually see some seasonality at this time of year where demand tends to plateau, particularly in Europe, from August through the end of the year. However, we have witnessed some demand softening outside Asia, but we expect that this will pick up again at the beginning of the year with renewed orders.
TGR: Iron ore swaps, based on anticipated first quarter prices at the Chinese port of Tianjin, are trading at about $129/t. Clarkson Securities says iron ore swaps are showing no price rebound until about 2013. In June, you were forecasting average freight-on-board Brazil prices of 62% iron at $124/t in 2012. Has your forecast changed?
GM: We are forecasting $130/t for 2012, based on our assumptions of continued demand from China together with potential increases in export taxes on iron ore in India, which are expected to place limitations of exports from that country. We think that underlying demand, as well as moderation in metallurgical coal prices, will help move the price higher in the shorter term and marry with our expectations.
TGR: Infrastructure growth in North America is stagnant. Is this a drag on the share growth of North American junior iron ore miners, despite the continued steady demand in iron ore use in the BRIC countries (Brazil, Russia, India, China)?
GM: For the time being, across the equities, we see a move away from risk largely independent of commodity. The juniors, in particular, suffer in the interim, independent of where commodity prices are going. Iron ore juniors have obviously dropped recently, but we do expect prices to rebound when commodity prices recover and risk appetite returns to the market.
TGR: In your coverage sector, you have 12-month target prices on more than one iron ore junior that could see its share prices quadruple from current levels. What’s the thesis for rebounding prices in this sector?
GM: Our thesis is continued demand growth. The world’s two most populous nations still require fundamental components for continued industrialization and urbanization. Other economies witnessed comparable infrastructure growth paths over their infantile stages of industrialization, such as the U.S., Germany, Japan and South Korea. In comparison, China has not reached the levels that those countries did in the past, and India still has an appreciable way to go if it is to reach the zenith of infrastructure investment intensities of the other economies.
In future support of our thesis toward growth in steel demand and maintenance of elevated iron ore prices, we see that India’s concern over the future needs of its domestic steel sector has resulted in the government looking to impose even greater tariffs on iron ore exports. Such a move, together with lower iron ore prices, is expected to temper Indian exports and provide a mechanism to moderate seaborne iron ore prices going forward.
In addition, while we see growth in demand from China, partially aided by the country’s domestic program of low-income housing development, the market sees risk in the housing sector beyond that supported by government investment.
TGR: Let’s get to your coverage sector, beginning with Alderon Iron Ore Corp. (ADV:TSX; ALDFF:OTCQX). You have a Sector Outperform on the company with a 12-month target of $5.80/share. Alderon is trading below $3/share now. Please map out how Alderon’s share price could be catalyzed between now and the spring.
GM: Our valuation anticipates that Alderon’s project will move into production by 2015. Over the next year, the company is expected to achieve a number of key milestones that could move it toward our price expectations. Those milestones include the company increasing its underlying resource base at Kami, lowering project risk at the deposit by completing a feasibility study and bringing an offtake partner onboard.
Alderon has increased the depth of management expertise in the iron ore sector recently. The company is making the right moves to lower risk and bring on partners.
TGR: Who are some potential offtake partners?
GM: I think the usual suspects, particularly steel utilities out of Asia, such as China and South Korea. Utilities are looking for security of supply and for access to supply at cost, which obviously moderates their ability to supply steel and lower steel price environments. These steel utilities also want to become less reliant on the big three iron ore producers: Vale SA (VALE:NYSE), Rio Tinto (RIO:NYSE; RIO:ASX) and BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK).
TGR: Would an offtake agreement inhibit a possible takeover?
GM: If structured in the right way, I don’t think so. Earlier this year, when Cliffs Natural Resources Inc. (CLF:NYSE) acquired Consolidated Thompson, the underlying offtake agreements that Consolidated Thompson had and its partnership with Wuhan Iron and Steel Corp. (WISCO) on a project and ownership basis didn’t limit the deal.
TGR: You are also bullish on Northland Resources Inc. (NAU:TSX), which plans to start mining iron ore in northern Sweden in late 2012. Most of the operations in Québec’s North Shore ship iron pellets, not concentrate. Do you have a preference as to what form the iron takes?
GM: I think the most important elements to consider here are what product captures the most value for a particular project and what is the proximity of the market that the company aims to sell into. An especially pertinent factor to consider for the iron ore sector is the generation of a project with the potential to feed into the market over the long term. On this basis, projects that can deliver higher iron content products—say 62% and above—are probably better positioned if they can moderate operating costs.
TGR: Your 12-month target on Northland is $6.80/share and it is currently trading at less than $1.50/share. That seems like a pretty bullish target. What are the catalysts?
GM: There is an overhang in the market related to the ongoing situation in Europe. Also, Northland must continue to finance project construction. The company is aiming to complete the raising of a syndicated $400 million in senior debt facility by the end of 2011.
We believe Northland’s Kaunisvaara project is on time and on budget for completion of construction by Q412. Completing the debt deal would be a significant catalyst because it removes significant uncertainty. Project completion in Q412, commencement of mining in Q412 and initial concentrate sales in Q113 are big catalysts for this company.
TGR: Northland recently worked out a deal to use Narvik as its port facility. Once the company starts shipping concentrate and seeing some cash flow, what will it do with that cash?
GM: We understand that Northland will re-inject its cash back into the company to facilitate organic output growth. It will look to increase output at Kaunisvaara, and then potentially develop the Hannukainen iron-copper-gold deposit just over the border in Finland.
TGR: Do you expect to see significant byproducts from the gold and the copper in that deposit?
GM: Northland’s predominant revenue generator is iron, but, certainly, copper from Hannukainen is likely to be a significant component. In the end, Northland is an iron ore company.
TGR: Once it achieves production, Northland will become the second-largest iron ore producer in Northern Europe. If an up-and-coming junior iron ore company can become the second-largest iron company overnight, that speaks volumes about how much room there is in this market.
GM: That is correct. In part, it has to do with Northland’s proximity to available infrastructure and the location of its deposits, which geologically reside within the same family of deposits that LKAB, Northern Europe’s largest iron ore producer, is exploiting today. It will be a big step for Northland to get into that 5 million ton (Mt) capacity.
TGR: Champion Minerals Inc. (CHM:TSX) has iron ore projects in the Labrador Trough. Your 12-month target there is $4.20/share, and it is trading at less than $1.40/share. Its Fire Lake North, Bellechasse and Harvey-Tuttle properties have a combined Measured and Indicated (M&I) resource of 400 Mt, grading about 30% total iron. There’s another 1.82 billion tons (Bt) at about 25.4% total iron. How does that resource compare with companies at similar stages of development, for example, Alderon?
GM: I think Champion compares directly with Alderon and Consolidated Thompson in terms of having ample resource size to consider a potential production path. Consolidated Thompson’s Bloom Lake resources had similar grade, but with more than 2 gigatons (Gt) of defined and compliant iron ore resources in its portfolio in the Fermont mining district, highlighted by more than 1 Gt on its flagship Fire Lake project, Champion is well positioned to use its resource portfolio to go into and expand on production.
TGR: What’s the likelihood that Champion will get its M&I resource above 1 Gt at around 30% iron within a calendar year?
GM: I think Champion has a good likelihood of graduating its resources into the M&I category. We expect to see a number of resource updates across the portfolio coming up. I would expect an updated preliminary economic assessment on Fire Lake North later in November.
TGR: Is 30.6% total iron a low grade for this sort of deposit? Is that a concern?
GM: It is similar to that exploited by Consolidated Thompson at the Bloom Lake mine. Many other features play a significant part if the underlying economics of a deposit (e.g., mass recovery and grind size). For instance, a measure of effective mass recovery is very important for iron ore resources as it can give you a gauge of the mass needed to be mined and processed to produce a certain amount of product of a particular quality. Mass recovery can vary significantly between deposits with similar iron content, so the figure plays an important role in evaluating the potential of an iron ore resource. You need to look at more than iron content to judge resource exploitation potential.
TGR: Do you cover any other iron ore stories our readers ought to know about?
GM: Talon Metals Corp. (TLO:TSX) is one that we have been keeping our eye on. It is included in our Junior X-Report. In late 2010, the company acquired a couple of iron ore exploration plays in Brazil, basically on the doorstep of Vale’s Carajás iron ore mine. Talon rapidly developed those projects and within a year moved it up to more than 1 Gt of defined iron ore resource.
We see a lot of catalysts going forward on Talon’s fairly rapid resource expansion and metallurgical definition programs. More resource expansion is likely to be announced via the publication of a number of resource updates over the next six months, and a preliminary economic assessment is expected to be completed in mid-2012. The company has now defined new resources of outcropping iron ore that look as though they have size potential in a region that is being actively mined for iron ore.
TGR: If investors want to add only one iron ore junior to their portfolio, how should they choose among the companies you’ve named?
GM: It all relates to their comfort with risk and geography, and whether they like to look at junior companies with resource expansion and development potential, or iron ore producers with output growth on the horizon. If investors are looking for resource expansion, Talon, Champion or Alderon deliver resource expansion and development potential. If they are looking for projects further along the development pipeline, New Millennium Iron Corp. (NML:TSX.V) and Northland are on the development path with their respective projects in Canada and Sweden. If they are looking for exposure to Canadian iron ore production, there is Labrador Iron Mines Holdings Ltd. (LIM:TSX) or Cliffs Natural Resources Inc. It just depends on where your risk comfort lies.
TGR: Geordie, thanks for your time and insights.
Dr. Geordie Mark, a research analyst with Haywood Securities, focuses principally on iron ore, coal and uranium companies involved in exploration, development and production. He joined Haywood Securities from the junior exploration sector, where he served in an executive role concentrating on exploration across Canada. Immediately prior to joining the exploration industry full-time, Dr. Mark lectured in economic geology in Australia and served as an industry consultant. He completed his doctorate in geology in 1998 at James Cook University’s Economic Geology Research Unit in Australia, specializing in aqueous geochemistry and igneous petrology applied to ore-forming systems.
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By The Energy Report, on November 11th, 2011
 Fertilizer companies have felt the pain of global monetary chaos, but as indicators lag, some potash equities are positioned ahead of the curve for big gains. Dundee Capital Markets Vice President and Senior Financial Analyst Richard Kelertas believes investors need to be sharpening their pencils and establishing positions. In this exclusive interview with The Energy Report, Kelertas shares his best names.
The Energy Report: There’s been damage done to potash stocks over the past six months. Why?
Richard Kelertas: Macro issues have hurt all commodities. When the world is worried about its next breath, all these stocks get hit very hard. We’ve had the Euro crisis and then the Greek debt crisis since these stocks peaked in summer. Also, I think there were expectations that North America and Europe would emerge from the last serious recession with half-decent growth going forward, and that recovery would be moderate, measured and continual from 2010 all the way up to 2013–2014. That’s now been interrupted by macro events, and the odds that they will be quickly resolved is almost nil. We are going to have to deal with slower economic growth worldwide, not just in the eurozone and North America, but also in China and all of Asia because it’s all interdependent.
We will also have to expect that the consumer will be drawn back a bit, both in Western societies where food is a necessity and a luxury, and in developing economies where it is a necessity. So, high-end food values, high-end organics and food stocks that are higher priced will be under pressure. That means lower requirements for meats, which means that the farmer may be cutting back on his crop output.
TER: Can you make a case for growth in potash consumption?
RK: For the next six months, I expect flat growth. Prices and volumes have retreated slightly. Inventories dropped in October. That’s good news. I expect prices will be flat to down.
However, if Europe’s debt crisis and low North American growth are resolved in the next 6–12 months, we could then see Asian export nations gear up again. That means that their diets will improve again, and crop prices and speculation in crop price increases going forward will pick up. That will happen sooner than six months in the futures market, but at the same time my expectation is that the next six months are going to be slow.
Within the next year, we should see some growth return. That will be composed of three components: Farmers will use potash at normal levels and growth will be reflected in shipments and prices. Lands that will be brought back into production will expand demand. This is fallow or abandoned agricultural land throughout the world, especially in Africa, that has been bought up by either investment pools or sovereign wealth funds or specialty farm land managers. In the grand scheme of things that doesn’t seem to be a lot in terms of the total farmland area throughout the world; however, potash application rates will be much higher than normal because you are bringing it from infertility to fertility levels. So, we could see a substantial push and it will show up in perhaps a 0.5–0.75% increase in potash demand worldwide.
TER: Are you able to venture a forecast on the price of potash?
RK: My international price forecast, the Vancouver export price, is about $450–465 per ton (/t) right now. For 2012 we expect an average price of $505/t and then moving to $520/t average price in 2013. The peak price in 2013 should be around $650/t, maybe $625/t. But, it won’t be as high as the $700-725/t that I thought may take place when I made that forecast a year ago.
TER: Are fertilizer prices leading or lagging economic indicators?
RK: They are lagging indicators. We need to see economic activity pickup first. The mood of farmers is always pretty gloomy, and getting them to change their view on world markets requires crop prices to move. But, crop prices won’t move really unless you see economic activity pickup.
TER: Is potash still low-hanging fruit? Or is it getting much more difficult to mine?
RK: That’s a good question. We just put on a seminar and heard from ERCOSPLAN, the German exploration consulting firm that has provided a lot of NI 43-101s for potash projects throughout the world. If you’re doing deep shaft, it is very expensive and time consuming, and there are long lead times. I would say that most of the best sites, except in Saskatchewan and Russia, are deep-shaft mines. There may be one or two open-pit opportunities in Ethiopia or in Utah where you’ve got very shallow deposits. Solution mining, though, provides you with the opportunity to get several large sites into production in a relatively short period of time.
But the limiting factor right now is financing, and that’s because you’re dealing with $800 million (M)–1 billion (B) for a 1–1.5 billion tons per year (tpa) equivalent of potash, even for a solution mine. The second limiting factor is cash balances. If we are going to have a long, drawn-out economic downturn here, which is quite possible, then very few of these projects will come to fruition and get into production. They will run out of cash before they can either get taken out or get the financing. So, there are only a couple of strong plays that have plenty of cash and, where cash-burn rates are low, can survive this downturn and lack of liquidity in the marketplace. The third thing is that we could possibly see some deep-shaft mines flood over the next 6, 12, or 24 months like we had in Russia with Sil’vinit (acquired by Uralkali OAO (URKA:RTS; URKA:MICEX; URKA:LSE). We could see something possibly happen in Saskatchewan or in other areas. And I don’t think it’s a question of “if”; I think it’s a question of “when”. Many deep-shaft mines are 2,200 meters down. A lot of money is being spent pumping out water, and you could see some production disruptions. If that’s the case then the market could get tighter very quickly.
TER: Limited access to financing could be a major problem for small companies, couldn’t it?
RK: Yes, absolutely. I think about 100 worldwide projects are being considered in potash, both public and private. I would say 10–15% of them have a hope of getting financing, and of that, I think perhaps three or four might actually get financing.
TER: From everything you’ve just said it sounds like margins are going to have to contract or that prices are going to have to go up. Where does this put the potash producers?
RK: Well, at the current pricing their margins are pretty good. For instance Potash Corp. (POT:TSX; POT:NYSE; Not Rated) is the most visible, and its operating margin, not gross margin, so we’re talking before interest, is about 40%–45%. Terra Nitrogen Co., L.P. (TNH:NYSE; Not Rated) is 65%. CF Industries Holdings Inc. (CF:NYSE; Not Rated) is 60%. Now CF is urea, and it’s a different kettle of fish, but Potash Corp. is about 40%. So, prices can come off quite a bit before they’re going to have any issues. However, I can tell you that any projects that are not in progress will be put on the back burner. You need to have potash pricing power. For instance, BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK; Not Rated) Jansen Project in Saskatchewan needs average long-term potash prices of about $500–550/t really to make a go of it, and from my work the long-term international price is about $410–425/t.
But to answer your question, in a lot of cases their cost inputs have gone up too. So, if they have the combination of prices falling while their cost inputs remain high for let’s say two, three or four quarters, their margins are going to get squeezed quite substantially. But there is no doubt about Q112 and Q212, so If this economic crisis settles down, they’re going to push for higher prices.
TER: The large-cap companies have so many advantages. It seems like there’s so much risk in the small-cap potash equities.
RK: Right: That’s why they’ve been hit very hard. The juniors are the most at risk.
TER: What regions are the most favorable for companies right now?
RK: I would say the best places are Saskatchewan, Utah, Arizona and Ethiopia in Africa.
TER: What specific companies are you telling your clients to invest in?
RK: We’ve been very consistent in the stocks we like since the economic crisis of 2008. On the large-cap side, Agrium Inc. (AGU:NYSE; Buy) has probably had the lowest margins of the big-cap names, but it tends to have the most diversity in its product mix. It has a wholesale nutrient division, a retail division and a specialty fertilizer division, which includes distribution. In a tough economic environment, we opt for diversification. In a very strong commodity market, it makes sense to go to single commodities or pure nutrient plays like Potash Corp., CF Industries, Terra, The Mosaic Company (MOS:NYSE; Not Rated) or Intrepid Potash Inc. (IPI:NYSE; Not Rated). Because we expected the economic recovery to be very difficult, we liked Agrium the best in the large-cap space, and we still feel that way. Until we see commodities fundamentals suggesting a speeding up of economic recovery, we’ll stick with Agrium on the large-cap side.
TER: What about small caps?
RK: On the small cap side our top picks continue to be Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX; Buy) and Karnalyte Resources Inc. (KRN:TSX; Buy). They have the most cash, the lowest burn rate and they are the closest to production and financing. They have all the components in place, including their NI 43-101 resource estimates. But they both have different advantages and disadvantages. Allana has the possibility of being an open-pit mine, or open-pit/solution mine combination, or just a solution mine, which would be low cost because of the solar evaporation in Ethiopia.
Karnalyte is a solution mine, but it’s a gigantic deposit and will probably only need one cavern for 10 years. It does not have to do a lot of drilling. But if it does, the drilling will be horizontal. The key thing with Karnalyte is that it has boron-free magnesium chloride. That is attached to the potassium salt, KCL. The magnesium chloride comes out with the potassium. Thus, its extraction costs are not any different. Refining costs are going to be a little bit more expensive to separate the magnesium chloride, but that’s an extra revenue source.
TER: So, Allana is getting the magnesium chloride practically for free?
RK: That’s correct. Allana has not only the opportunity for MOP (muriate of potash), which is the standard potash, but also SOP (sulfate of potash), which sells at a premium. When the first million tons is fully operational, Allana will be able to produce 20–30% SOP.
TER: Karnalyte is up 31% over the past 12 weeks, and it’s the only one I see with its head above water over that period. Most others are the mirror image of that, down anywhere from 20–40%. Why such high relative strength?
RK: I think there are a few things: One, it has been getting its story out aggressively. Number two, it has been very close to getting the feasibility portion of its magnesium chloride production, and that will be ready by the end of November. I think that’s the most important thing, and it is just now starting to be understood by the market, which has been quite anticipatory of that. Three, there’s been some talk on the street that Karnalyte has worked a 30% contingency into its production costs, which is a lot higher than what it will actually work out to be. That means that its return on the project is much higher, we think, than what the company has been telling the street.
TER: How much per ton is the magnesium chloride right now?
RK: Well, it sells anywhere from $450–700/t depending on the end-product use and the purity levels. It will almost be a one for one. I think that Karnalyte will be able to get 600,000 tpa of magnesium product that they’ll be able to take out of the ground. That’s not factored into its numbers, but my NAV reflects that expectation to a small extent. So, it could be double the size in terms of profitability and revenue than the consensus on the street.
TER: Your target price on Allana is $3.05, which is an implied return of about 200% from current levels. I’m wondering about its preliminary economic assessment (PEA) due out before year-end. What is that going to tell investors?
RK: Well, I think it is going to solidify the resource in terms of measured/inferred. And of course, you’ll get a good idea of whether Allana can go to an open-pit or solution or both. More than everything else it’ll firm up the opex and capex. It will be quite clear that the area will support not just a million tons per year (Mtpa), but 2–2.5 Mtpa.
TER: If it is a solution mine, how much advantage will the solar heat evaporation be?
RK: If it’s open-pit, opex will be $40–50/t. If it is a solution mine it’ll be $65–70. A typical solution mine with natural gas or coal evaporation costs would be close to $90–100/t.
TER: What other companies are you talking to investors about?
RK: Well, at our conference we had nine presenters. Of course Allana and Karnalyte were there. We also had Passport Potash Inc. (PPI:TSX.V; PPRTF:OTCQX; Restricted). There were others at the conference that we have put on our watch list, and we are bringing them forward to investors as items of interest. We are looking at the resource and numbers on each one. They include Western Potash Corp. (WPX:TSX.V; Neutral), which just came out with a further update on its NI 43-101 and firmed up its resource estimate and capex/opex. We had IC Potash Corp. (ICP:TSX.V; ICPTF:OTCQX; Buy). We had Encanto Potash Corp. (EPO:TSX.V; Buy) and we also had ENP Minerals, which is hoping to get going in Utah. We had Rio Verde Minerals Development Corp. (RVD:TSX; Neutral), Epm Mining Ventures Inc. (EPK:TSX.V; Neutral) and Verde Potash (NPK:TSX.V; Neutral). So, we’re talking about those and getting up to speed as well on the numbers and the resource for each one of those companies. We’ve issued research on them and put them on our watch list, but we don’t have firm numbers or target prices for them yet. We will continue to speak with those companies.
TER: Western Potash CEO John Costigan noted that his company has the largest resource base of current junior potash explorers and developers. What does that mean to you?
RK: Well, there’s the old adage: It’s not necessarily how big it is but how low-cost it gets. To me, quality or concentration of the resource is number one. You have to take a lot of brine out before you get a half-decent concentration of potash. So, it is going to be all about costs. It seems to have fairly low opex costs, but I have to check into that and do more work on it. On the surface, costs seem to be a bit low compared with comparable projects. The initial capex of $2.5B to get it started sounds reasonable for a 2 Mta mine. I think it’s going to be a question of distance to market and ease of getting the mine up and running.
TER: Encanto was one of the presenters at your conference. How much can it expand its resource?
RK: From the information we have, we think the resource could be expanded quite significantly. With all the agreements Encanto has with native groups in Saskatchewan and its proximity to the Esterhazy deposit where Potash Corp., Agrium and Mosiac all operate, I think it has a good chance of expanding its resource anywhere from 25–50%. That is quite possible. But, again, before we make any pronouncements on it, we’re going to be speaking with management and talking with the engineers and geologists.
TER: Were there any other companies you wanted to mention?
RK: Not at this stage. We haven’t done enough work on, for instance, Ethiopian Potash Corp. (FED:TSX.V; FED.WT:TSX.V; Not Rated). We haven’t done enough work on IC Potash or EPM Minerals. So, we’ll reserve judgment on those for the time being.
TER: Richard, it was a great pleasure speaking with you once again.
RK: No problem, my pleasure as well.
Richard Kelertas has 25 years experience as a research analyst covering the forest products sector. He has been one of the top-ranked analysts in the sector over the years consistently, and was most recently ranked No. 1 by Brendan Woods. Kelertas has worked for a number of well-known brokerage firms, including ScotiaMcLeod, Deutsche Morgan Grenfell, UBS Warburg, and Desjardins Securities. He has a bachelor’s degree in forestry and a master’s degree in forestry and economics from the University of Toronto. Richard is also a Registered Professional Forester.
By The Gold Report, on November 1st, 2011
 Junior gold explorers are in a predicament; despite record gold bullion prices, stock valuations are suffering. Many of them, even those on the heels of exciting discoveries, are faced with either rounding up the cash and teams needed to build out mines themselves or turning the projects over to companies with the money and infrastructure already in place. In this exclusive interview with The Gold Report, David Goguen, director of institutional sales at PI Financial in Vancouver, discusses the merger and acquisition landscape.
The Gold Report: China posted its worst growth rate in more than two years during the third quarter. China is one of gold’s biggest buyers and largely drives demand. Should gold bugs be concerned?
David Goguen: I don’t think so. While it was the worst growth rate in two years, China still had a very respectable growth rate of 9.1%. Also adding to demand is China’s growing middle class and its affinity toward gold bullion that has lasted centuries and will likely continue for centuries both as a savings vehicle (through retail investment demand) and as the central bank continues with its purchases to diversify its foreign currency reserves. According to figures released by the World Gold Council, China and India accounted for 54% of global bar and coin investment and 55% of global jewelry demand in 2010. These markets for gold have been growing at a remarkable 30% per annum.
TGR: Global markets seem confident that a plan can be reached to solve the Eurozone’s sovereign debt problems. As more details about a solution emerge, how do you expect gold will react?
DG: There’s a possibility for a pullback in the bullion price if investors perceive that the global macroeconomic risk has been reduced or that systemic risk within capital markets has been reduced because of these measures.
I believe that the bullion price should be well supported by government policies and the entitlement programs that exist in North America and Europe are unsustainable in the long term. Until that has been dealt with, we are still going to accrue large annual fiscal deficits. In that environment people are going to question the soundness of fiat currencies.
I can see gold trading in a range of $1,500–2,000/ounce (oz) through the remainder of 2011.
TGR: Do you think that the gold price has established something of a floor for now?
DG: I believe that we’re probably within 10–15% of a floor. There is still an element of speculative risk capital in the bullion price. Some of that may exit as alternative opportunities present themselves in a more stable, “risk on” type capital market environment.
TGR: In 2010, there were some big takeovers in the sector with Newcrest Mining Ltd. (NCM:ASX) buying Lihir Gold Ltd. for almost $10 billion (B); Kinross Gold Corp. (K:TSX; KGC:NYSE) buying Red Back Mining for $7.2B; and Goldcorp Inc. (G:TSX; GG:NYSE) paying $3.4B to acquire Andean Resources. So far in 2011, the only big deal we’ve seen is Newmont Mining Corp.’s (NEM:NYSE) takeover of Fronteer Gold Inc. for about $2.3B. Why haven’t we seen more big deals in 2011?
DG: It is probably a combination of factors. There has been a lack of big new discoveries made by junior explorers. Also, some of the larger deposits that are under development are considered “wait and see” deposits in terms of their ability to deliver name-plate production results. Having some of these single-mine, large-deposit companies come onstream successfully will derisk these potential acquisition targets and the majors will be more comfortable stepping in and buying them.
TGR: With gold above $1,500/oz, the major producers are selling their gold at somewhat unprecedented margins and have a lot of cash flow. Meanwhile, a number of the juniors have seen their share prices erode throughout 2011. These junior metal explorers have extremely cheap ounces in the ground right now and it seems like the stage is set for a fresh wave of merger and acquisition (M&A) activity.
DG: I agree. Select Golds, our Latin focused, quantitative publication tracking junior gold companies has seen a lot of M&A activity. We see a number of juniors that have made important discoveries advance those projects from resource definition to pre-development. Now they find themselves in a situation where they are forced to choose between building out the mine themselves or putting the company up for sale.
It is at this decision junction that companies need to assess their ability to raise the very substantial capital and recruit the critical personnel, the “build it” personnel that allow them to credibly develop these projects on their own or to put themselves up for sale.
As a result, some takeovers reflect the idea that some junior companies are in the business of making discoveries and are not mine builders. Junior companies at the end of the day have to realize that in many instances the best way to surface and preserve shareholder value is to allow an intermediate or major mining company to develop the deposit through sale of the company. Shareholders often underestimate the execution risk and shareholder dilution required to reach production. At this stage in the mining cycle more juniors are increasingly in this position, hence our expectation of more M&A on the horizon.
TGR: Why is the market not providing full value in these equities with advanced projects?
DG: Mainly because equity valuations across the board are heavily discounted. There exists at the moment a big disconnect between asset values and equity market prices. This can be seen in some of the large premiums we are seeing on announced transactions. They also reflect the market’s aversion to risk.
Acquiring companies are recognizing the long-term value in specific assets. The asset in the sweet spot at the moment is one where capital expenditure (capex) budget is in the order of $150–300 million (M), is fairly defined, and is limited in its probability of unforeseen big capex blowout that would impair the acquiring company’s returns.
Those attributes make a project attractive to an acquiring company. It is easily executable with respect to the capital investment required and also the complexity of project construction. An acquirer with a strong development team can develop projects in an 18-month period as opposed to a two-to-three year build.
The new sweet spot used to be considered too small for intermediates. But it is a really competitive environment for the larger deposits. Some of the better values in the marketplace are for the 2 million ounce (Moz) deposits that have an annual 100,000–150,000 oz production. Those projects are being sought after.
TGR: Agnico-Eagle Mines Ltd. (AEM:TSX; AEM:NYSE) recently paid about $258M, or a 66% premium, for Grayd Resource Corp. Agnico-Eagle was mostly interested in Grayd’s La India deposit, which has an established resource and simple metallurgy located about 70 kilometers from Agnico-Eagle’s Pinos Altos Gold Mine in Mexico. Is this typical of the deals you expect to see?
DG: Each deal will have its own motivating factors. In the case of Grayd, Agnico-Eagle had capital equipment at Pinos Altos that it foresaw becoming available and the acquisition benefited from that obvious capital savings. It represented a continued commitment by Agnico-Eagle to a geographic region that it was already building competencies in and had a demonstrated track record of being able to execute in. Grayd’s La India project is expected to have a capex of $110M and a fairly simple capital infrastructure required to put it into production. It was a logical transaction for Agnico-Eagle to do.
TGR: What are some juniors in Latin America that have made discoveries that could lead to either mine build-outs or takeovers?
DG: Extorre Gold Mines Ltd. (XG:TSX; XG:NYSE.A; E1R:Fkft) in Argentina has very high-grade ounces at their Cerro Moro project—likely 2 Moz and growing. The resource grade is 24 grams per ton (g/t) gold equivalent—these are near surface ounces that according to a preliminary economic assessment (PEA) could generate internal rates of return in excess of 80%. The anticipated capex is $150M and cash cost are expected to be sub $300/oz.
TGR: Goldcorp bought Andean Resources, which had a gold project in Argentina. Before Goldcorp wound up with Andean, Eldorado Gold Corp. (ELD:TSX; EGO:NYSE) had made a bid. Do you see Eldorado being a potential suitor for Extorre since it was looking at acquisitions in that area?
DG: Eldorado must have become comfortable with the region and its geology through its due diligence. They viewed Cerro Negro as a world-class asset and as a stepping-stone to other potential acquisitions in the area. I still see acquisitions in Santa Cruz, Argentina, as a possibility for Eldorado.
TGR: Extorre hasn’t put out a feasibility study on Cerro Moro, its gold project in Argentina. When do you expect that?
DG: We’re expecting an updated PEA study early in the first quarter of 2012. That will be preceded by an updated NI 43-101 resource in mid-November.
TGR: What is the top end of your estimate for that resource?
DG: Goldcorp has grown Andean’s Cerro Negro from 2 Moz to in excess of 5 Moz since the acquisition. I think that the geology at Extorre’s nearby Cerro Moro deposit has that kind of growth potential.
TGR: What is another junior that you see as being a potential target?
DG: Newstrike Capital Inc. (NES:TSX.V) in the Guerrero Gold Belt of Mexico has acquired a resource from Goldcorp that was north of 1 Moz at the time of acquisition, but has grown that through an extensive drill program. It is probably north of 3 Moz now. It has also benefited from the discovery of high-grade breccia material proximal to the mineralized intrusive body itself. That higher-grade breccia material may very well represent the starter pit material that will provide for some early project payback and thereby impact the project economics positively.
Given some of the existing producers in the area, there’s a ready audience of companies with operating competencies that would see this as a very logical opportunity.
TGR: Newstrike has had some impressive results. It had about 231 meters (m) of 7.5 grams (g) gold. It recently had another intercept that was almost 120m of 3.76g gold. This looks like it could be a high-grade open pit. Is that what you’re seeing?
DG: I think it will be about a 1 g/t Au open-pit scenario that will benefit from some specific higher-grade zones of which the ultimate tonnage has yet to be defined
TGR: What are your thoughts on the management’s ability to continue to derisk that project and perhaps attract a potential suitor?
DG: The exploration team in Mexico has been exploring in that region for over 15 years. They have a good understanding of the geology and a good understanding of local relations. The control of the company largely rests with companies related to Lukas Lundin. Lukas is no stranger to surfacing value in corporate transactions. The company benefits highly from his involvement. Richard Whittall, as president and chief executive, is also guiding the company’s pace of exploration well and is great at communicating its story to the capital markets.
TGR: Which other companies might be ripe for acquisition as they derisk?
DG: Kimber Resources Inc. (KBR:TSX; KBX:NYSE.A) is a good example of a discovery from the early 2000s that is going through a process of derisking. It is currently drilling to expand the resource at their Monterde project for inclusion in a revised NI 43-101 resource calculation. The new data will be incorporated in a prefeasibility expected in Q212.
The prefeasability will effectively assist in derisking the asset and leaving the company open to possible acquisition or a decision to go it alone. There are a number of existing producers in the Sierra Madres for whom this asset would make a good fit. Kimber’s Monterde is profiled to produce 60 thousand ounces gold and 1.9 Moz silver per year for about 12 years. The capital costs there are going to be somewhere in the order of $125M. It’s the typical profile of a small, yet executable, profitable, low-risk acquisition that companies can achieve without getting involved in an extremely competitive process on overly sought-after assets.
Kimber is gaining a better understanding of the geological controls at depth and making some discoveries on its Monterde deposit in the Sierra Madres below the 400m level. It is encountering high-grade, multi-ounce material and opening up the specter of a significant increase in the deposit size. This puts a little fire under any potential acquirers to make a move as Kimber exhibits the continued propensity for new ounces at the Monterde project.
TGR: Could Sulliden Gold Corp. (SUE:TSX; SDDDF:OTCQX) in Peru be a company that acquirers would be interested in?
DG: Sulliden is mostly pure gold with some silver. The model there is for a heap-leach operation producing 150,000 gold equivalent ounces per year with a 10-year mine life and an expected capex of $200M. Sulliden is going down two paths at once. It continues to make large increases in its resource, now in excess of 4 Moz, while refining prefeasibility and feasibility studies. The company expects that ultimately the scale of the operation will need to be expanded in order to accommodate the growing resource. Sulliden is now in feasibility mode and refining the engineering parameters and nailing down costs and project economics.
The simplicity of the operation could leave Sulliden in a position where it could credibly proceed with the development of the asset on its own but more likely it will be acquired before ever breaking ground.
TGR: In another deal, B2Gold Corp. (BTO:TSX; BGLPF:OTCQX) recently bought Auryx Gold Corp. (AYX:TSX) to consolidate gold properties in Namibia. B2Gold already has two operating mines in Nicaragua. Most of the B2Gold management team was with Bema Gold when Bema was bought by Kinross Gold in 2007. It looks like the B2Gold team is setting itself up as a takeover target once again. What are your thoughts?
DG: It is a possibility. However, I would characterize B2Gold as a team that is still looking to build on its assets through both organic growth and acquisition. It has a team that has a proven track record of being able to enter new jurisdictions, understand the local landscape and successfully build and operate mines within that landscape. I would expect B2Gold to evolve into a bonafide intermediate gold producer over the next two to four years.
TGR: Another scenario that has grown in popularity in recent years is large companies, like Barrick Gold Corp. (ABX:TSX; ABX:NYSE) acquiring cooper-gold porphyry deposits. These tend to be large deposits, which really boost reserves, but at the same time, companies are also getting a tremendous byproduct credit with the copper. Are there any projects with established resources that are proximal to other operations that could be targets as well?
DG: There’s a real dearth of large quality gold deposits that fit Barrick’s scale of doing business. The number of politically stable jurisdictions to build operations has shrunk over the years as well. Therefore, Barrick needs to look outside of the strictly gold bracket. I think you will see Barrick add to its portfolio of copper-gold deposits going forward.
TGR: What’s going on in Guyana with copper-gold porphyry deposits? The country has established resources. Are companies like Guyana Goldfields Inc. (GUY:TSX) and Sandspring Resources Ltd. (SSP:TSX.V) on the radar of companies like Barrick?
DG: Guyana Goldfields probably is on the radar as an acquisition candidate. Guyana Goldfields is currently working toward completion of a feasibility study on the 6.9 Moz Aurora project, which is due to be complete in January 2012. The project is expected to profile 300,000 oz of annual production with a life of mine operating cost of $400/oz. The company plans to begin construction on the project in Q112, which is expected to cost $375M.
TGR: If Guyana Goldfields gets up and running, doesn’t that increase Sandspring’s value because it’s not far away?
DG: I think it will have the effect of validating the ability to construct within Guyana successfully and overcome some challenging logistics. Sandspring’s Toro Paru is now moving toward completing a prefeasability study. Through that process the company will continue to refine the amount of capital investment that is going to be required and what kind of returns on a per-ton basis it can expect to generate. It has to refine project economics through more detailed engineering that will provide some comfort that the capex of $637M is indeed the right number. The present valuation on Sandspring, while inviting, does reflect a market awareness of these risks.
TGR: How do you recommend investors play these takeover targets?
DG: Every company is unique. Every deposit is unique. Investors want to focus high-grade deposits that are valued exponentially higher by acquirers because of the margins they tend to generate. While these ounces in the ground appear to trade at premium valuations in the market, they are still some of the best risk-adjusted values in our Select Golds screen.
Investors should also want to be looking at situations where there’s a high propensity to double or triple the existing resource that’s in place. It may be that the target company is focused on engineering instead of exploration and it’s leaving all that value on the table for someone else down the road. The acquiring company recognizes it as being an opportunity and is able to afford to pay a larger premium on the front end knowing that value is going to get backfilled amply with new discovery and additional ounces on that resource itself.
TGR: Thanks for sharing your thoughts with us.
David Goguen focuses on the mining sector at PI Financial Corp. as director, institutional mining sales. Goguen’s focus includes Select Golds—advanced, exploration, emerging producers and junior producers. Goguen earned a bachelor’s in economics from Carleton University and holds the Chartered Financial Analyst designation.
By Bron Suchecki, on October 31st, 2011
Shall we count how many bloggers pick up on this news item Chinese silver imports decline 39% y/y; exports tumble 44% y/y:
Silver imports in China fell by 39% y/y and 16% m/m to 264.7 tonnes, the lowest level since February, while silver exports declined by 44% y/y to 83.5 tonnes, keeping China a net importer of the metal for two consecutive years on a monthly basis.
On a product basis, silver powder, unwrought silver, semi-manufactured silver, and silver jewelery all declined y/y in September with the latter two products suffering the steepest decline and silver powder only falling by 4% y/y. Indeed, silver powder is the only product that has grown for the year-to-date.
And from the “Chinese love paper more than physical” department, see China’s gold frenzy gives birth to small bourses:
The emerging exchanges offer a lot size as small as one ounce, which lowers the capital needed to begin trading, even though the margin requirements can be as high as 30 percent. With lot size set at 10 ounces and margins at 20 percent, the initial capital requirement to start trading is about half the amount required by the SGE.
Emerging exchanges claim to trade physical gold, but most investors are not interested in taking physical delivery. Some exchanges make it difficult and expensive to take delivery. …
“Who would want to take physical gold? People just want to speculate on price moves and make a profit,” said a customer service representative at the exchange who gave her last name as Chen.
Analysts compared the gold investment spree to the wave of retail stock market investors in the last decade, who rushed to a bull market with little know-how, only to suffer huge losses during later market turbulence. …
Although China’s central government has vowed to open up the market, and has made progress by allowing more foreign banks access to the two Shanghai exchanges, an open market for retail investors is yet to take shape. …
But it was unlikely to happen as long as the country’s foreign currency exchange remains tightly controlled. Until foreign exchange controls are lifted, Chinese gold bugs would continue to need tables to put down their bets. “The Chinese love gambling,” said Hou.
Doesn’t sound like China’s exchanges are any different from COMEX. If the Chinese Government wanted its people to buy physical gold you’d think all this paper gold would be shut down. I suppose we will have to wait until the much hyped PAGE is up and running [sarcasm]. 
By The Energy Report, on October 28th, 2011
 Headlines scream gloom and doom, but Vikas Ranjan of Ubika Research sees brilliance on the horizon. As emerging markets develop, opportunities for profit abound: it’s only a matter of identifying the most in-demand commodities. Meanwhile, cleantech companies are creating commercial solutions to keep the lights on and the water flowing. In this exclusive interview with The Energy Report, Vikas discusses the new Ubika Mining 30 Index and some companies ready to feed the need.
The Energy Report: Vikas, Ubika Research launched its Mining 30 Index on October 1, during a time of less-than-robust projections for the global economy. Why commodities, and why now?
Vikas Ranjan: It is true that in the short term, the global economy does look sluggish. However, we are very optimistic about the longer-term health of the global economy, especially the emerging markets. Countries like China, India, Brazil, South Africa, Russia, Indonesia and Vietnam will continue to grow at a robust pace. Commodities are a big part of that growth story. At this stage, a slight economic downturn creates an opportunity to spot undervalued assets.
TER: How did you choose which commodities to focus on?
VR: Because our investment thesis concerns broad-based growth in emerging markets, we looked for commodities that are used in a range of industries. We asked ourselves what particular emerging markets will need the most in the next five to 10 years and which commodities will meet those requirements. Base metals like copper, nickel and zinc address the need to expand infrastructure, and agricultural commodities like potash and phosphate are key to feeding an increasing population.
TER: About 19% of the index is coal companies. Why did you allocate such a large percentage of the index to an energy source that governments are increasingly trying to phase out?
VR: Coal is going to be in use for a long, long time. More than two-thirds of the world’s energy still comes from coal. China sources 80% of its energy from coal, as does India. In fact, the largest market cap company in India is Coal India Ltd. (COALINDIA:NSE), which went public about a year ago. In the next five to 10 years I don’t see any energy source coming close to coal. Beyond electricity generation, coal is also used to produce steel. Coal may be phased out in the future, but that future is far, far away.
TER: Could the Ubika Mining 30 Index serve as an indicator of global economic health, similar to copper, the so-called barometer of global markets?
VR: Copper will still play its role as an early indicator, a bellwether, for the direction of the global economy. There really is no substitute. However, a broader index, like the Ubika Mining 30, may provide a more decisive indication of the health of the economy, though it may take time for its performance to reflect what is happening in the global economy.
TER: Since its launch, the Ubika Mining 30 is up roughly 12%. Which companies on the index do you believe will continue to outperform the broader market?
VR: All 30 companies are highly prospective, with solid fundamentals and strong management. We’re pretty optimistic about most of them. Of course, we will keep a close eye on their performance and make changes as needed.
Having said that, we have more in-depth research on a few of them: Allana Potash Corp. (AAA:TSX; ALLRF:OTCQX), Rodinia Lithium Inc. (RM:TSX.V; RDNAF:OTCQX), Glen Eagle Resources Inc. (GER:TSX.V) and Champion Minerals Inc. (CHM:TSX).
TER: As of June 20, you had a model price of US$2.56 on Allana Potash. At that time, the company had about US$60 million (M) in cash. How much does the company have now, and will it be enough to carry it through the bankable feasibility study?
VR: Allana is our top pick in the junior potash exploration field. It has a strong prospect for a potash mine in Ethiopia.
Its price has come down quite a bit; it’s now trading at US$1.02. This is what happens when expectations run ahead and when markets in general tumble, causing more high-profile stocks like Allana’s to get impacted negatively. But we will stay by our model price. The resource estimate far exceeded our expectations. It has more than 1 billion tons (Bt) of potash resource at its projects, most of it in the measured and indicated (M&I) category. We think that Allana has close to US$50M in the bank, and it’s fully funded to move forward with a bankable feasibility study. If anything, Allana is less risky than it was 18 months ago.
TER: In your research report, you note the possibility of a takeover. Do you expect that to happen before the bankable feasibility study or after?
VR: At current levels, I suspect Allana would probably not consider a takeover offer because the price does not reflect its true value. I think it will continue to build value in its assets and its share price will reflect that.
After the bankable feasibility study, once the value of those deposits are proven, bigger players will start to show serious interest in Allana’s exploitable potash.
TER: Let’s move on to Rodinia Lithium. Its flagship project is the Salar de Diablillos Project in Argentina. Rodinia recently had positive brine processing reports, yet the stock, which is trading at US$0.21, didn’t move at all. Why is that?
VR: Lithium is a little out of favor right now. Although it has other uses, lithium’s major role is in electric vehicle batteries. Demand is generally down now, and this is reflected in lithium exploration stocks. General economic conditions have also impacted stock valuations.
Rodinia is moving ahead. It has been getting very good exploration results and has had some good results on the processing side. We believe in Rodinia’s prospects; it has good projects and a good management team. The company is focused on its Argentinean project right now, but it also has land in the U.S. The stock will likely bounce back once the general sector regains strength.
Another advantage for the company is the strategic investment from Shanshan, China’s largest lithium-ion battery materials provider. It shows that the company is attracting right type of interest. Rodinia has a good technical team with previous experience in lithium projects and process development. So we remain optimistic about Rodinia’s prospects.
TER: There are quite a few salars in that region of Argentina, and other companies are working on brine projects there. Do you foresee consolidation?
VR: I would assume so. That is typically what happens when junior companies like Rodinia develop these assets. It’s much less likely that it will produce the deposits. If a company has built a good deposit base, has moved the project along and advanced it, it will have better chances of attracting outside interest. Rodinia is in the right place, in one of the most prolific belts for lithium deposits.
TER: Glen Eagle Resources has several projects based in Québec, Canada; a very safe jurisdiction.
VR: We’re very excited about Glen Eagle. The company is focused on phosphate. It also has a reserve on a lithium project next to Canada Lithium Corp. (CLQ:TSX; CLQMF:OTCQX).
Glen Eagle recently announced an option agreement to acquire 100% of the Moose Lake phosphate property. It’s immediately adjacent to a phosphate property called Mirepoix, which is controlled by Arianne Resources Inc. (DAN:TSX.V; DRRSF:OTCBB; JE9N:Fkft). A grab sampling and initial work were very promising. Glen Eagle is currently developing its Lac Lisette phosphate project. It is presently drilling on it. The Lac Lisette property is 40 km away from Arianne Resources’ Lac à Paul property, and shares the same main road.
Phosphate, like potash, has tremendous use in agriculture and is in high demand. Glen Eagle is very undervalued because not many people know about that resource. Its market cap is about US$18–20M. Right next door, Arianne Resources is roughly a US$140–150M market cap company. We see Glen Eagle closing that valuation gap once it starts to prove up the deposit. We have a model price of US$0.96 on that stock. It trades at about US$0.43. We started covering Glen Eagle when it was about US$0.30.
TER: The last company you mentioned is Champion Minerals. That’s trading at about US$1.25. What’s your model price for that one?
VR: We don’t have a model price, because Champion Minerals isn’t part of our in-depth research. We had it as a stock-watch list pick.
This is an iron-ore exploration company with some very good properties in the Labrador/Québec area. It has been getting some really good results and management is good. They’re in a very prospective area for iron ore exploration, near other majors and prospective companies. For example, Consolidated Thompson Iron Mines Ltd. (CLM:TSX) acquired Quinto Mining Corp., which had properties next to Champion Minerals’ property. We feel this project could be a prospective inclusion candidate.
TER: You also operate the Ubika Cleantech 30 Index. As of December 31, 2010, the combined market cap of the companies on that index was US$7.8B. By October 14, 2011, the value had fallen to US$5.8B. Why is this sector underperforming?
VR: It has been a rough year for cleantech. Our index has fallen along with other benchmark indexes, in similar proportions or even more, for various reasons. Most of the companies in our index are very early-stage companies. Most have no revenue because they are at a pre-commercial stage, and they fluctuate more widely. It’s a classic case of market euphoria and high expectations taking hold and running ahead of fundamentals.
Cleantech is a very broad sector, so not everything is performing badly. The energy side of it, such as solar and wind, has not proven to be as commercially viable as anticipated. Investors are getting disillusioned, wondering if these companies will become commercial. It’s a classic research-and-development (R&D) situation. Some of these companies come out well, but many will fall by the wayside. It hasn’t helped that there have been some high-profile failures.
TER: Has Solyndra’s bankruptcy hurt the credibility of the renewable energy/cleantech sector as a whole?
VR: It has tarnished the industry. It was certainly not good for the cleantech sector. It also shows you that it is risky for the government to get too involved, for example, in selecting prospective winners or losers in a sector that is still at such an early stage. The better approach is to provide a conducive environment, one that spurs more innovation and R&D, but that ultimately lets the market decide.
TER: What’s your outlook for the sector?
VR: Winners will emerge. Investors are looking for companies that can solve a particular problem countries face, especially emerging countries. Examples are companies that have solutions for water pollution, for helping countries improve the livelihood of their population.
TER: Which companies fit this description?
VR: Westport Innovations Inc. (WPT:TSX) is developing fuel technology to reduce emissions by reconfiguring diesel engines to use compressed natural gas (CNG) or liquefied natural gas. That is an example of a company with clean technology that is both retrofitting and allowing new commercial vehicles to use CNG-based engines. Natural gas is still a fossil fuel, but it’s a lot cleaner than, say, diesel. In the last year or so, Westport’s stock has gone up 40%–45%. It’s a good example of a commercial company with rapidly rising revenue that will continue to do well.
Clearford Industries Inc. (CLI:TSX.V) is another example. The company developed a patent for a small-bore sewer system. Centralized sewage systems push everything to a single location for treatment. These centralized systems place heavy demand on water, and they are inefficient and costly for emerging countries like India, China and Peru.
Clearford developed a solution that treats sewage in a localized environment, suitable for a small community or a collection of small communities. It has anchored its technology in India, where it won a major contract with a large real estate developer that will use the technology for a development of something like 6,000-plus houses or apartments. Once Clearford gets that commercial proof, it should do very well. Getting the first contract under the belt is the biggest challenge. On August 11, 2011, Clearford announced that it has signed a memorandum of intention with Engineers India Ltd., a major engineering consulting firm owned by the Indian government, to jointly pursue projects using Clearford technology in India. This clears the path for the company’s growth among municipalities and cities.
TER: Any others?
VR: I still like H2O Innovation Inc. (HEO:TSX.V), a major player in Canada’s water treatment industry. It designs and produces environmentally friendly water treatment systems, especially for wastewater and industrial processed water. It has been performing relatively well even in the downturn. This is one of the fastest-growing companies in Canada. Its revenue has grown through acquisition, and it has a client base of over 500 installations worldwide. This is a good example of a commercial company solving a real problem.
TER: Do you have any parting thoughts for us?
VR: I would conclude by saying that we don’t believe the global economy is dipping into a double-dip recession, which was a major concern in the summer and early fall. We believe the markets made their lows for the year in August, and we see better times ahead. Yes, there is a slowdown, and developed countries are struggling, but the growth story in emerging markets is intact.
TER: Excellent. Thank you.
Vikas Ranjan, a principal of Ubika Research, has over 15 years’ experience in investment management, finance, customer analytics and research. His experience includes management positions with TAL Global Asset Management and Bank of Montreal. He holds a Bachelor of Arts in economics, a Master of management studies from University of Mumbai, and a Master of Business Administration in finance from McGill University. Vikas co-founded P2P Systems Inc., which was acquired by Microforum Inc.
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By The Energy Report, on October 26th, 2011
 Lithium continues to be in high demand as battery application growth outpaces the economy. In this exclusive interview with The Energy Report, Jonathan Lee of Byron Capital calls on his engineering and manufacturing background to explain the factors shaping the evolution of this growing market. He also brings us up to date on several promising companies blazing trails in the lithium industry.
The Energy Report: Thank you for joining us this afternoon, Jonathan. You have a technical background in engineering and manufacturing in addition to your experience as an analyst. This gives you a unique perspective in evaluating investment opportunities. What do you look for specifically in a lithium company?
Jonathan Lee: Numerous factors. Our strategy is to find low-cost producers within a sector. Then from a capital cost side, it’s always more beneficial to have a lower capital cost to get a better return on equity and make the project more feasible. We like to have low capital expenditures and operating expenditures. Beyond that, it really comes down to valuing the company and trying to make sure that the equity is purchased at the right price. The two major factors that contribute to a better return on equity are good assets and low costs.
TER: Are you looking across the broad spectrum of levels of development, from prospectors to companies that are already producers? Or do you narrow it down to more advanced companies?
JL: We look at everything from exploration to producing companies. When we look at producing companies, a lot of times there is less technological risk or execution risk involved. At the earlier stage, there’s a lot more risk entailed in proving out the deposit, proving up a resource and gathering more metallurgical information, etc. Earlier-stage companies usually are valued less and have the potential of higher returns but also entail more risk.
TER: Lithium has been a hot topic in the past several years. For those readers who are not all that familiar with it, can you give us a little background on the metal, its uses and what people should be looking at when considering lithium investments?
JL: Lithium is a metal that’s used in a slew of different products. Batteries are a big percentage of it, roughly 25%-30% of production. Glass and ceramics are also a big usage because it lowers the heating temperature, which saves energy. It’s also used in lubricants and castings. A variety of products utilize the element, but these end users make up the majority.
TER: Is battery usage growing faster than other applications?
JL: Yes. Although penetration into automobiles is not great as of yet, there is significant growth in consumer applications for lithium-ion batteries, and you’re seeing that growth year over year. We think that’s going to continue to grow as things get switched over from, say, nickel-metal hydride rechargeable batteries to lithium-ion batteries in consumer electronics.
TER: With all the market turmoil that we’ve had here since you last spoke with us back in April, can you bring us up to date on what’s been happening in the battery materials industry in the past six months? Have there been any major changes?
JL: There are only four major lithium producers. Chemetall and FMC Lithium Corporation (FMC:NYSE) publicly stated in July that they were raising their prices, partly because of increased demand. That definitely helped out along with rising raw materials prices. Soda ash (sodium carbonate) has increased dramatically, thereby increasing the cost to produce lithium carbonate. Because demand is still strong, they’ve been able to raise prices and pass on those extra costs to customers. If you look at companies like Talison Lithium Ltd. (TLH:TSX), which we currently cover and have a Buy recommendation on—it is also selling at capacity. You’re likely to see FMC increase its capacity by 30% next year. So the overall strength of the market is definitely there in the short term. We believe producing companies, such as Talison, will be able to take advantage of that market demand.
TER: Has anything happened recently on the technical front to affect the lithium market in either a positive or negative way?
JL: As kind of a leading indicator of where the market is going, you can look at the amount of money that a company is going to spend on new lithium-ion plants. GS Yuasa Corp. (TYO:6674) is increasing the capacity of its plant. It’s spending roughly $300M on that plant. When it’s up and running in 2014, that will be a significant buyer of lithium for batteries. Panasonic, although it’s scrapping its plant in Japan, is also expanding in China. More and more battery producers are increasing capacity, and that’s a clear signal of where we think the market is going.
TER: A number of companies are mining lithium deposits, mainly in South America, but also in Canada. Do you foresee a supply glut in the market?
JL: Most of the mining companies could come into production within the next year. Demand should increase in step with supply. Talison is increasing its production as is FMC. The markets have a pretty good way of clearing out producers that aren’t able to compete. That is why locating potential low-cost producers is part of our investment strategy. Just like any other market or mining sector, not all exploration juniors make it to production. We try to find those companies that will be in the lower quartile of relative production costs.
TER: You mentioned that a couple of the major producers raised prices. Is lithium mainly a negotiated or supplier price-based market rather than one driven by investment demand?
JL: Yes, it’s mainly supplier-price based. It’s sold over the counter, and we doubt there is going to be any type of LME (London Metal Exchange). It’s not going to be an exchange-traded material because customers have specific criteria for batteries on the chemical side as well as the physical side. A lot of the juniors that we cover are working with trading or industrial companies or even an end user like the Argonne National Laboratory, which has an agreement with Western Lithium USA Corp. (WLC:TSX; WLCDF:OTCQX). Determining the physical and chemical characteristics of lithium products will be based on customers’ needs. Because each customer has different needs, we think that it will remain a negotiated market, and people will pay different prices for different chemical and physical characteristics.
TER: Back in April, you told us about the four major companies that dominate the market, which are Sociedad Química y Minera de Chile S.A. (SQM:NYSE; SQM-B:SSX; SQM-A) a Chilean company; FMC Lithium Corp.; Chemetall, a unit of Rockwood Holdings, Inc. (ROC:NYSE); and Talison. What are the prospects for smaller companies now entering the market?
JL: Recently, demand has been strong and the majors are expanding. But we believe there will be space for companies to enter the market because the four majors will, at some point, max out on capacity. We think there is space for some of the juniors. In the short or medium term, you may see companies that have strategic investors who may pay up for the security of having that supply in an offtake agreement. If one of those strategic investors makes a more substantial equity investment in the near future, we think that shows that the customers are more worried about the security of supply rather than price. And that could bode well for some of these juniors.
TER: You’ve done some research reports recently on Talison Lithium, Lithium One Inc. (LI:TSX.V) and also Western Lithium. Of course, Talison is one of the majors. What can you tell us about Lithium One and Western Lithium, which are not in that category?
JL: Lithium One is a junior brine exploration company in Argentina. It just released its preliminary economic assessment (PEA), which showed positive economics. It showed it could be a low-cost producer of lithium as well as potash. Its estimated production includes a substantial amount of potash, which, on the byproduct credit basis, significantly reduces the cost of lithium production. It’s similar to the model that SQM uses in Chile, where it has potassium and lithium co-products that make for positive economics. We think it’s definitely tangible given that its salar looks very much like FMC’s salar.
On Western Lithium’s front, it signed up with the Argonne National Laboratory to collaborate and work on creating better lithium products. Because lithium is a non-commodity with respect to its chemical and physical characteristics, having that knowledge of what its customers want is a significant turn of events.
TER: How close are these companies to production?
JL: Most of them are at least a few years away from production. I guess the closest one out of the brine projects would potentially be Orocobre Ltd. (ORL:TSX; ORE:ASX). It’s in negotiations with Toyota Tsusho Group (TYHOF:OTCPK) to finalize its offtake and strategic investment. Even after that is done, you still have to construct the mine, pump brine into the ponds and evaporate it for at least a year. So you are looking at a timeframe of at least two to three years to production. I think it would be one of the earliest companies to come to production. Most of them are fairly far off.
TER: What kind of capital costs are associated with putting these operations into production?
JL: It really depends on the size, but a lot of their economic assessments have come in roughly between $200-$360M, ranging in size from 15,000-25,000 tons. And those estimates seem fairly reasonable. Financing is going to be one of the risks for companies getting projects up and running. Mining is a capital-intensive business.
TER: Are there any other lithium development names that you think are worth considering at this point?
JL: The other two names that we cover are Lithium Americas Corp. (LAC:TSX; LHMAF:OTCQX) and Rodinia Lithium Inc. (RM:TSX.V; RDNAF:OTCQX). Lithium Americas has a strong management team with a property adjacent to Orocobre with very similar brine chemistry, and it already has strategic partners in Magna International Inc. and the Mitsubishi Corporation. Rodinia has a brine project in Argentina, which is highly prospective. It should have its PEA released within this quarter. That should bode well for it and prove up its economics as well.
TER: How would you summarize your reading on the lithium business at this point?
JL: I think the lithium business is strong. I’m seeing strong growth in the near term. With the consumption of lithium in consumer batteries, you’ll see substantial growth, especially with the implementation of transportation vehicles. Companies are committing hundreds of millions of dollars in capital to build these plants. We think that’s a leading indicator of where demand is heading.
TER: As far as you are aware, is anyone developing any competing technology?
JL: No. When you look at where lithium is on the periodic table, it’s on the top left, so it’s the cathode of choice because of its energy density.
TER: It looks like lithium is here to stay for the foreseeable future.
JL: We believe so as well.
TER: Very good. We appreciate the update and your current thoughts. Thanks for talking with us today.
JL: Thank you.
Jonathan Lee is a battery materials and technologies analyst with Byron Capital Markets in Toronto. As a member of Byron’s research department, Lee’s primary focus is on the battery materials sectors, which includes lithium, vanadium and cobalt.
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